**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**








**FORM
      10-Q**








**QUARTERLY
      REPORT**


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


**THE
      SECURITIES EXCHANGE ACT OF 1934**





**For
      the quarterly period ended February 28, 2007**


**Commission
      file number 0-5905**








**CHATTEM,
      INC.**


**A
      TENNESSEE CORPORATION**


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


**1715
      WEST 38TH STREET**


**CHATTANOOGA,
      TENNESSEE 37409**


**TELEPHONE:  423-821-4571**











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




**YES**þ**NO**o





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





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


********





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




**YES**o**NO**þ





**As
      of March 26, 2007, 18,976,365shares of the
      Company’s common stock, without par value, were
      outstanding.**











**CHATTEM,
      INC.**





**INDEX**
















PAGE
                  NO.**PART
                I.  FINANCIAL INFORMATION**Item
                  1.  Financial StatementsConsolidated
                  Balance Sheets as of February 28, 2007 andNovember
                  30, 2006
              3Consolidated
                  Statements of Income for the ThreeMonths
                  Ended February 28, 2007 and February 28, 2006
              5Consolidated
                  Statements of Cash Flows for the Three MonthsEnded
                  February 28, 2007 and February 28, 2006
              6Notes
                  to Consolidated Financial Statements
              7Item
                  2.  Management’s
                  Discussion
                  and Analysis of Financial Conditionand
                  Results of Operations
              27Item
                  3.  Quantitative and Qualitative Disclosures About Market
                  Risk
              36Item
                  4.  Controls and Procedures
              36**PART
                  II.  OTHER INFORMATION**Item
                  1. Legal Proceedings
              37Item
                  1A. Risk Factors
              37Item
                  2. Unregistered Sales of Equity Securities and Use of
                  Proceeds
              37Item
                  3. Defaults Upon Senior Securities
              37Item
                  4. Submission of Matters to a Vote of Security Holders
              37Item
                  5. Other Information
              37Item
                  6. Exhibits
              38**SIGNATURES**
              39




2


**PART
      1. FINANCIAL INFORMATION**








**Item
      1. Financial Statements**








**CHATTEM,
      INC. AND SUBSIDIARIES**





**CONSOLIDATED
      BALANCE SHEETS**


(In
      thousands)





ASSETS
                  
                  FEBRUARY
                      28,
                    2007
                  
                  
                  NOVEMBER
                      30,
                    2006(Unaudited)CURRENT
                      ASSETS:Cash
                      and cash equivalents
                  
                  $
                  15,749
                  
                  
                  $
                  90,527Accounts
                      receivable, less allowances of $11,793 at
                    February
                      28, 2007 and $10,907 at November 30, 2006
                  
                  
                  52,805
                  
                  
                  
                  29,595Other
                      receivables
                  
                  
                  259
                  
                  
                  
                  257Inventories
                  
                  
                  37,570
                  
                  
                  
                  31,389Refundable
                      income taxes
                  
                  
                  2,817
                  
                  
                  
                  —Deferred
                      income taxes
                  
                  
                  4,221
                  
                  
                  
                  4,341Prepaid
                      expenses and other current assets
                  
                  
                  4,167
                  
                  
                  
                  5,857Total
                      current assets
                  
                  
                  117,588
                  
                  
                  
                  161,966PROPERTY,
                      PLANT AND EQUIPMENT, NET
                  
                  
                  30,168
                  
                  
                  
                  30,353OTHER
                      NONCURRENT ASSETS:Patents,
                      trademarks and other purchased product rights, net
                  
                  
                  613,029
                  
                  
                  
                  206,149Debt
                      issuance costs, net
                  
                  
                  16,890
                  
                  
                  
                  11,399Other
                  
                  
                  6,067
                  
                  
                  
                  5,446Total
                      other noncurrent assets
                  
                  
                  635,986
                  
                  
                  
                  222,994TOTAL
                      ASSETS
                  
                  $
                  783,742
                  
                  
                  $
                  415,313







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


3


**CHATTEM,
      INC. AND SUBSIDIARIES**





**CONSOLIDATED
      BALANCE SHEETS**


(In
      thousands)








LIABILITIES
                      AND SHAREHOLDERS’ EQUITY
                  
                  FEBRUARY
                      28,
                    2007
                  
                  
                  NOVEMBER
                      30,
                    2006(Unaudited)CURRENT
                      LIABILITIES:Current
                      maturities of long-term debt
                  
                  $
                  3,000
                  
                  
                  $
                  —Accounts
                      payable and other
                  
                  
                  15,758
                  
                  
                  
                  9,948Bank
                      overdraft
                  
                  
                  2,105
                  
                  
                  
                  5,824Accrued
                      liabilities
                  
                  
                  22,827
                  
                  
                  
                  11,805Total
                      current liabilities
                  
                  
                  43,690
                  
                  
                  
                  27,577LONG-TERM
                      DEBT, less current maturities
                  
                  
                  559,500
                  
                  
                  
                  232,500DEFERRED
                      INCOME TAXES
                  
                  
                  20,905
                  
                  
                  
                  17,668OTHER
                      NONCURRENT LIABILITIES
                  
                  
                  1,589
                  
                  
                  
                  1,987COMMITMENTS
                      AND CONTINGENCIES (Note 19)SHAREHOLDERS’
                      EQUITY:Preferred
                      shares, without par value, authorized 1,000,
                    none
                      issued
                  
                  
                  —
                  
                  
                  
                  —Common
                      shares, without par value, authorized 100,000,
                    issued
                      and outstanding 18,965 at February 28, 2007 and
                    18,669
                      at November 30, 2006
                  
                  
                  39,016
                  
                  
                  
                  30,452Retained
                      earnings
                  
                  
                  119,615
                  
                  
                  
                  105,965158,631
                  
                  
                  
                  136,417Cumulative
                      other comprehensive income, net of tax:Interest
                      rate cap adjustment
                  
                  
                  (263
                  )
                  
                  
                  (597
                  )Foreign
                      currency translation adjustment
                  
                  
                  (310
                  )
                  
                  
                  (239
                  )Total
                      shareholders’ equity
                  
                  
                  158,058
                  
                  
                  
                  135,581TOTAL
                      LIABILITIES AND SHAREHOLDERS’
                    EQUITY
                  
                  $
                  783,742
                  
                  
                  $
                  415,313










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




4


**CHATTEM,
      INC. AND SUBSIDIARIES**





**CONSOLIDATED
      STATEMENTS OF INCOME**


(Unaudited
      and in thousands, except per share amounts)


FOR
                      THE THREE MONTHS ENDEDFEBRUARY
                      28,
                  
                  
                  FEBRUARY
                      28,2007
                  
                  
                  2006TOTAL
                      REVENUES:Net
                      sales
                  
                  $
                  100,779
                  
                  
                  $
                  83,977Royalties
                  
                  
                  52
                  
                  
                  
                  47Total
                      revenues
                  
                  
                  100,831
                  
                  
                  
                  84,024COSTS
                      AND EXPENSES:Cost
                      of sales
                  
                  
                  30,980
                  
                  
                  
                  26,020Advertising
                      and promotion
                  
                  
                  28,787
                  
                  
                  
                  27,187Selling,
                      general and administrative
                  
                  
                  12,586
                  
                  
                  
                  11,591Acquisition
                      expenses
                  
                  
                  1,171
                  
                  
                  
                  —Litigation
                      settlement
                  
                  
                  —
                  
                  
                  
                  (8,613
                  )Total
                      costs and expenses
                  
                  
                  73,524
                  
                  
                  
                  56,185INCOME
                      FROM OPERATIONS
                  
                  
                  27,307
                  
                  
                  
                  27,839OTHER
                      INCOME (EXPENSE):Interest
                      expense
                  
                  
                  (7,236
                  )
                  
                  
                  (2,844
                  )Investment
                      and other income, net
                  
                  
                  768
                  
                  
                  
                  194Loss
                      on early extinguishment of debt
                  
                  
                  —
                  
                  
                  
                  (2,805
                  )Total
                      other income (expense)
                  
                  
                  (6,468
                  )
                  
                  
                  (5,455
                  )INCOME
                      BEFORE INCOME TAXES
                  
                  
                  20,839
                  
                  
                  
                  22,384PROVISION
                      FOR INCOME TAXES
                  
                  
                  7,189
                  
                  
                  
                  7,611NET
                      INCOME
                  
                  $
                  13,650
                  
                  
                  $
                  14,773NUMBER
                      OF COMMON SHARES:
                    Weighted
                      average outstanding - basic
                  
                  
                  18,657
                  
                  
                  
                  19,553Weighted
                      average and potential dilutive outstanding
                  
                  
                  19,224
                  
                  
                  
                  19,577NET
                      INCOME  PER COMMON SHARE:Basic
                  
                  $
                  .73
                  
                  
                  $
                  .76Diluted
                  
                  $
                  .71
                  
                  
                  $
                  .75





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


5


**CHATTEM,
      INC. AND SUBSIDIARIES**





**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


(Unaudited
      and in thousands, except per share amount)





FOR
                    THE THREE MONTHS ENDEDFEBRUARY
                    28,
                  2007
                
                
                FEBRUARY
                    28,
                  2006OPERATING
                    ACTIVITIES:Net
                    income
                
                $
                13,650
                
                
                $
                14,773Adjustments
                    to reconcile net income to net cash provided by
                  operating
                    activities:Depreciation
                    and amortization
                
                
                2,029
                
                
                
                1,425Deferred
                    income taxes
                
                
                2,794
                
                
                
                239Tax
                    benefit realized from stock options
                
                
                (3,013
                )
                
                
                (309
                )Stock–based
                    compensation expense
                
                
                1,204
                
                
                
                852Loss
                    on early extinguishment of debt
                
                
                —
                
                
                
                2,805Other,
                    net
                
                
                124
                
                
                
                66Changes
                    in operating assets and liabilities, net of effects from
                    acquisitions:Accounts
                    receivable and other
                
                
                (23,212
                )
                
                
                (14,466
                )Inventories
                
                
                358
                
                
                
                (1,644
                )Refundable
                    income taxes
                
                
                196
                
                
                
                1,516Prepaid
                    expenses and other current assets
                
                
                680
                
                
                
                652Accounts
                    payable and accrued liabilities
                
                
                15,127
                
                
                
                (183
                )Net
                    cash provided by operating activities
                
                
                9,937
                
                
                
                5,726INVESTING
                    ACTIVITIES:Purchases
                    of property, plant and equipment
                
                
                (453
                )
                
                
                (1,276
                )Acquisition
                    of brands
                
                
                (411,888
                )
                
                
                —Increase
                    in other assets, net
                
                
                (26
                )
                
                
                (611
                )Net
                    cash used in investing activities
                
                
                (412,367
                )
                
                
                (1,887
                )FINANCING
                    ACTIVITIES:Repayment
                    of long-term debt
                
                
                —
                
                
                
                (75,000
                )Proceeds
                    from long-term debt
                
                
                300,000
                
                
                
                —Proceeds
                    from borrowings under revolving credit facility
                
                
                39,000
                
                
                
                43,000Repayments
                    of revolving credit facility
                
                
                (9,000
                )
                
                
                —Bank
                    overdraft
                
                
                (3,719
                )
                
                
                2,979Proceeds
                    from exercise of stock options
                
                
                4,457
                
                
                
                311Repurchase
                    of common shares
                
                
                —
                
                
                
                (10,130
                )Increase
                    in debt issuance costs
                
                
                (6,079
                )
                
                
                (15
                )Debt
                    retirement costs
                
                
                —
                
                
                
                (1,501
                )Tax
                    benefit realized from stock options
                
                
                3,013
                
                
                
                309Net
                    cash provided by (used in) financing activities
                
                
                327,672
                
                
                
                (40,047
                )EFFECT
                    OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
                
                
                (20
                )
                
                
                (15
                )CASH
                    AND CASH EQUIVALENTS:Decrease
                    for the period
                
                
                (74,778
                )
                
                
                (36,223
                )At
                    beginning of period
                
                
                90,527
                
                
                
                47,327At
                    end of period
                
                $
                15,749
                
                
                $
                11,104PAYMENTS
                    FOR:Interest
                
                $
                688
                
                
                $
                1,793Taxes
                
                $
                4,787
                
                
                $
                1,045





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


6


**CHATTEM,
      INC.  AND SUBSIDIARIES**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Unaudited)**





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





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





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





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





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





**3.**
            **RECLASSIFICATIONS**





Certain
      prior year amounts have been reclassified to conform to the current period’s
      presentation.  The accrual for vendor allowances of $3,309 as of
      February 28, 2006, which was included as a component of accrued liabilities,
      has
      been reclassified as a reduction of accounts receivable.  The bank
      overdraft of $2,979 was included in cash and cash equivalents as of February
      28,
      2006 and has been reclassified as an increase to total current
      liablilities.





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





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





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





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





In
      September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined
      Benefit Pension and Other Postretirement Plans — An Amendment of FASB Statements
      No. 87, 88, 106, and 132R” (“SFAS 158”).  SFAS 158 requires an
      employer to recognize in its balance sheet an asset or liability for a
      plan’s funded status, measure a plan’s assets and obligations




7


as
      of the
      end of the employer’s fiscal year and recognize changes in the funded status in
      the year in which the changes occur.  SFAS 158 also enhances the
      current disclosure requirements for pension and other postretirement plans
      to
      include disclosure related to certain effects on net periodic benefit
      cost.  The requirement to recognize the funded status of a benefit
      plan and the disclosure requirements are effective as of the end of the fiscal
      year ending after December 15, 2006, or our fiscal 2007.  The
      requirement to measure plan assets and benefit obligations as of the employer’s
      fiscal year-end is effective for fiscal years ending after December 15, 2008,
      or
      our fiscal 2009.  We are evaluating the impact of adopting SFAS 158 on
      our consolidated financial statements.





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





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





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





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





In
      the
      first quarter of fiscal 2007, we recorded compensation expense related to stock
      options that reduced income from operations by $1,204, provision for income
      taxes by $415, net income by $789 and basic and diluted net income per share
      by
      $0.04.  The stock option compensation expense was included partly in
      advertising and promotion expenses and partly in selling, general and
      administrative expenses in the accompanying consolidated statement of
      income.  We capitalized $174 of stock option compensation cost as a
      component of the carrying cost of inventory on-hand as of February 28,
      2007.





There
      were no stock option grants during the three months ended February 28,
      2007.  The weighted average fair value of stock options at the date of
      grant during the three months ended February 28, 2006 was $13.03.  The
      fair value of each stock option grant was estimated on the date of grant using
      a
      Flex Lattice Model.  We used the following assumptions to determine
      the fair value of stock option grants during the three months ended February
      28,
      2006:




Three
                    Months Ended
                  February
                    28, 2006Expected
                    life
                4.6
                    yearsVolatility
                48%Risk-free
                    interest rate
                4.55%Dividend
                    yield
                0%Forfeitures
                0.9%





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


8


A
      summary
      of stock option activity for the three-months ended February 28, 2007 is
      presented below:





Shares
                      Under
                      Option
                    
                    
                    Weighted
                      Average
                      Exercise
                      Price
                    
                    
                    Weighted
                      Average
                      Remaining
                      Contractual
                      Life
                    
                    
                    Aggregate
                      Intrinsic
                        ValueOutstanding
                        at December 1, 2006
                    
                    
                    1,936
                    
                    
                    $
                    27.63Granted
                    
                    
                    —
                    
                    
                    
                    —Exercised
                    
                    
                    (294
                    )
                    
                    
                    15.16Cancelled
                    
                    
                    —
                    
                    
                    
                    —Outstanding
                        at February 28, 2007
                    
                    
                    1,642
                    
                    
                    $
                    29.87
                    
                    
                    5.8
                        years
                    
                    
                    $
                    40,038Exercisable
                        at February 28, 2007
                    
                    
                    936
                    
                    
                    $
                    29.63
                    
                    
                    5.6
                        years
                    
                    
                    $
                    23,042





The
      total
      fair value of stock options that vested during the three months ended February
      28, 2007 and 2006 was $1,215 and $1,004, respectively.  The total
      intrinsic value of stock options exercised during the three months ended
      February 28, 2007 and 2006 was $11,472 and $860, respectively.





As
      of
      February 28, 2007, we had $7,571 of unrecognized compensation cost related
      to
      stock options that will be recorded over a weighted average period of
      approximately two years.





We
      are
      also authorized to grant restricted shares of common stock to employees under
      our stock incentive plans that have been approved by
      shareholders.  The restricted shares under these plans meet the
      definition of “nonvested shares” in SFAS 123R.  The restricted shares
      generally vest over a four year service period commencing upon the date of
      grant.  The total fair market value of restricted shares on the date
      of grant is amortized to expense on a straight line basis over the four-year
      vesting period.  The amortization expense related to restricted shares
      during the three months ended February 28, 2007 and 2006 was $184 and $190,
      respectively.





Restricted
      share activity under the
      plans is summarized as follows:





Number
                    of  Shares
                
                
                Weighted
                    Average
                  Grant
                    Date Fair
                  ValueNonvested
                    at December 1, 2006
                
                
                37
                
                
                $
                26.45Granted
                
                
                —
                
                
                
                —Vested
                
                
                8
                
                
                
                21.13Forfeited
                
                
                —
                
                
                
                —Nonvested
                    at February 28, 2007
                
                
                29
                
                
                $
                28.04





9





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





The
      following table presents the computation of per share earnings for the three
      months ended February 28, 2007 and February 28, 2006,
      respectively:





2007
                
                
                2006NET
                    INCOME
                
                $
                13,650
                
                
                $
                14,773NUMBER
                    OF COMMON SHARES:Weighted
                    average outstanding
                
                
                18,657
                
                
                
                19,553Issued
                    upon assumed exercise of outstanding stock options
                
                
                549
                
                
                
                —Effect
                    of issuance of restricted common shares
                
                
                18
                
                
                
                24Weighted
                    average and potential dilutive outstanding (1)
                
                
                19,224
                
                
                
                19,577NET
                    INCOME PER COMMON SHARE:Basic
                
                $
                .73
                
                
                $
                .76Diluted
                
                $
                .71
                
                
                $
                .75





(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: 0 and 571 shares
      for the three months ended February 28, 2007 and 2006,
      respectively.





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





Long-term
      debt consisted of the following as of February 28, 2007 and November 30,
      2006:





2007
                
                
                2006Revolving
                    Credit Facility due 2010 at a variable rate
                    of 7.35%  and 8.25% as of February 28, 2007 and
                    November 30, 2006, respectively
                
                $
                30,000
                
                
                $
                —2.0%
                    Convertible Senior Notes due 2013
                
                
                125,000
                
                
                
                125,000Term
                    Loan due 2013 at a variable rate of 7.11% as of February 28,
                    2007
                
                
                300,000
                
                
                
                —7.0%
                    Senior Subordinated Notes due 2014
                
                
                107,500
                
                
                
                107,500Total
                    long-term debt
                
                
                562,500
                
                
                
                232,500Less:  current
                    maturities
                
                
                3,000
                
                
                
                —Total
                    long-term debt, net of current maturities
                
                $
                559,500
                
                
                $
                232,500





On
      February 26, 2004, we entered into a new Senior Secured Revolving Credit
      Facility with a maturity date of February 26, 2009 (the “Revolving Credit
      Facility”) with Bank of America, N.A. that provided an initial borrowing
      capacity of $25,000 and an additional $25,000, subject to successful
      syndication.  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 enabled us to borrow up to a total of $50,000 under the Revolving
      Credit Facility and an additional $50,000, subject to successful
      syndication.  On November 29, 2005, we entered into an amendment to
      our Revolving Credit Facility (the “Amended Revolving Credit Facility”) that,
      among other things, increased our borrowing capacity under the facility from
      $50,000 to $100,000, increased our flexibility to repurchase shares of our
      stock, improved our borrowing rate under the facility and extended the maturity
      date to November 15, 2010.  Upon successful syndication, we were able
      to increase the borrowing capacity under the Amended Revolving Credit Facility
      by $50,000 to an aggregate of $150,000.  On November 16, 2006, we
      entered into an amendment to our Amended Revolving Credit Facility that, among
      other things, permitted the sale of the 2.0% Convertible Senior Notes due
      2013.  On January 2, 2007, we completed an amended credit facility
      providing for up to a $100,000 revolving credit facility and a $300,000 term
      loan (the “Credit Facility”).  The proceeds from the term loan under
      the Credit Facility were used to finance in part the acquisition of the five
      consumer and OTC brands from Johnson & Johnson.  The Credit
      Facility includes an “accordion” feature that permits us under certain




10


circumstances
      to increase our borrowings under the revolving credit facility by $50,000 and
      to
      borrow an additional $50,000 as a term loan.





Borrowings
      under the revolving credit facility portion of our Credit Facility bear interest
      at LIBOR plus applicable percentages of 1.0% to 2.0% or the higher of the
      federal funds rate plus 0.5% or the prime rate (the “Base Rate”) plus applicable
      percentages up to 0.5%.  The applicable percentages are calculated
      based on our leverage ratio.  As of February 28, 2007 and November 30,
      2006, we had $30,000 and $0, respectively, of borrowings outstanding under
      the
      revolving credit facility portion of our Credit Facility.  As of March
      26, 2007, we had $15,000 of borrowings outstanding under the revolving credit
      facility portion of our Credit Facility and our borrowing capacity was
      $85,000.





The
      term
      loan under the Credit Facility bears interest at either LIBOR plus 1.75% or
      the
      Base Rate plus 0.75%.  The term loan borrowings are to be repaid in
      increments of $750 each calendar quarter, with the first principal payment
      due
      June 30, 2007.  The principal outstanding after scheduled repayment
      and any unscheduled prepayments is due January 2, 2013.





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





On
      February 26, 2004, we issued and sold $75,000 of Floating Rate Senior Notes
      due
      March 1, 2010 (the “Floating Rate Senior Notes”) and $125,000 of 7.0%
      Subordinated Notes due 2014, the proceeds of which were used to purchase the
      outstanding $204,538 of our 8.875% Senior Subordinated Notes due 2008 on
      February 26, 2004 and April 1, 2004 and refinance our then existing credit
      facility.  The repurchases resulted in a loss on early extinguishment
      of debt of $12,958.





On
      November 30, 2005, we called our $75,000 of Floating Rate Senior Notes for
      full
      redemption on December 30, 2005.  On December 30, 2005, we fully
      redeemed our $75,000 of Floating Rate Senior Notes at a price of 102% of par
      plus accrued interest to December 30, 2005.  We utilized borrowings of
      $38,000 under our Amended Revolving Credit Facility and $38,948 of our cash
      on
      hand to fund the redemption of the Floating Rate Senior Notes.  As a
      result of the redemption, we paid a 2% premium over par or $1,500, retired
      associated debt issuance costs of $1,303 and incurred other related call fees,
      which resulted in a loss on early extinguishment of debt of $2,805 during the
      first quarter of fiscal 2006.





Interest
      payments on the 7.0% Subordinated Notes are due semi-annually in arrears on
      March 1 and September 1.  Our domestic subsidiaries are guarantors of
      the 7.0% Subordinated Notes.  The guarantees of the 7.0% Subordinated
      Notes are unsecured senior subordinated obligations of the
      guarantors.  At any time after March 1, 2009, we may redeem any of the
      7.0% Subordinated Notes upon not less than 30 nor more than 60 days’ notice at
      redemption prices (expressed in percentages of principal amount), plus accrued
      and unpaid interest, if any, and liquidation damages, if any, to the applicable
      redemption rate, if redeemed during the twelve-month periods beginning March
      1,
      2009 at 103.500%, March 1, 2010 at 102.333%, March 1, 2011 at 101.167% and
      March
      1, 2012 and thereafter at 100.000%.  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 the 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
      indenture governing the 7.0% Subordinated Notes, among other things, limits
      our
      ability and the ability of our restricted subsidiaries to: (i) borrow money
      or
      sell preferred stock, (ii) create liens, (iii) pay dividends on or redeem or
      repurchase stock, (iv) make certain types of investments, (v) sell stock in
      our
      restricted subsidiaries, (vi) restrict dividends or other payments from
      restricted subsidiaries, (vii) enter into transactions with affiliates, (viii)
      issue guarantees of debt and (ix) sell assets or merge with other
      companies.  In addition, if we experience specific kinds of changes in
      control, we must offer to purchase the 7.0% Subordinated Notes at 101.0% of
      their principal amount plus accrued and unpaid interest.





During
      fiscal 2005, we repurchased $17,500 of our 7.0% Subordinated Notes in the open
      market at an average premium of 1.6% over the principal amount of the
      notes.  The repurchases resulted in a loss on early extinguishment of
      debt, including related expenses of $750.  The outstanding balance of
      the remaining 7.0% Subordinated Notes was reduced to $107,500.





On
      March
      8, 2004, we entered into an interest rate cap agreement effective June 1, 2004
      with decreasing annual notional principal amounts of $15,000 beginning March
      1,
      2006 and cap rates ranging from 4.0% to 5.0% over the life of the
      agreement.  We paid a $1,375 premium to enter into the interest rate
      cap agreement, which will be amortized over the life of the




11


agreement.  As
      of February 28, 2007, increases in the variable interest rate of up to $60,000
      of LIBOR based borrowings could be hedged under the provisions of the
      cap.  We had $60,000 of LIBOR based borrowings with an interest rate
      capped at 4.0% as of February 28, 2007.  During the three months ended
      February 28, 2007, the amortized value of the premium on the interest rate
      cap
      was compared to the fair value of the interest rate cap and the change in the
      market value of the premium of $81, was recorded as additional interest expense
      in the accompanying consolidated statement of income.  The current
      portion of the premium on the interest rate cap agreement of $205 is included
      in
      prepaid expenses and other current assets, and the long-term portion of $411
      is
      included in other non-current assets.   The fair value of the
      interest rate cap is valued by a third party.  The interest rate cap
      agreement terminates on March 1, 2010.





On
      July
      25, 2006, we successfully completed a consent solicitation from the holders
      of
      the 7.0% Subordinated Notes to an amendment to the indenture to increase our
      capacity to make restricted payments by an additional $85,000, including
      payments for the repurchase of our common stock, and adjust the fixed charge
      coverage ratio as defined in the indenture.





On
      November 22, 2006, we completed a private offering of $125,000 of convertible
      senior notes due 2013 (“Convertible Notes”) to qualified institutional
      purchasers pursuant to Section 4(2) of the Securities Act of
      1933.  The Convertible Notes bear interest at an annual rate of 2.0%,
      payable semi-annually on May 15 and November 15 of each year, with the first
      interest payment due on May 15, 2007.  The Convertible Notes are
      convertible into our common stock at an initial conversion price of $58.92
      per
      share, upon the occurrence of certain events, including the closing price of
      our
      common stock exceeding 130% of the conversion price per share for 20 of the
      last
      30 trading days of the conversion reference period.  The stock price
      at which the notes would be convertible is $76.59 and as of February 28, 2007
      our closing stock price was $53.37. Upon conversion, a holder will receive,
      in
      lieu of common stock, an amount of cash equal to the lesser of (i) the
      principal amount of the convertible note, or (ii) the conversion value,
      determined in the manner set forth in the indenture governing the Convertible
      Notes, of a number of shares equal to the conversion rate. If the conversion
      value exceeds the principal amount of the Convertible Note on the conversion
      date, we will also deliver, at our election, cash or common stock or a
      combination of cash and common stock with respect to the conversion value upon
      conversion. If conversion occurs in connection with a change of control, we
      may
      be required to deliver additional shares of our common stock by increasing
      the
      conversion rate with respect to such notes. The maximum aggregate number of
      shares that we would be obligated to issue upon conversion of the Convertible
      Notes is 2,673.





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





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





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





On
      November 22, 2006, we entered into a forward starting interest rate cap
      agreement effective January 15, 2007.  The forward starting cap has
      decreasing notional principal amounts beginning October 15, 2007 and a cap
      rate
      of 5.0% over the life of the agreement.  We paid a $687 premium to
      enter into the forward starting cap agreement, which will be amortized over
      the
      life of the agreement.  As of February 28, 2007, we had $94,500 of
      LIBOR based borrowings hedged under the provisions of the cap.  During
      the three months ended February 28, 2007, the value of the premium on the
      forward starting cap was compared to the fair value of the forward starting
      cap
      and the increase in the market value of the premium of $25, net of tax, was
      recorded to other comprehensive income.  The current portion of the
      premium on the forward starting cap agreement of $188 is included in prepaid
      expenses and other current assets, and the long-term portion of $376 is included
      in other non-current assets.  As of February 28, 2007, the entire
      forward starting cap was deemed to be an effective cash flow
      hedge.  The fair value of the forward starting cap agreement is valued
      by a third party.  The forward starting cap agreement terminates on
      January 15, 2010.





On
      November 22, 2006, we entered into a forward starting interest rate swap
      agreement effective January 15, 2007.  The forward starting swap has
      decreasing notional principal amounts beginning October 15, 2007 and a swap
      rate
      of 4.98% over the life of the agreement.  As of February 28, 2007, we
      had $175,500 of LIBOR based borrowings hedged under the provisions




12


of
      the
      swap.  During the three months ended February 28, 2007, the increase
      in fair value of the forward starting swap of $309, net of tax, was recorded
      to
      other comprehensive income.  The current portion of the fair value of
      the forward starting swap of $71 is included in accrued liabilities, and
      the long-term portion of $142 is included in other non-current
      liabilities.  As of February 28, 2007, the entire forward starting
      swap was deemed to be an effective cash flow hedge.  The fair value of
      the forward starting swap agreement is valued by a third party.  The
      forward starting swap agreement terminates on January 15, 2010.





The
      future maturities of long-term debt to be funded for the next five successive
      fiscal years and those thereafter as of February 28, 2007 are as
      follows:





2007
                
                $
                1,5002008
                
                
                3,0002009
                
                
                3,0002010
                
                
                33,0002011
                
                
                3,000Thereafter
                
                
                519,000$
                562,500








**8.**
            **ACQUISITION
                AND SALE OF BRANDS**





On
      January 2, 2007, we acquired the U.S. rights to five leading consumer and
      over-the-counter (“OTC”) brands from Johnson & Johnson (“J&J
      Acquisition”).  The acquired brands are: *ACT*, an anti-cavity
      mouthwash/mouth rinse; *Unisom*, an OTC sleep-aid; *Cortizone*, a
      hydrocortisone anti-itch product; *Kaopectate*, an anti-diarrhea product;
      and *Balmex*, a diaper rash product.  The J&J Acquisition
      was funded with the proceeds from the new $300,000 term loan provided under
      our
      Credit Facility, borrowings under the revolving credit facility of the Credit
      Facility and through the use of a portion of the proceeds derived from the
      Convertible Notes.  The purchase price of the J&J Acquisition was
      $410,000 and $2,357 of costs directly related to the acquisition, of which
      $469
      was incurred and funded during our fiscal year ended November 30,
      2006.  The purchase price was allocated $6,528 to inventory, $1,704 to
      assumed liabilities, $463 to equipment, $403,156 to trademarks which were
      assigned an indefinite life and $3,914 to distribution rights which was assigned
      a useful life of five years.  This is a preliminary allocation which
      will be revised upon completion of asset appraisals.  Johnson &
Johnson will continue to manufacture and supply the products for a period of
      up
      to 18 months, or such earlier date as we are able to move production to our
      facilities.  The price shall be equivalent to the manufacturing cost,
      which shall include all costs associated with the manufacturing and delivery
      of
      the product.  For a period of up to six months, Johnson &
Johnson will provide transition services consisting of consumer affairs,
      distribution and collection services (including related financial, accounting
      and reporting services).  We expect to terminate the distribution and
      collections services as of March 30, 2007.  The costs to be charged
      for these transition services are to be the approximate actual costs incurred
      by
      Johnson & Johnson.  During the three months ended February 28,
      2007, we incurred $1,171 of expenses primarily related to the transition
      services described above.





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





PRO
      FORMA
      CONSOLIDATED RESULTS OF OPERATIONS (Unaudited)





Three
                    Months Ended February 28,2007
                
                
                2006Total
                    revenue
                
                $
                110,012
                
                
                $
                113,694Net
                    income
                
                
                14,432
                
                
                
                17,644Earnings
                    per share –   basic:
                
                
                0.77
                
                
                
                0.90Earnings
                    per share –   diluted:
                
                
                0.75
                
                
                
                0.90





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





13


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





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





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





Shipping
      and handling costs of $2,401 and $2,264 are included in selling expenses for
      the
      three months ended February 28, 2007 and 2006, respectively.





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





The
      carrying value of trademarks, which are not subject to amortization under the
      provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”),
      was $609,139 and $205,983 as of February 28, 2007 and November 30, 2006,
      respectively.  The gross carrying amount of intangible assets subject
      to amortization at February 28, 2007 and November 30, 2006, which consist
      primarily of non-compete agreements and distribution rights, was $6,053 and
      $2,139, respectively.  The related accumulated amortization of
      intangible assets at February 28, 2007 and November 30, 2006 was $2,163 and
      $1,973, respectively.  Amortization of our intangible assets subject
      to amortization under the provisions of SFAS 142 for the three months ended
      February 28, 2007 and 2006 was $190 and $60, respectively.  Estimated
      annual amortization expense for these assets for the years ended November 30,
      2008, 2009, 2010, 2011 and 2012 is $823, $803, $783, $783 and $65,
      respectively.





**12.**
            **INVENTORIES**





Inventories
      consisted of the following as of February 28, 2007 and November 30,
      2006:





2007
                
                
                2006Raw
                    materials and work in process
                
                $
                14,014
                
                
                $
                15,495Finished
                    goods
                
                
                23,556
                
                
                
                15,894Total
                    inventories
                
                $
                37,570
                
                
                $
                31,389




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





Accrued
      liabilities consisted of the following as of February 28, 2007 and November
      30,
      2006:





2007
                
                
                2006Interest
                
                $
                8,647
                
                
                $
                2,599Salaries,
                    wages and commissions
                
                
                2,231
                
                
                
                3,878Product
                    advertising and promotion
                
                
                6,906
                
                
                
                1,936Litigation
                    settlement and legal fees
                
                
                1,159
                
                
                
                1,162Income
                    taxes payable
                
                
                258
                
                
                
                635Other
                
                
                3,626
                
                
                
                1,595Total
                    accrued liabilities
                
                $
                22,827
                
                
                $
                11,805


14


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





Comprehensive
      income consisted of the following components for the three months ended February
      28, 2007 and 2006, respectively:





2007
                
                
                2006Net
                    income
                
                $
                13,650
                
                
                $
                14,773Other
                    – interest rate cap adjustment
                
                
                334
                
                
                
                53Other
                    – foreign currency translation adjustment
                
                
                (71
                )
                
                
                242Total
                
                $
                13,913
                
                
                $
                15,068





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





On
      July 25, 2006, our Board of Directors authorized the repurchase of up to an
      additional $100,000 of our common stock under the terms of our existing stock
      repurchase program.  On January 2, 2007, in connection with the
      completion of the amendment to the Credit Facility, the ability to make
      restricted payments under the Credit Facility, including payments for the
      repurchase of our common stock, was increased to $93,110.  As of March
      26, 2007, the current amount available under the authorization from the Board
      of
      Directors was $88,147.  No share repurchases have occurred in fiscal
      2007.





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





RETIREMENT
      PLANS





We
      have a
      noncontributory defined benefit pension plan (“the Plan”), which covers
      substantially all employees as of December 31, 2000.  The Plan
      provides benefits based upon years of service and the employee’s
      compensation.  Our contributions are based on computations by
      independent actuaries.  Plan assets at February 28, 2007 and November
      30, 2006 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 months ended February 28, 2007 and 2006
      comprised the following components:





2007
                
                
                2006Service
                    cost
                
                $
                —
                
                
                $
                —Interest
                    cost on projected benefit obligation
                
                
                153
                
                
                
                156Expected
                    return on plan assets
                
                
                (220
                )
                
                
                (226
                )Net
                    amortization and deferral
                
                
                —
                
                
                
                —Net
                    pension cost (benefit)
                
                $
                (67
                )
                
                $
                (70
                )





No
      employer contributions were made for the three months ended February 28, 2007
      and 2006, and no employer contributions are expected to be made in fiscal
      2007.





POSTRETIREMENT
      HEALTH CARE BENEFITS





We
      maintain certain postretirement health care benefits for eligible
      employees.  Employees become eligible for these benefits if they meet
      certain age and service requirements.  We pay a portion of the cost of
      medical benefits for certain retired employees over the age of
      65.  Effective 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 2007 are
      approximately $78.





15
 
 Net
          periodic postretirement health care benefits cost for the three months
          ended
          February 28, 2007 and 2006, included the following components:


2007
                
                
                2006Service
                    cost
                
                $
                14
                
                
                $
                20Interest
                    cost on accumulated postretirement
                  benefit
                    obligation
                
                
                18
                
                
                
                22Amortization
                    of prior service cost
                
                
                4
                
                
                
                4Amortization
                    of net gain
                
                
                (4
                )
                
                
                (4
                )Net
                    periodic postretirement benefits cost
                
                $
                32
                
                
                $
                42








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





We
      account for income taxes using the asset and liability approach as prescribed
      by
      SFAS 109, and applicable FASB Staff Positions and
      Interpretations.  This approach requires recognition of deferred tax
      assets and liabilities for the expected future tax consequences of events that
      have been included in 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 months ended February 28, 2007
      was 34.5%, as compared to 34% for the three months ended February 28,
      2006.





Undistributed
      earnings of Chattem Canada amounted to approximately $98 for the three months
      ended February 28, 2007.  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).








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





Net
      sales
      of our domestic product categories within our single healthcare business segment
      for the three months ended February 28, 2007 and 2006 are as
      follows:





2007
                
                
                2006Topical
                    pain care
                
                $
                27,226
                
                
                $
                32,441Medicated
                    skin care
                
                
                27,833
                
                
                
                16,892Medicated
                    dandruff shampoos
                
                
                10,296
                
                
                
                11,816Oral
                    care products
                
                
                8,487
                
                
                
                1,615Internal
                    OTC products
                
                
                8,449
                
                
                
                2,561Dietary
                    supplements
                
                
                8,030
                
                
                
                8,853Other
                    OTC and toiletry products
                
                
                4,302
                
                
                
                4,265Total
                
                $
                94,623
                
                
                $
                78,443




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




**GENERAL
      LITIGATION**





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




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




The
      *Dexatrim* PPA settlement included claims against us involving alleged
      injuries by *Dexatrim* products containing PPA in which the alleged
      injury occurred after December 21, 1998, the date we acquired the
*Dexatrim* brand.  In accordance with




16


the
      terms
      of the class action settlement agreement, we previously published notice of
      the
      settlement and details as to the manner in which claims could be
      submitted.  The deadline for submission of claims was July 7,
      2004.  A total of 391 claims were certified by the court as timely
      submitted.  A total of 14 claimants with alleged injuries that
      occurred after December 21, 1998 elected to opt out of the class
      settlement.  Subsequently, we have settled eleven of the opt out
      claims. The three remaining opt out claimants may pursue claims for damages
      against us in separate lawsuits.  As of March 26, 2007, one of the
      three remaining opt-out claimants has filed a lawsuit against us.  The
      other two opt-outs have not filed lawsuits against us and we believe the
      applicable statutes of limitation have run against their
      claims.  Consequently, we are currently defending one PPA products
      liability claim.




In
      accordance with the terms of the class action settlement, approximately $70,885
      was initially funded into a settlement trust.  Over the past two
      years, we have resolved all of the claims submitted in the *Dexatrim* PPA
      settlement. All claims in the settlement and expenses of the trust have now
      been
      paid.  On June 14, 2006, we filed a motion to dissolve the settlement
      trust.  The court granted this motion on July 14, 2006.  On
      August 31, 2006, the settlement trust paid us $10,720, which is included as
      a
      component of litigation settlement in our condensed consolidated statement
      of
      income for 2006.  The settlement trust currently has a balance of
      approximately $2,805.  We expect to use those funds to resolve the
      pending opt-out PPA case.  Any funds remaining after we resolve the
      opt-out case will be returned to one of our insurance carriers. We currently
      do
      not expect to record any additional charges relative to the settlement of the
      PPA litigation, except for legal expenses that will be recorded in the period
      incurred.  During the past year ending November 30, 2006, we also
      recorded net expenses of approximately $178 related to the *Dexatrim*
      litigation.




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




We
      entered into a settlement agreement with DELACO dated June 30, 2005 that
      resolved DELACO’s indemnity obligations to us (“the DELACO
      Agreement”).  The DELACO Agreement was approved by the DELACO
      bankruptcy court on July 28, 2005.  Pursuant to the DELACO Agreement,
      we agreed to assume responsibility for all claims against DELACO and its
      predecessor, Thompson Medical Company, Inc., or us relating to *Dexatrim*
      products involving an injury date after December 21, 1998, and hold the DELACO
      bankruptcy estate harmless from any such claims.  In exchange, a
      settlement trust that was established under DELACO’s bankruptcy plan agreed to
      pay us $8,750 and assume responsibility for all claims related to
*Dexatrim* products alleging injury dates on or before December 21, 1998.
      On February 17, 2006, the DELACO bankruptcy court entered an order confirming
      the DELACO bankruptcy plan which incorporated the terms of the DELACO
      Agreement.  In accordance with the DELACO bankruptcy plan, the
      settlement trust established under the plan paid us $8,750 on March 17, 2006,
      which is included in our condensed consolidated statement of income, net of
      legal expenses, as litigation settlement for 2006.  In addition, this
      order will allow us to dismiss all cases against us with injury dates prior
      to
      December 21, 1998.  The DELACO settlement trust is currently resolving
      and paying *Dexatrim* claims with injury dates prior to December 21, 1998
      in accordance with the DELACO bankruptcy plan.




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




On
      December 30, 2003, the United States Food and Drug Administration ("FDA") issued
      a consumer alert on the safety of dietary supplements containing ephedrine
      alkaloids and on February 6, 2004 published a final rule with respect to these
      products.  The final rule prohibits the sale of dietary supplements
      containing ephedrine alkaloids because such supplements present an unreasonable
      risk of illness or injury.  The final rule became effective on April
      11, 2004.  Although we discontinued the manufacturing and shipment of
*Dexatrim* containing ephedrine 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.  There are currently two *Dexatrim* with ephedrine
      products liability lawsuits pending against us.




We
      maintain insurance coverage for product liability claims relating to our
      products, including *Dexatrim* products containing ephedrine, under
      claims-made policies which are subject to annual renewal.   For
      the current annual policy period beginning June 1, 2006, we maintain product
      liability insurance coverage in the amount of $25,000 through our captive
      insurance subsidiary, of which approximately $3,796 has been funded as of March
      26, 2007.  We also have $20,000 of excess coverage through a third
      party reinsurance policy, which excludes coverage for our *Dexatrim*
      products containing ephedrine.




17


We
      were
      named as a defendant in a putative class action lawsuit filed in the Superior
      Court of the State of California for the County of Los Angeles on February
      11,
      2004, relating to the labeling, advertising, promotion and sale of our
*Bullfrog* suncare products.  We filed an answer to this
      lawsuit on June 28, 2004.  An amended complaint was filed March 29,
      2006, pursuant to a court order formally consolidating this lawsuit with eight
      existing lawsuits involving other manufacturers of sunscreen products into
      a
      coordinated proceeding in California state court. The amended lawsuit seeks
      class certification of all persons who purchased our *Bullfrog* sun care
      products in California during a four-year period prior to February 11,
      2004.  The amended lawsuit seeks restitution and/or disgorgement of
      profits, actual damages, injunctive relief, punitive damages and attorneys
      fees
      and costs arising out of alleged deceptive, untrue or misleading advertising
      and
      breach of warranty, fraudulent or negligent misrepresentations, in connection
      with the manufacturing, labeling, advertising, promotion and sale of
*Bullfrog* products in California.  We filed an answer to the
      lawsuit in April 2006, and we are vigorously defending this
      lawsuit.  In fact, we filed a motion for summary judgment on or about
      November 22, 2006, which is set for argument on April 18,
      2007.




On
      March
      9, 2006, we were named in a lawsuit filed in the Southern District of New York
      by Novogen, Inc.  Novogen alleges that our product *New Phase*
      infringes upon Novogen patents by containing certain phytoestrogens from clover
      or equivalent sources.  Novogen seeks to force us to reformulate our
      product and to recover damages**.**We filed an answer
      to the lawsuit on April 12, 2006 and we are vigorously defending Novogen’s
      allegations.




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





**REGULATORY**





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





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





Certain
      of our topical analgesic products are currently marketed under a FDA tentative
      final external analgesic monograph. The FDA has proposed that the final
      monograph exclude external analgesic products in patch, plaster or poultice
      form, unless the FDA receives additional data supporting the safety and efficacy
      of these products. On October 14, 2003, we submitted to the FDA information
      regarding the safety of our *Icy Hot* patches and arguments to support
      our product’s inclusion in the final monograph. We have also participated in an
      industry effort coordinated by Consumer Healthcare Products Association (“CHPA”)
      to establish with the FDA a protocol of additional research that will allow
      the
      patches to be marketed under the final monograph even if the final monograph
      does not explicitly allow them. The CHPA submission to FDA was made on October
      15, 2003. Thereafter, in April 2004, we launched the *Icy Hot* Sleeve, a
      flexible, non-occlusive fabric patch containing 16% menthol.  In
      February 2006, we launched the *Icy Hot Pro-Therapy* Medicated Foam Pad
      with Knee Wrap containing 5% menthol, and the *Capzasin* Back & Body
      patch containing 0.025% capsaicin.  All of these drug products contain
      levels of active ingredients consistent with levels permitted in the OTC
      monograph.  If additional research is required either as a preliminary
      to final FDA monograph approval and/or as a requirement of future individual
      product sale, we may need to invest in a considerable amount of expensive
      testing and data analysis. Any preliminary cost may be shared with other patch
      manufacturers. Because the




18


submissions
      made into the FDA docket have been forwarded from its OTC Division to its
      Dermatological Division within the Center for Drug Evaluation and Research
      (“CDER”), we are uncertain as to when this matter is likely to become
      final.  For example, the FDA could choose to hold in abeyance a final
      ruling on alternative dose forms even if the monograph is otherwise
      finalized.  If the final monograph excludes such products, we will
      have to file a new drug application (“NDA”) for previously marketed drugs in
      order to continue to market the *Icy Hot* and *Aspercreme*Patches, the *Icy Hot* Sleeve, the *Icy Hot Pro-Therapy*
      Medicated Foam Pad with Knee Wrap, *Capzasin* Back & Body Patch
      and/or similar delivery systems under our other topical analgesic brands. In
      such case, we would likely have to remove the existing products from the market
      one year from the effective date of the final monograph, pending FDA review
      and
      approval of an NDA. The preparation of an NDA would likely take us six to 18
      months and would be expensive. It typically takes the FDA at least twelve months
      to rule on an NDA once it is submitted.





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





In
      early
      2005, infrequent, but serious, adverse cardiovascular events were reported
      to
      the FDA associated with patients who were prescribed a subclass of COX-2
      inhibitor non-steroidal anti-inflammatory drugs (“NSAID’s”) for long periods to
      relieve pain of chronic diseases such as arthritis.  These products
      include Vioxx®, Bextra®, and Celebrex®.  In February 2005, the FDA
      held a joint advisory committee meeting to seek external counsel on the extent
      to which manufacturers might further warn patients of these cardiovascular
      risks
      on prescription product labeling, or prohibit sale of these prescription
      products.  As part of its response on this issue, the FDA has
      recommended labeling changes for both the prescription and OTC NSAID’s.
      Well-known OTC NSAID’s such as ibuprofen and naproxen, which have been sold in
      vast quantities since the 1970s, were affected by this regulatory
      action.   Manufacturers of OTC NSAID’s were asked to revise their
      labeling to provide more specific information about the potential cardiovascular
      and gastrointestinal risks recognizing the limited dose and duration of
      treatment of these products.  Our *Pamprin All Day*product,
      which contains naproxen sodium, is subject to these new labeling
      requirements.  *Pamprin All Day* is manufactured for us by The
      Perrigo Company (“Perrigo”), holder of an abbreviated NDA for naproxen
      sodium.  As holder of the abbreviated NDA, Perrigo made the mandated
      labeling changes within the time frame required by the FDA. Product with revised
      labeling compliant with new FDA regulations began shipping in February
      2006.  We are also aware of the FDA’s concern about the potential
      toxicity due to concomitant use of OTC and prescription products that contain
      the analgesic ingredient acetaminophen, an ingredient also found in
*Pamprin* and *Prēmsyn PMS*.  We are also aware that the
      FDA will revise acetaminophen labeling to reflect the concerns similar to NSAID
      analgesics such as naproxen.  We are participating in an industry-wide
      effort to reassure the FDA that the current recommended dosing regimen is safe
      and effective and that proper labeling and public education by both OTC and
      prescription drug companies are the best policies to abate the FDA’s
      concern.   The FDA will address both issues in its effort to
      finalize the monograph on internal analgesic products.  We believe the
      FDA may issue revised labeling requirements within the next year, perhaps prior
      to monograph closure that will cause the industry to relabel its analgesic
      products to better inform consumers.





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





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




19


ingredient
      in our *Bullfrog* Superblock products. We have participated in an
      industry-wide submission to the State of California, facilitated through the
      CHPA, presenting evidence that titanium dioxide presents “no significant risk”
to consumers.





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





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




The
      consolidating financial statements, for the dates or periods indicated, of
      Chattem, Inc.  (“Chattem”), Signal Investment & Management Co.
      (“Signal”), SunDex, LLC (“SunDex”) and Chattem (Canada) Holdings, Inc.
      (“Canada”), the guarantors of the long-term debt of Chattem, and the
      non-guarantor direct and indirect wholly-owned subsidiaries of Chattem are
      presented below.  Signal is 89% owned by Chattem and 11% owned by
      Canada.  SunDex and Canada are wholly-owned subsidiaries of
      Chattem.  The guarantees of Signal, SunDex and Canada are full and
      unconditional and joint and several.  The guarantees of Signal, SunDex
      and Canada as of February 28, 2007 arose in conjunction with our Credit Facility
      and our issuance of the 7.0% Subordinated Notes (See Note 7).  The
      maximum amount of future payments the guarantors would be required to make
      under
      the guarantees as of February 28, 2007 is $437,500.


20


Note
      20


CHATTEM,
        INC. AND SUBSIDIARIES
 CONSOLIDATING
          BALANCE SHEETS




FEBRUARY
                28, 2007


(Unaudited
                and in thousands)


CHATTEM
                  
                  
                  GUARANTOR
                    SUBSIDIARY
                    COMPANIES
                  
                  
                  NON-GUARANTOR
                    SUBSIDIARY
                    COMPANIES
                  
                  
                  ELIMINATIONS
                  
                  
                  CONSOLIDATEDASSETSCURRENT
                      ASSETS:Cash
                      and cash equivalents
                  
                  $
                  7,724
                  
                  
                  $
                  1,848
                  
                  
                  $
                  6,177
                  
                  
                  $
                  —
                  
                  
                  $
                  15,749Accounts
                      receivable, less allowances of $11,793
                  
                  
                  47,800
                  
                  
                  
                  14,928
                  
                  
                  
                  5,005
                  
                  
                  
                  (14,928
                  )
                  
                  
                  52,805Other
                      receivables
                  
                  
                  259
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  259Interest
                      receivable
                  
                  
                  17
                  
                  
                  
                  625
                  
                  
                  
                  —
                  
                  
                  
                  (642
                  )
                  
                  
                  —Inventories
                  
                  
                  30,939
                  
                  
                  
                  4,208
                  
                  
                  
                  2,423
                  
                  
                  
                  —
                  
                  
                  
                  37,570Refundable
                      income taxes
                  
                  
                  2,817
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  2,817Deferred
                      income taxes
                  
                  
                  4,185
                  
                  
                  
                  —
                  
                  
                  
                  36
                  
                  
                  
                  —
                  
                  
                  
                  4,221Prepaid
                      expenses and other current assets
                  
                  
                  4,068
                  
                  
                  
                  —
                  
                  
                  
                  1,290
                  
                  
                  
                  (1,191
                  )
                  
                  
                  4,167Total
                      current assets
                  
                  
                  97,809
                  
                  
                  
                  21,609
                  
                  
                  
                  14,931
                  
                  
                  
                  (16,761
                  )
                  
                  
                  117,588PROPERTY,
                      PLANT AND EQUIPMENT, NET
                  
                  
                  28,821
                  
                  
                  
                  775
                  
                  
                  
                  572
                  
                  
                  
                  —
                  
                  
                  
                  30,168OTHER
                      NONCURRENT ASSETS:Patents,
                      trademarks and other purchased product rights, net
                  
                  
                  3,889
                  
                  
                  
                  671,430
                  
                  
                  
                  —
                  
                  
                  
                  (62,290
                  )
                  
                  
                  613,029Debt
                      issuance costs, net
                  
                  
                  16,890
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  16,890Investment
                      in subsidiaries
                  
                  
                  324,625
                  
                  
                  
                  33,000
                  
                  
                  
                  66,860
                  
                  
                  
                  (424,485
                  )
                  
                  
                  —Note
                      receivable
                  
                  
                  —
                  
                  
                  
                  33,000
                  
                  
                  
                  —
                  
                  
                  
                  (33,000
                  )
                  
                  
                  —Other
                  
                  
                  5,057
                  
                  
                  
                  —
                  
                  
                  
                  1,010
                  
                  
                  
                  —
                  
                  
                  
                  6,067Total
                      other noncurrent assets
                  
                  
                  350,461
                  
                  
                  
                  737,430
                  
                  
                  
                  67,870
                  
                  
                  
                  (519,775
                  )
                  
                  
                  635,986TOTAL
                      ASSETS
                  
                  $
                  477,091
                  
                  
                  $
                  759,814
                  
                  
                  $
                  83,373
                  
                  
                  $
                  (536,536
                  )
                  
                  $
                  783,742LIABILITIES
                      AND SHAREHOLDERS’ EQUITYCURRENT
                      LIABILITIES:Current
                      maturities of long-term debt
                  
                  $
                  3,000
                  
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  3,000Accounts
                      payable and other
                  
                  
                  14,821
                  
                  
                  
                  —
                  
                  
                  
                  937
                  
                  
                  
                  —
                  
                  
                  
                  15,758Bank
                      overdraft
                  
                  
                  2,105
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  2,105Accrued
                      liabilities
                  
                  
                  33,861
                  
                  
                  
                  1,305
                  
                  
                  
                  4,422
                  
                  
                  
                  (16,761
                  )
                  
                  
                  22,827Total
                      current liabilities
                  
                  
                  53,787
                  
                  
                  
                  1,305
                  
                  
                  
                  5,359
                  
                  
                  
                  (16,761
                  )
                  
                  
                  43,690LONG-TERM
                      DEBT, less current maturities
                  
                  
                  566,500
                  
                  
                  
                  —
                  
                  
                  
                  26,000
                  
                  
                  
                  (33,000
                  )
                  
                  
                  559,500DEFERRED
                      INCOME TAXES
                  
                  
                  (13,280
                  )
                  
                  
                  34,185
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  20,905OTHER
                      NONCURRENT LIABILITIES
                  
                  
                  1,589
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  1,589INTERCOMPANY
                      ACCOUNTS
                  
                  
                  (289,563
                  )
                  
                  
                  283,796
                  
                  
                  
                  5,767
                  
                  
                  
                  —
                  
                  
                  
                  —SHAREHOLDERS’
                      EQUITY:Preferred
                      shares, without par value, authorized 1,000, none issued
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Common
                      shares, without par value, authorized 100,000, issued and outstanding
                      18,965
                  
                  
                  39,016
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  39,016Share
                      capital of subsidiaries
                  
                  
                  —
                  
                  
                  
                  329,705
                  
                  
                  
                  39,803
                  
                  
                  
                  (369,508
                  )
                  
                  
                  —Retained
                      earnings
                  
                  
                  119,615
                  
                  
                  
                  110,823
                  
                  
                  
                  6,315
                  
                  
                  
                  (117,138
                  )
                  
                  
                  119,615Total
                  
                  
                  158,631
                  
                  
                  
                  440,528
                  
                  
                  
                  46,118
                  
                  
                  
                  (486,646
                  )
                  
                  
                  158,631Cumulative
                      other comprehensive income, net of taxes:Interest
                      rate cap adjustment
                  
                  
                  (263
                  )
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (263
                  )Foreign
                      currency translation adjustment
                  
                  
                  (310
                  )
                  
                  
                  —
                  
                  
                  
                  129
                  
                  
                  
                  (129
                  )
                  
                  
                  (310
                  )Total
                      shareholders’ equity
                  
                  
                  158,058
                  
                  
                  
                  440,528
                  
                  
                  
                  46,247
                  
                  
                  
                  (486,775
                  )
                  
                  
                  158,058TOTAL
                      LIABILITIES AND SHAREHOLDERS’ EQUITY
                  
                  $
                  477,091
                  
                  
                  $
                  759,814
                  
                  
                  $
                  83,373
                  
                  
                  $
                  (536,536
                  )
                  
                  $
                  783,742


21


Note
      20


CHATTEM,
        INC. AND SUBSIDIARIES
 CONSOLIDATING
          BALANCE SHEETS
  NOVEMBER
            30, 2006
 (In
              thousands)




CHATTEM
                  
                  
                  GUARANTOR
                      SUBSIDIARY COMPANIES
                  
                  
                  NON-GUARANTOR
                       SUBSIDIARY
                    COMPANIES
                  
                  
                  ELIMINATIONS
                  
                  
                  CONSOLIDATEDASSETSCURRENT
                      ASSETS:Cash
                      and cash equivalents
                  
                  $
                  80,198
                  
                  
                  $
                  1,967
                  
                  
                  $
                  8,362
                  
                  
                  $
                  —
                  
                  
                  $
                  90,527Accounts
                      receivable, less allowances of $10,907
                  
                  
                  24,946
                  
                  
                  
                  9,407
                  
                  
                  
                  4,649
                  
                  
                  
                  (9,407
                  )
                  
                  
                  29,595Other
                      receivables
                  
                  
                  257
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  257Interest
                      receivable
                  
                  
                  17
                  
                  
                  
                  625
                  
                  
                  
                  —
                  
                  
                  
                  (642
                  )
                  
                  
                  —Inventories
                  
                  
                  24,444
                  
                  
                  
                  4,160
                  
                  
                  
                  2,785
                  
                  
                  
                  —
                  
                  
                  
                  31,389Refundable
                      income taxes
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Deferred
                      income taxes
                  
                  
                  4,304
                  
                  
                  
                  —
                  
                  
                  
                  37
                  
                  
                  
                  —
                  
                  
                  
                  4,341Prepaid
                      expenses and other current assets
                  
                  
                  3,666
                  
                  
                  
                  —
                  
                  
                  
                  2,191
                  
                  
                  
                  —
                  
                  
                  
                  5,857Total
                      current assets
                  
                  
                  137,832
                  
                  
                  
                  16,159
                  
                  
                  
                  18,024
                  
                  
                  
                  (10,049
                  )
                  
                  
                  161,966PROPERTY,
                      PLANT AND EQUIPMENT, NET
                  
                  
                  28,985
                  
                  
                  
                  775
                  
                  
                  
                  593
                  
                  
                  
                  —
                  
                  
                  
                  30,353OTHER
                      NONCURRENT ASSETS:Patents,
                      trademarks and other purchased product rights, net
                  
                  
                  166
                  
                  
                  
                  268,273
                  
                  
                  
                  —
                  
                  
                  
                  (62,290
                  )
                  
                  
                  206,149Debt
                      issuance costs, net
                  
                  
                  11,399
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  11,399Investment
                      in subsidiaries
                  
                  
                  313,922
                  
                  
                  
                  33,000
                  
                  
                  
                  66,860
                  
                  
                  
                  (413,782
                  )
                  
                  
                  —Note
                      receivable
                  
                  
                  —
                  
                  
                  
                  33,000
                  
                  
                  
                  —
                  
                  
                  
                  (33,000
                  )
                  
                  
                  —Other
                  
                  
                  4,978
                  
                  
                  
                  468
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  5,446Total
                      other noncurrent assets
                  
                  
                  330,465
                  
                  
                  
                  334,741
                  
                  
                  
                  66,860
                  
                  
                  
                  (509,072
                  )
                  
                  
                  222,994TOTAL
                      ASSETS
                  
                  $
                  497,282
                  
                  
                  $
                  351,675
                  
                  
                  $
                  85,477
                  
                  
                  $
                  (519,121
                  )
                  
                  $
                  415,313LIABILITIES
                      AND SHAREHOLDERS’ EQUITYCURRENT
                      LIABILITIES:Current
                      maturities of long-term debt
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  —Accounts
                      payable and other
                  
                  
                  10,473
                  
                  
                  
                  —
                  
                  
                  
                  1,580
                  
                  
                  
                  (2,105
                  )
                  
                  
                  9,948Bank
                      overdraft
                  
                  
                  5,824
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  5,824Accrued
                      liabilities
                  
                  
                  17,869
                  
                  
                  
                  1,132
                  
                  
                  
                  748
                  
                  
                  
                  (7,944
                  )
                  
                  
                  11,805Total
                      current liabilities
                  
                  
                  34,166
                  
                  
                  
                  1,132
                  
                  
                  
                  2,328
                  
                  
                  
                  (10,049
                  )
                  
                  
                  27,577LONG-TERM
                      DEBT, less current maturities
                  
                  
                  232,500
                  
                  
                  
                  —
                  
                  
                  
                  33,000
                  
                  
                  
                  (33,000
                  )
                  
                  
                  232,500DEFERRED
                      INCOME TAXES
                  
                  
                  (16,517
                  )
                  
                  
                  34,185
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  17,668OTHER
                      NONCURRENT LIABILITIES
                  
                  
                  1,987
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  1,987INTERCOMPANY
                      ACCOUNTS
                  
                  
                  109,564
                  
                  
                  
                  (114,014
                  )
                  
                  
                  4,450
                  
                  
                  
                  —
                  
                  
                  
                  —SHAREHOLDERS’
                      EQUITY:Preferred
                      shares, without par value, authorized 1,000, none
                      issued
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Common
                      shares, without par value, authorized 100,000, issued
                      18,669
                  
                  
                  30,452
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  30,452Share
                      capital of subsidiaries
                  
                  
                  —
                  
                  
                  
                  329,705
                  
                  
                  
                  39,803
                  
                  
                  
                  (369,508
                  )
                  
                  
                  —Retained
                      earnings
                  
                  
                  105,965
                  
                  
                  
                  100,667
                  
                  
                  
                  5,679
                  
                  
                  
                  (106,346
                  )
                  
                  
                  105,965Total
                  
                  
                  136,417
                  
                  
                  
                  430,372
                  
                  
                  
                  45,482
                  
                  
                  
                  (475,854
                  )
                  
                  
                  136,417Cumulative
                      other comprehensive income, net oftaxes:Interest
                      rate cap adjustment
                  
                  
                  (597
                  )
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (597
                  )Foreign
                      currency translation adjustment
                  
                  
                  (238
                  )
                  
                  
                  —
                  
                  
                  
                  217
                  
                  
                  
                  (218
                  )
                  
                  
                  (239
                  )Total
                      shareholders’ equity
                  
                  
                  135,582
                  
                  
                  
                  430,372
                  
                  
                  
                  45,699
                  
                  
                  
                  (476,072
                  )
                  
                  
                  135,581TOTAL
                      LIABILITIES AND SHAREHOLDERS’ EQUITY
                  
                  $
                  497,282
                  
                  
                  $
                  351,675
                  
                  
                  $
                  85,477
                  
                  
                  $
                  (519,121
                  )
                  
                  $
                  415,313




22


Note
      20


CHATTEM,
        INC. AND SUBSIDIARIES


CONSOLIDATING
        STATEMENTS OF INCOME




FOR
        THE
        THREE MONTHS ENDED FEBRUARY 28, 2007
 (Unaudited
          and in thousands)


CHATTEM
              
              
              GUARANTOR
                  SUBSIDIARY  COMPANIES
              
              
              NON-GUARANTOR
                SUBSIDIARY
                COMPANIES
              
              
              ELIMINATIONS
              
              
              CONSOLIDATEDTOTAL
                  REVENUES
              
              $
              88,217
              
              
              $
              23,010
              
              
              $
              5,337
              
              
              $
              (15,733
              )
              
              $
              100,831COSTS
                  AND EXPENSES:Cost
                  of sales
              
              
              26,988
              
              
              
              2,315
              
              
              
              2,482
              
              
              
              (805
              )
              
              
              30,980Advertising
                  and promotion
              
              
              24,147
              
              
              
              2,880
              
              
              
              1,760
              
              
              
              —
              
              
              
              28,787Selling,
                  general and administrative
              
              
              12,386
              
              
              
              (42
              )
              
              
              242
              
              
              
              —
              
              
              
              12,586Acquisition
                  expenses
              
              
              1,171
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,171Equity
                  in subsidiary income
              
              
              (10,792
              )
              
              
              —
              
              
              
              —
              
              
              
              10,792
              
              
              
              —Total
                  costs and expenses
              
              
              53,900
              
              
              
              5,153
              
              
              
              4,484
              
              
              
              9,987
              
              
              
              73,524INCOME
                  FROM OPERATIONS
              
              
              34,317
              
              
              
              17,857
              
              
              
              853
              
              
              
              (25,720
              )
              
              
              27,307OTHER
                  INCOME (EXPENSE):Interest
                  expense
              
              
              (7,190
              )
              
              
              —
              
              
              
              (665
              )
              
              
              619
              
              
              
              (7,236
              )Investment
                  and other income, net
              
              
              578
              
              
              
              636
              
              
              
              798
              
              
              
              (1,244
              )
              
              
              768Royalties
              
              
              (13,622
              )
              
              
              (1,306
              )
              
              
              —
              
              
              
              14,928
              
              
              
              —Corporate
                  allocations
              
              
              743
              
              
              
              (727
              )
              
              
              (16
              )
              
              
              —
              
              
              
              —Total
                  other income (expense)
              
              
              (19,491
              )
              
              
              (1,397
              )
              
              
              117
              
              
              
              14,303
              
              
              
              (6,468
              )INCOME
                  BEFORE INCOME TAXES
              
              
              14,826
              
              
              
              16,460
              
              
              
              970
              
              
              
              (11,417
              )
              
              
              20,839PROVISION
                  FOR INCOME TAXES
              
              
              1,176
              
              
              
              5,679
              
              
              
              334
              
              
              
              —
              
              
              
              7,189NET
                  INCOME
              
              $
              13,650
              
              
              $
              10,781
              
              
              $
              636
              
              
              $
              (11,417
              )
              
              $
              13,650








23


Note
      20


CHATTEM,
        INC. AND SUBSIDIARIES


CONSOLIDATING
        STATEMENTS OF INCOME




FOR
        THE
        THREE MONTHS ENDED FEBRUARY 28, 2006


(Unaudited
        and in thousands)




CHATTEM
              
              
              GUARANTOR
                  SUBSIDIARY  COMPANIES
              
              
              NON-GUARANTOR
                SUBSIDIARY
                COMPANIES
              
              
              ELIMINATIONS
              
              
              CONSOLIDATEDTOTAL
                  REVENUES
              
              $
              71,077
              
              
              $
              21,432
              
              
              $
              4,625
              
              
              $
              (13,110
              )
              
              $
              84,024COSTS
                  AND EXPENSES:Cost
                  of sales
              
              
              22,567
              
              
              
              2,121
              
              
              
              1,938
              
              
              
              (606
              )
              
              
              26,020Advertising
                  and promotion
              
              
              22,773
              
              
              
              2,829
              
              
              
              1,585
              
              
              
              —
              
              
              
              27,187Selling,
                  general and administrative
              
              
              11,529
              
              
              
              (102
              )
              
              
              164
              
              
              
              —
              
              
              
              11,591Litigation
                  settlement
              
              
              (8,613
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (8,613
              )Equity
                  in subsidiary income
              
              
              (9,915
              )
              
              
              —
              
              
              
              —
              
              
              
              9,915
              
              
              
              —Total
                  costs and expenses
              
              
              38,341
              
              
              
              4,848
              
              
              
              3,687
              
              
              
              9,309
              
              
              
              56,185INCOME  FROM
                  OPERATIONS
              
              
              32,736
              
              
              
              16,584
              
              
              
              938
              
              
              
              (22,419
              )
              
              
              27,839OTHER
                  INCOME (EXPENSE):Interest
                  expense
              
              
              (2,844
              )
              
              
              —
              
              
              
              (619
              )
              
              
              619
              
              
              
              (2,844
              )Investment
                  and other income, net
              
              
              124
              
              
              
              630
              
              
              
              684
              
              
              
              (1,244
              )
              
              
              194Loss
                  on early extinguishment of debt
              
              
              (2,805
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (2,805
              )Royalties
              
              
              (11,099
              )
              
              
              (1,406
              )
              
              
              —
              
              
              
              12,505
              
              
              
              —Corporate
                  allocations
              
              
              841
              
              
              
              (825
              )
              
              
              (16
              )
              
              
              —
              
              
              
              —Total
                  other income (expense)
              
              
              (15,783
              )
              
              
              (1,601
              )
              
              
              49
              
              
              
              11,880
              
              
              
              (5,455
              )INCOME
                  BEFORE INCOME TAXES
              
              
              16,953
              
              
              
              14,983
              
              
              
              987
              
              
              
              (10,539
              )
              
              
              22,384PROVISION
                  FOR INCOME TAXES
              
              
              2,180
              
              
              
              5,095
              
              
              
              336
              
              
              
              —
              
              
              
              7,611NET
                  INCOME
              
              $
              14,773
              
              
              $
              9,888
              
              
              $
              651
              
              
              $
              (10,539
              )
              
              $
              14,773








24


Note
      20


CHATTEM,
      INC. AND SUBSIDIARIES


CONSOLIDATING
      STATEMENTS OF CASH FLOWS





FOR
      THE
      THREE MONTHS ENDED FEBRUARY 28, 2007


(Unaudited
        and in thousands)




CHATTEM
              
              
              GUARANTOR
                  SUBSIDIARY
                COMPANIES
              
              
              NON-GUARANTOR
                SUBSIDIARY
                COMPANIES
              
              
              ELIMINATIONS
              
              
              CONSOLIDATEDOPERATING
                  ACTIVITIES:Net
                  income
              
              $
              13,650
              
              
              $
              10,781
              
              
              $
              636
              
              
              $
              (11,417
              )
              
              $
              13,650Adjustments
                  to reconcile net income to net cashprovided
                  by (used in) operating activities:Depreciation
                  and amortization
              
              
              2,005
              
              
              
              —
              
              
              
              24
              
              
              
              —
              
              
              
              2,029Deferred
                  income taxes
              
              
              2,795
              
              
              
              —
              
              
              
              (1
              )
              
              
              —
              
              
              
              2,794Tax
                  benefit realized from stock options
              
              
              (3,013
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (3,013
              )Stock-based
                  compensation expense
              
              
              1,204
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,204Other,
                  net
              
              
              104
              
              
              
              —
              
              
              
              20
              
              
              
              —
              
              
              
              124Equity
                  in subsidiary income
              
              
              (11,417
              )
              
              
              —
              
              
              
              —
              
              
              
              11,417
              
              
              
              —Changes
                  in operating assets and liabilities:Accounts
                  receivable and other
              
              
              (22,855
              )
              
              
              (5,521
              )
              
              
              (357
              )
              
              
              5,521
              
              
              
              (23,212
              )Inventories
              
              
              43
              
              
              
              (48
              )
              
              
              363
              
              
              
              —
              
              
              
              358Refundable
                  income taxes
              
              
              196
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              196Prepaid
                  expenses and other current assets
              
              
              (402
              )
              
              
              —
              
              
              
              (109
              )
              
              
              1,191
              
              
              
              680Accounts
                  payable and accrued liabilities
              
              
              18,635
              
              
              
              173
              
              
              
              3,031
              
              
              
              (6,712
              )
              
              
              15,127Net
                  cash provided by (used in) operating activities
              
              
              945
              
              
              
              5,385
              
              
              
              3,607
              
              
              
              —
              
              
              
              9,937INVESTING
                  ACTIVITIES:Purchases
                  of property, plant and equipment
              
              
              (451
              )
              
              
              —
              
              
              
              (2
              )
              
              
              —
              
              
              
              (453
              )Acquisition
                  of brands
              
              
              (8,732
              )
              
              
              (403,156
              )
              
              
              —
              
              
              
              
              
              
              
              (411,888
              )Change
                  in other assets, net
              
              
              (405
              )
              
              
              468
              
              
              
              (89
              )
              
              
              —
              
              
              
              (26
              )Net
                  cash used in investing activities
              
              
              (9,588
              )
              
              
              (402,688
              )
              
              
              (91
              )
              
              
              —
              
              
              
              (412,367
              )FINANCING
                  ACTIVITIES:Intercompany
                  debt proceeds (payments)
              
              
              7,000
              
              
              
              —
              
              
              
              (7,000
              )
              
              
              —
              
              
              
              —Proceeds
                  from long-term debt
              
              
              300,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              300,000Proceeds
                  from borrowings under revolving credit facility
              
              
              39,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              39,000Repayment
                  of revolving credit facility
              
              
              (9,000
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (9,000
              )Bank
                  overdraft
              
              
              (3,719
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (3,719
              )Proceeds
                  from exercise of stock options
              
              
              4,457
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              4,457Increase
                  in debt issuance costs
              
              
              (6,079
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (6,079
              )Tax
                  benefit realized from stock options
              
              
              3,013
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              3,013Changes
                  in intercompany accounts
              
              
              (398,503
              )
              
              
              397,809
              
              
              
              694
              
              
              
              —
              
              
              
              —Dividends
                  paid
              
              
              —
              
              
              
              (625
              )
              
              
              625
              
              
              
              —
              
              
              
              —Net
                  cash (used in) provided by financing activities
              
              
              (63,831
              )
              
              
              397,184
              
              
              
              (5,681
              )
              
              
              —
              
              
              
              327,672EFFECT
                  OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
              
              
              —
              
              
              
              —
              
              
              
              (20
              )
              
              
              —
              
              
              
              (20
              )CASH
                  AND CASH EQUIVALENTS:Increase
                  (decrease) for the period
              
              
              (72,474
              )
              
              
              (119
              )
              
              
              (2,185
              )
              
              
              —
              
              
              
              (74,778
              )At
                  beginning of period
              
              
              80,198
              
              
              
              1,967
              
              
              
              8,362
              
              
              
              —
              
              
              
              90,527At
                  end of period
              
              $
              7,724
              
              
              $
              1,848
              
              
              $
              6,177
              
              
              $
              —
              
              
              $
              15,749




25


Note
      20





CHATTEM,
      INC. AND SUBSIDIARIES


CONSOLIDATING
      STATEMENTS OF CASH FLOWS





FOR
      THE
      THREE MONTHS ENDED FEBRUARY 28, 2006


(Unaudited
        and in thousands)




CHATTEM
              
              
              GUARANTOR
                  SUBSIDIARY  COMPANIES
              
              
              NON-GUARANTOR SUBSIDIARY 
                   COMPANIES
              
              
              ELIMINATIONS
              
              
              CONSOLIDATEDOPERATING
                  ACTIVITIES:Net
                  income
              
              $
              14,773
              
              
              $
              9,888
              
              
              $
              651
              
              
              $
              (10,539
              )
              
              $
              14,773Adjustments
                  to reconcile net income to net cashprovided
                  by (used in) operating activities:Depreciation
                  and amortization
              
              
              1,379
              
              
              
              —
              
              
              
              46
              
              
              
              —
              
              
              
              1,425Deferred
                  income taxes
              
              
              233
              
              
              
              —
              
              
              
              6
              
              
              
              —
              
              
              
              239Tax
                  benefit realized from stock options
              
              
              (309
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (309
              )Stock-based
                  compensation expense
              
              
              852
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              852Loss
                  on early extinguishment of debt
              
              
              2,805
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              2,805Other,
                  net
              
              
              51
              
              
              
              —
              
              
              
              15
              
              
              
              —
              
              
              
              66Equity
                  in subsidiary income
              
              
              (10,539
              )
              
              
              —
              
              
              
              —
              
              
              
              10,539
              
              
              
              —Changes
                  in operating assets and liabilities:Accounts
                  receivable and other
              
              
              (14,121
              )
              
              
              (12,505
              )
              
              
              (345
              )
              
              
              12,505
              
              
              
              (14,466
              )Interest
                  receivable
              
              
              —
              
              
              
              (619
              )
              
              
              —
              
              
              
              619
              
              
              
              —Inventories
              
              
              (1,430
              )
              
              
              (539
              )
              
              
              325
              
              
              
              —
              
              
              
              (1,644
              )Refundable
                  income taxes
              
              
              1,516
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,516Prepaid
                  expenses and other current assets
              
              
              838
              
              
              
              —
              
              
              
              9
              
              
              
              (195
              )
              
              
              652Accounts
                  payable and accrued liabilities
              
              
              11,142
              
              
              
              1,406
              
              
              
              198
              
              
              
              (12,929
              )
              
              
              (183
              )Net
                  cash provided by (used in) operating activities
              
              
              7,190
              
              
              
              (2,369
              )
              
              
              905
              
              
              
              —
              
              
              
              5,726INVESTING
                  ACTIVITIES:Purchases
                  of property, plant and equipment
              
              
              (1,276
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (1,276
              )Increase
                  in other assets, net
              
              
              (271
              )
              
              
              —
              
              
              
              (340
              )
              
              
              —
              
              
              
              (611
              )Net
                  cash used in investing activities
              
              
              (1,547
              )
              
              
              —
              
              
              
              (340
              )
              
              
              —
              
              
              
              (1,887
              )FINANCING
                  ACTIVITIES:Repayment
                  of long-term debt
              
              
              (75,000
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (75,000
              )Proceeds
                  from borrowings under revolving credit facility
              
              
              43,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              43,000Bank
                  overdraft
              
              
              2,979
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              2,979Proceeds
                  from exercise of stock options
              
              
              311
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              311Repurchase
                  of common shares
              
              
              (10,130
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (10,130
              )Increase
                  in debt issuance costs
              
              
              (15
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (15
              )Debt
                  retirement costs
              
              
              (1,501
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (1,501
              )Tax
                  benefit realized from stock options
              
              
              309
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              309Changes
                  in intercompany accounts
              
              
              (380
              )
              
              
              2,998
              
              
              
              (2,618
              )
              
              
              —
              
              
              
              —Dividends
                  paid
              
              
              —
              
              
              
              (625
              )
              
              
              625
              
              
              
              —
              
              
              
              —Net
                  cash (used in) provided by financing activities
              
              
              (40,427
              )
              
              
              2,373
              
              
              
              (1,993
              )
              
              
              —
              
              
              
              (40,047
              )EFFECT
                  OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
              
              
              —
              
              
              
              —
              
              
              
              (15
              )
              
              
              —
              
              
              
              (15
              )CASH
                  AND CASH EQUIVALENTS:Decrease
                  for the period
              
              
              (34,784
              )
              
              
              4
              
              
              
              (1,443
              )
              
              
              —
              
              
              
              (36,223
              )At
                  beginning of period
              
              
              36,647
              
              
              
              1,982
              
              
              
              8,698
              
              
              
              —
              
              
              
              47,327At
                  end of period
              
              $
              1,863
              
              
              $
              1,986
              
              
              $
              7,255
              
              
              $
              —
              
              
              $
              11,104




26


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





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





***Overview***





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





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





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





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





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





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





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





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





Our
      products target niche markets that are often outside the focus of larger
      companies where we believe we can achieve and sustain significant market share
      through innovation and strong advertising and promotion support. Many of our
      products are among the U.S. market leaders in their respective categories.
      For
      example, our portfolio of topical analgesic brands and our *Gold
      Bond* medicated body powders have the leading U.S. market share in these
      categories. We support our brands through extensive and cost-effective
      advertising and promotion, the expenditures for which represented approximately
      29% of our total revenues in the first quarter of fiscal 2007. We sell our
      products nationally through mass merchandiser, drug and food channels,
      principally utilizing our own sales force.





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





***Developments
      During Fiscal 2007***





***Acquisition
      of Brands***





On
      January 2, 2007, we acquired the U.S. rights to five leading consumer and OTC
      brands from Johnson & Johnson (“J&J Acquisition”).  The
      acquired brands are: *ACT*, an anti-cavity mouthwash/mouth rinse;
*Unisom*, an OTC sleep-aid; *Cortizone*, a hydrocortisone
      anti-itch product; *Kaopectate*, an anti-diarrhea product; and
*Balmex*, a diaper rash product.  The J&J Acquisition was
      funded with the proceeds from the new $300.0 million term loan provided under
      our Credit Facility, borrowings under the revolving credit facility portion
      of
      the Credit Facility and through the use of a portion of the proceeds derived
      from the Convertible Notes.  The purchase price of the J&J
      Acquisition was $410.0 million and $2.4 million of costs directly related to
      the
      acquisition, of which $0.5 million was incurred and funded during our fiscal
      year ended November 30, 2006.  The purchase price was allocated $6.5
      million to inventory, $1.7 million to assumed liabilities, $0.5 million to
      equipment, $403.2 million to trademarks which were assigned an indefinite life
      and $3.9 million to distribution rights which was assigned a useful life of
      five
      years.  This is a preliminary allocation which will be revised upon
      completion of asset appraisals. Johnson & Johnson will continue to
      manufacture and supply the products for a period of up to 18 months, or such
      earlier date as we are able to move production to our facilities.  The
      price shall be equivalent to the manufacturing cost, which shall include all
      costs associated with the manufacturing and delivery of the
      product.  For a period of up to six months, Johnson & Johnson
      will provide transition services consisting of consumer affairs, distribution
      and collection services (including related financial, accounting and reporting
      services).  We expect




27


to
      terminate the distribution and collections services as of March 30,
      2007.  The costs to be charged for these transition services are to be
      the approximate actual costs incurred by Johnson & Johnson.





***Products***





In
      the
      first quarter of fiscal 2007, we introduced the following product line
      extensions: *Icy Hot Heat Therapy*, *Bullfrog**Marathon Mist*and*Dexatrim**Max* Evening Appetite Control.





***Debt***





On
      January 2, 2007, we completed an amended credit facility providing for up to
      a
      $100.0 million revolving credit facility and a $300.0 million term loan (the
      “Credit Facility”).  The proceeds from the term loan under the Credit
      Facility were used to finance in part the J&J Acquisition.  The
      Credit Facility includes an “accordion” feature that permits us under certain
      circumstances to increase our borrowings under the revolving credit facility
      by
      $50.0 million and to borrow an additional $50.0 million as a term
      loan.





Borrowings
      under the revolving credit facility portion of our Credit Facility bear interest
      at LIBOR plus applicable percentages of 1.0% to 2.0% or the higher of the
      federal funds rate plus 0.5% or the prime rate (the “Base Rate”) plus applicable
      percentages up to 0.5%.  The applicable percentages are calculated
      based on our leverage ratio.  As of February 28, 2007 and November 30,
      2006, we had $30.0 million and $0, respectively, of borrowings outstanding
      under
      the revolving credit facility portion of our Credit Facility.  As of
      March 26, 2007, we had $15.0 million of borrowings outstanding under the
      revolving credit facility portion of our Credit Facility and our borrowing
      capacity was $85.0 million.





The
      term
      loan under the Credit Facility bears interest of either LIBOR plus 1.75% or
      the
      Base Rate plus 0.75%.  The term loan borrowings are to be repaid in
      increments of $0.8 million each calendar quarter, with the first principal
      payment due June 30, 2007.  The principal outstanding after scheduled
      repayment and any unscheduled prepayments is due January 2, 2013.





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


28


***Results
      of Operations***





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




For
                    the Three Months EndedFebruary
                    28, 2007
                
                
                February
                    28, 2006TOTAL
                    REVENUES
                
                
                100.0
                %
                
                
                100.0
                %COSTS
                    AND EXPENSES:Cost
                    of sales
                
                
                30.7
                
                
                
                31.0Advertising
                    and promotion
                
                
                28.5
                
                
                
                32.4Selling,
                    general and administrative
                
                
                12.5
                
                
                
                13.8Acquisition
                    expenses
                
                
                1.2
                
                
                
                —Litigation
                    settlement
                
                
                —
                
                
                
                (10.3
                )Total
                    costs and expenses
                
                
                72.9
                
                
                
                66.9INCOME
                    FROM OPERATIONS
                
                
                27.1
                
                
                
                33.1OTHER
                    INCOME (EXPENSE):Interest
                    expense
                
                
                (7.2
                )
                
                
                (3.4
                )Investment
                    and other income, net
                
                
                0.8
                
                
                
                0.2Loss
                    on early extinguishment of debt
                
                
                —
                
                
                
                (3.3
                )Total
                    other income (expense)
                
                
                (6.4
                )
                
                
                (6.5
                )INCOME
                    BEFORE INCOME TAXES
                
                
                20.7
                
                
                
                26.6PROVISION
                    FOR INCOME TAXES
                
                
                7.1
                
                
                
                9.1NET
                    INCOME
                
                
                13.6
                %
                
                
                17.5
                %





***Critical
      Accounting Policies***





The
      preparation of financial statements in accordance with U.S. generally accepted
      accounting principles requires management to use estimates.  Several
      different estimates or methods can be used by management that might yield
      different results.  The following are the significant estimates used
      by management in the preparation of the February 28, 2007 unaudited consolidated
      financial statements:





***Allowance
      for Doubtful Accounts***





As
      of
      February 28, 2007, an estimate was made of the collectibility of the outstanding
      accounts receivable balances.   This estimate requires the
      utilization of outside credit services, knowledge about the customer and the
      customer’s industry, new developments in the customer’s industry and operating
      results of the customer as well as general economic conditions and historical
      trends.  When all these facts are compiled, a judgment as to the
      collectibility of the individual account is made.   Many factors
      can impact this estimate, including those noted in this
      paragraph.  The adequacy of the estimated allowance may be impacted by
      the deterioration in the financial condition of a large customer, weakness
      in
      the economic environment resulting in a higher level of customer bankruptcy
      filings or delinquencies and the competitive environment in which the customer
      operates.  During the first quarter of fiscal 2007, we performed a
      detailed assessment of the collectibility of trade accounts receivable and
      did
      not make any significant adjustments to our estimate of allowance for doubtful
      accounts.  The balance of allowance for doubtful accounts was
      $0.3 million at February 28, 2007 and November 30, 2006.





***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




29


sales
      are
      recorded, we accrue an estimated amount for product returns, as a reduction
      of
      these sales, based upon our historical experience and consideration of
      discontinued products, products divestitures, estimated inventory levels held
      by
      our customers and retail point of sale data on existing and newly introduced
      products.  The level of returns may fluctuate from our estimates due
      to several factors including weather conditions, customer inventory levels
      and
      competitive conditions.  We charge the allowance account resulting
      from this accrual with any authorized deduction from remittance by the customer
      or product returns upon receipt of the product.





We
      separate returns into the two categories of seasonal and non-seasonal
      products.  We use the historical return detail of seasonal and
      non-seasonal products for at least the most recent three fiscal years on
      generally all products, which is normalized for any specific occurrence that
      is
      not reasonably likely to recur, to determine the amount of product returned
      as a
      percentage of sales, and estimate an allowance for potential returns based
      on
      product sold in the current period.  To consider product sold in
      current and prior periods, an estimate of inventory held by our retail customers
      is calculated based on customer inventory detail.  This estimate of
      inventory held by our customers, along with historical returns as a percentage
      of sales, is used to determine an estimate of potential product
      returns.  This estimate of the allowance for seasonal and non-seasonal
      returns is further analyzed by considering retail customer point of sale
      data.  We also consider specific events, such as discontinued product
      or product divestitures, when determining the adequacy of the
      allowance.  Based on consideration of the sales of *Icy Hot
      Pro-Therapy* performing below expectations, review of retail point of sales
      data throughout fiscal 2006 and an estimate of inventory on hand at customers,
      an allowance for returns of $3.3 million was recorded as of November 30,
      2006.  As of February 28, 2007, the allowance for *Icy Hot
      Pro-Therapy* returns is $2.9 million.  As of February 28, 2007, we
      have completed our obligation with respect to pHisoderm returns and no longer
      have exposure to any liability.  Our estimate of product returns for
      seasonal and non-seasonal products as of February 28, 2007 was $0.9 million
      and
      $1.1 million, respectively, and $1.2 million and $1.3 million, respectively,
      as
      of November 30, 2006.  For the three months ended February 28, 2007,
      we decreased our estimate of returns for seasonal products and non-seasonal
      returns by approximately $0.3 million and $0.2 million, respectively, which
      resulted in an increase to net sales in our consolidated financial
      statements.  During the three months ended February 28, 2006, we
      increased our estimate of returns for seasonal products and non-seasonal returns
      by approximately $0.4 million and $0.3 million, respectively, which resulted
      in
      a decrease to net sales in our consolidated financial
      statements.  Each percentage point change in the seasonal return rate
      would impact net sales by approximately $0.1 million.  Each percentage
      point change in the non-seasonal return rate would impact net sales by
      approximately $0.6 million.





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





We
      analyze promotional programs in two primary categories — coupons and vendor
      allowances.  Customers normally utilize vendor allowances in the form
      of temporary price reductions, scan downs, display activity and participations
      in in-store programs provided uniquely by the customer.  We estimate
      the accrual for outstanding coupons by utilizing a third-party clearinghouse
      to
      track coupons issued, coupon value, distribution and expiration dates, quantity
      distributed and estimated redemption rates that are provided by
      us.  We estimate the redemption rates based on internal analysis of
      historical coupon redemption rates and expected future retail sales by
      considering recent point of sale data.  The estimate for vendor
      allowances is based on estimated unit sales of a product under a program and
      amounts committed for such programs in each fiscal year.  Estimated
      unit sales are determined by considering customer forecasted sales, point of
      sale data and the nature of the program being offered.  The three most
      recent years of expected program payments versus actual payments made and
      current year retail point of sale trends are analyzed to determine future
      expected payments.  Customer delays in requesting promotional program
      payments due to their audit of program participation and resulting request
      for
      reimbursement is also considered to evaluate the accrual for vendor
      allowances.  The costs of these programs is often variable based on
      the number of units actually sold.  As of February 28, 2007, the
      coupon accrual and reserve for vendor allowances were $1.4 million and $5.5
      million, respectively, and $1.2 million and $3.7 million, respectively, as
      of
      November 30, 2006.  Each percentage point change in promotional
      program participation and advertising and promotion expense would impact net
      sales by an insignificant amount.





***Income
      Taxes***





We
      account for income taxes using the asset and liability approach as prescribed
      by
      SFAS 109 and applicable FASB Staff Positions and
      Interpretations.  This approach requires recognition of deferred tax
      assets and liabilities for the expected future tax consequences of events that
      have been included in our condensed 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




30


liabilities
      are determined based on the differences between the financial reporting and
      the
      tax basis of an asset or liability.  We record income tax expense in
      our consolidated financial statements based on an estimated annual effective
      income tax rate.  Our tax rate for the three months ended February 28,
      2007 was 34.5%, as compared to 34% in the three months ended February 28, 2006,
      respectively.





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





***Comparison
      of Three Months Ended February 28, 2007 and 2006***





To
      facilitate discussion of our operating results for the three months ended
      February 28, 2007 and 2006, we have included the following selected data from
      our unaudited Consolidated Statements of Income:





Increase
                  (Decrease)2007
              
              
              2006
              
              
              Amount
              
              
              Percentage(dollars
                  in thousands)Domestic
                  net sales
              
              $
              94,623
              
              
              $
              78,443
              
              
              $
              16,180
              
              
              
              20.6
              %International
                  revenues (including royalties)
              
              
              6,208
              
              
              
              5,581
              
              
              
              627
              
              
              
              11.2Total
                  revenues
              
              
              100,831
              
              
              
              84,024
              
              
              
              16,807
              
              
              
              20.0Cost
                  of sales
              
              
              30,980
              
              
              
              26,020
              
              
              
              4,960
              
              
              
              19.1Advertising
                  and promotion expense
              
              
              28,787
              
              
              
              27,187
              
              
              
              1,600
              
              
              
              5.9Selling,
                  general and administrative expense
              
              
              12,586
              
              
              
              11,591
              
              
              
              995
              
              
              
              8.6Acquisition
                  expenses
              
              
              1,171
              
              
              
              —
              
              
              nm
              
              
              nmLitigation
                  settlement
              
              
              —
              
              
              
              (8,613
              )
              
              nm
              
              
              nmInterest
                  expense
              
              
              7,236
              
              
              
              2,844
              
              
              
              4,392
              
              
              
              154.4Loss
                  on early extinguishment of debt
              
              
              —
              
              
              
              2,805
              
              
              nm
              
              
              nmNet
                  income
              
              
              13,650
              
              
              
              14,773
              
              
              
              (1,123
              )
              
              
              (7.6
              )





**Domestic
      Net Sales**





Domestic
      net sales for the three months ended February 28, 2007 increased
      $16.2  million, or 20.6%, to $94.6 million from $78.4 million in
      the prior year quarter.   A comparison of domestic net sales for
      the categories of products included in our portfolio of OTC healthcare products
      is as follows:


Increase
                  (Decrease)2007
              
              
              2006
              
              
              Amount
              
              
              Percentage(dollars
                  in thousands)Topical
                  pain care
              
              $
              27,226
              
              
              $
              32,441
              
              
              $
              (5,215
              )
              
              
              (16.1
              )%Medicated
                  skin care
              
              
              27,833
              
              
              
              16,892
              
              
              
              10,941
              
              
              
              64.8Medicated
                  dandruff shampoos
              
              
              10,296
              
              
              
              11,816
              
              
              
              (1,520
              )
              
              
              (12.9
              )Oral
                  care
              
              
              8,487
              
              
              
              1,615
              
              
              
              6,872
              
              
              
              425.5Internal
                  OTC products
              
              
              8,449
              
              
              
              2,561
              
              
              
              5,888
              
              
              
              229.9Dietary
                  supplements
              
              
              8,030
              
              
              
              8,853
              
              
              
              (823
              )
              
              
              (9.3
              )Other
                  OTC and toiletry products
              
              
              4,302
              
              
              
              4,265
              
              
              
              37
              
              
              
              0.9Total
              
              $
              94,623
              
              
              $
              78,443
              
              
              $
              16,180
              
              
              
              20.6





Net
      sales
      in the topical pain care category decreased 16.1% for the first quarter of
      fiscal 2007 compared to the prior year quarter, due primarily to the launch
      and
      initial sell-in of *Icy Hot Pro-Therapy*in the first quarter of fiscal
      2006.  Excluding sales of *Icy Hot Pro-Therapy,* the category
      increased 25.7% compared to the prior year quarter, led by the introduction
      of
*Icy Hot Heat Therapy*and the continued success of the *Icy Hot*
      back patches.





Net
      sales
      in the medicated skin care products category increased 64.8% in the first
      quarter of fiscal 2007 compared to the prior year quarter due to the acquisition
      of the *Cortizone* and *Balmex* brands effective January 2, 2007
      and the 26.6% increase in net sales of *Gold Bond*, led by strong sales
      of *Gold Bond Ultimate* Softening Lotion.





Net
      sales
      in the medicated dandruff shampoos category decreased 12.9% in the first quarter
      of fiscal 2007 compared to the prior year quarter due to the launch and initial
      sell-in of *Selsun Salon* in the first quarter of fiscal
      2006.





Net
      sales
      in the oral care products category increased 425.5% in the first quarter of
      fiscal 2007 compared to the prior year quarter due to the acquisition of
*ACT* effective January 2, 2007 and increased sales of
*Benzodent*.





31


Net
      sales
      in the internal OTC products category increased 229.9% in the first quarter
      of
      fiscal 2007 compared to the prior year quarter due to the acquisition of
*Unisom* and *Kaopectate* effective January 2, 2007.





Net
      sales
      in the dietary supplements category decreased 9.3% for the first quarter of
      fiscal 2007 compared to the prior year quarter as a result of the launch and
      initial sell-in of *Garlique* Cardio Assist in the first quarter of
      fiscal 2006 offset in part by the launch of *Dexatrim Max*Evening
      Appetite Control in the first quarter of fiscal 2007 and the continued growth
      of
*Dexatrim*Max2O.





Net
      sales
      in the other OTC and toiletry products category increased 0.9% for the first
      quarter of fiscal 2007 compared to the prior year quarter due primarily to
      the
      timing of shipments of *Bullfrog Marathon Mist*.





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





**International
      Revenues**





For
      the
      first quarter of fiscal 2007, international revenues increased $0.6 million,
      or
      11.2%, compared to the first quarter of fiscal 2006, primarily due to increased
      sales to certain countries and the expansion into a new European
      market.





**Cost
      of Sales**





Cost
      of
      sales as a percentage of total revenues was 30.7% for the first quarter of
      fiscal 2007 as compared to 31.0% in the prior year
      quarter.  Gross margin for the first quarter of fiscal 2007 was 69.3%
      compared to 69.0% in the prior year quarter.  The increase of gross
      margin was largely attributable to reduced sales of *Icy Hot
      Pro-Therapy*, a lower margin product.





**Advertising
      and Promotion Expense**





Advertising
      and promotion expenses in the first quarter of fiscal 2007 increased $1.6
      million, or 5.9%, as compared to the same quarter of fiscal 2006 and were
      28.5% of total revenues for the three months ended February 28, 2007 compared
      to
      32.4% for the prior year quarter.  The reduction as a percentage of
      total revenue is largely a result of the initial advertising and promotion
      support for *Icy**Hot Pro-Therapy* in the first quarter of fiscal
      2006.





**Selling,
      General and Administrative Expense**





Selling,
      general and administrative expenses increased $1.0 million, or 8.6%, compared
      to
      the prior year quarter.  Selling, general and administrative expenses
      were 12.5% and 13.8% of total revenues for the first quarter of fiscal 2007
      and
      2006, respectively.  The $1.0 million increase is attributable to the
      additional costs resulting from the J&J Acquisition and transitioning the
      acquired brands to our operations.





**Acquisition
      Expenses**





Acquisition
      expenses of $1.2 million for the first quarter of fiscal 2007 primarily related
      to transition services in connection with the integration of the five acquired
      brands from the J&J Acquisition.





**Litigation
      Settlement**





The
      $8.6 million litigation settlement
      in the first quarter of fiscal 2006 related to the recovery (net of legal
      expenses) from the DELACO settlement trust in the Dexatrim litigation settlement
      and there was no corresponding amount recorded in the first fiscal quarter
      of
      2007.





**Interest
      Expense**





Interest
      expense increased $4.4 million, or 154.4%, in the first quarter of fiscal 2007
      as compared to the prior year quarter, reflecting the impact of additional
      indebtedness incurred to finance the J&J Acquisition.  Until our
      indebtedness is reduced substantially, interest expense will continue to
      represent a significant percentage of our total revenues.





**Loss
      on Early Extinguishment of Debt**





Our
      $75.0 million of Floating Rate
      Senior Notes were fully redeemed in the first quarter of fiscal
      2006.  As a result of the redemption, a loss on early extinguishment
      of debt of $2.8 million was recorded in the first quarter of fiscal
      2006.  No corresponding charge was incurred in the first quarter of
      fiscal 2007.





32


***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
      $9.9 million and $5.7 million was provided by operations for the three
      months ended February 28, 2007 and 2006, respectively.  The increase
      in cash flows from operations over the prior year quarter was primarily
      attributable to increased accounts payable and accrued liabilities partially
      offset by increased accounts receivable.





Investing
      activities used cash of
      $412.4 and $1.9 million in the three months ended February 28, 2007 and 2006,
      respectively.  The increase in the use of cash was related to the use
      of funds to complete the J&J Acquisition on January 2, 2007.





Financing
      activities provided cash of $327.7 million and used cash of $40.0 million in
      the
      three months ended February 28, 2007 and 2006, respectively.  The
      increase in cash provided in the current period was primarily attributable
      to
      the funds borrowed to complete the J&J Acquisition.





***Foreign
      Operations***





Historically,
      our primary foreign operations have been conducted through our Canadian and
      United Kingdom (“U.K.”) subsidiaries.  Effective November 1, 2004, we
      transitioned our European business to Chattem Global Consumer Products Limited,
      a wholly-owned subsidiary located in Limerick, Ireland.  The
      functional currencies of these subsidiaries are Canadian dollars and Euros,
      respectively.  Fluctuations in exchange rates can impact operating
      results, including total revenues and expenses, when translations of the
      subsidiary financial statements are made in accordance with SFAS No. 52,
“Foreign Currency Translation”.  For the three months ended February
      28, 2007 and 2006, these subsidiaries accounted for 5% and 6% of total revenues,
      respectively, and 2% and 3% of total assets, respectively.  It has not
      been our practice to hedge our assets and liabilities in Canada, the U.K. and
      Ireland or our intercompany transactions due to the inherent risks associated
      with foreign currency hedging transactions and the timing of payments between
      us
      and our foreign subsidiaries.    Historically, gains or
      losses from foreign currency transactions have not had a material impact on
      our
      operating results.  Losses resulting from foreign currency
      transactions are insignificant for the three months ended February 28, 2007
      and
      2006 and are included in selling, general and administrative expenses in the
      Consolidated Statements of Income.





***Recent
      Accounting Pronouncements***





In
      December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
      123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which is a revision of
      SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS
      123”).  SFAS 123R supersedes APB Opinion No. 25, “Accounting for Stock
      Issued to Employees” (“APB 25”) and amends SFAS No. 95, “Statement of Cash
      Flows”.  SFAS 123R focuses primarily on accounting for transactions in
      which an entity obtains employee services in share-based payment transactions
      and requires all share-based payments to employees, including grants of employee
      stock options, to be recognized as additional compensation expense in the
      financial statements based on the calculated fair value of the
      awards.  SFAS 123R also requires the benefits of tax deductions in
      excess of recognized compensation costs to be reported as a financing cash
      flow.  We adopted SFAS 123R effective for our fiscal year beginning
      December 1, 2005.  We have described the impact of adopting SFAS 123R
      in our consolidated financial statements in Note 5, Stock-Based
      Compensation.





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





In
      September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS
      157”).  SFAS 157 provides guidance for using fair value to measure
      assets and liabilities and is intended to respond to investors’ requests for
      expanded information about the extent to which companies measure assets and
      liabilities at fair value, the information used to measure fair value, and
      the
      effect of fair value measurements on earnings.  SFAS 157 applies
      whenever other standards require (or permit) assets or liabilities to be
      measured at fair value but does not expand the use of fair value in any new
      circumstances.  SFAS 157 also requires expanded disclosure of the
      effect on earnings for items measured using unobservable data, establishes
      a
      fair value




33


hierarchy
      that prioritizes the information used to develop those assumptions and requires
      separate disclosure by level within the fair value hierarchy.  The
      provisions of SFAS 157 are effective for interim financial statements issued
      for
      fiscal years beginning after November 15, 2007, or our fiscal 2008.





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





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





***Forward
      Looking Statements***





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





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


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


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


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


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


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


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


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


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


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


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


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


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


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


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




34


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


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


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


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


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


·
            the
                trading price of our common stock may be
                volatile; ·
            to
              service our indebtness, we will require a significant amount of cash;
              and


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









































35


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





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





Our
      exposure to interest rate risk currently relates to amounts outstanding under
      our Credit Facility.  Loans under the revolving credit facility
      portion of our Credit Facility bear interest at LIBOR plus applicable
      percentages of 1.00% to 2.00% or the higher of the federal funds rate plus
      0.5%
      or the prime rate (the “Base Rate”) plus applicable percentages of up to
      0.5%.  The applicable percentages are calculated based on our leverage
      ratio.  The term loan under our Credit Facility bears interest at
      either LIBOR plus 1.75% or the Base Rate plus 0.75%.  As of February
      28, 2007, $30.0 million was outstanding under the revolving credit facility
      and
      $300.0 million was outstanding under the term loan of our Credit
      Facility.  The variable rates on the revolving credit facility was
      LIBOR plus 2.00%, or 7.35%, and the term loan was LIBOR plus 1.75%, or
      7.11%.  The 7.0% Subordinated Notes and the 2.0% Convertible Senior
      Notes are fixed interest rate obligations.





On
      March
      8, 2004, we entered into an interest rate cap agreement effective June 1, 2004
      with decreasing annual notional principal amounts of $15.0 million beginning
      March 1, 2006 and cap rates ranging from 4.0% to 5.0% over the life of the
      agreement.  The amortized value of the premium on the interest rate
      cap was compared to its fair value as of February 28, 2007 resulting in a loss
      of $0.1 million, reflected in our consolidated income statement as interest
      expense.  The interest rate cap agreement terminates on March 1,
      2010.





On
      November 22, 2006, we entered into a forward starting cap agreement effective
      January 15, 2007.  The forward starting cap has decreasing notional
      principal amounts beginning October 15, 2007 and a cap rate of 5.0% over the
      life of the agreement.  As of February 28, 2007, the value of the
      premium on the forward starting cap was compared to the fair value of the
      forward starting cap and the increase in the market value of the premium of
      $25,000, net of tax, was recorded to other comprehensive income.  The
      cap was deemed to be an effective cash flow hedge.  The forward
      starting cap agreement terminates on January 15, 2010.





On
      November 22, 2006, we entered into a forward starting swap agreement effective
      January 15, 2007.  The forward starting swap has decreasing notional
      principal amounts beginning October 15, 2007 and a swap rate of 4.98% over
      the
      life of the agreement.  As of February 28, 2007, the increase in fair
      value of $0.3 million, net of tax, was recorded to other comprehensive
      income.  The swap was deemed to be an effective cash flow
      hedge.  The forward starting swap agreement terminates on January 15,
      2010.





The
      impact on our results of operations of a one-point rate change on the March
      26,
      2007 outstanding revolving credit facility balance of $15.0 million and $300.0
      million term loan balance of our Credit Facility for the next twelve months
      would be approximately $2.1 million, net of tax.





We
      are subject to risk from changes in
      the foreign exchange rates relating to our Canadian, U.K. and Irish
      subsidiaries. Assets and liabilities of these subsidiaries are translated to
      U.S. dollars at year-end exchange rates. Income and expense items are translated
      at average rates of exchange prevailing during the year.  Translation
      adjustments are accumulated as a separate component of shareholders’ equity.
      Gains and losses, which result from foreign currency transactions, are included
      in the consolidated statements of income.  The potential loss
      resulting from a hypothetical 10.0% adverse change in the quoted foreign
      currency exchange rate amounts to approximately $0.9 million as of February
      28,
      2007.





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





**Item
      4. Controls and Procedures**





Under
      the
      supervision and with the participation of our management, including our
      principal executive officer and principal financial officer, we have evaluated
      the effectiveness of our disclosure controls and procedures (as such terms
      are
      defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act
      of
      1934, as amended (the “Exchange Act”), as of February 28, 2007 (the “Evaluation
      Date”).  Based on such evaluation, such officers have concluded that,
      as of the Evaluation Date, our disclosure controls and procedures were effective
      in alerting them on a timely basis to material information relating to us
      (including our consolidated subsidiaries) required to be included in our reports
      filed or submitted under the Exchange Act.


36


**PART
      II.  OTHER INFORMATION**


**Item
      1.  Legal Proceedings**





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





**Item
      1A.  Risk Factors**





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





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





A
      summary of the common stock
      repurchase activity for our first quarter of fiscal 2007 is as
      follows:





Period
              
              Total
                  Number
                of
                  Shares
                Purchased
              
              
              Average
                  Price
                Paid
                  Per Share (1)
              
              
              Total
                  Number of
                Shares
                  Purchased
                as
                  Part of Publicly
                Announced
                  Plans or
                Programs
                  (2)
              
              
              Approximate
                  Dollar
                Value
                  that may yet
                be
                  Purchased under
                the
                  Plans or
                Programs (2)December
                  1– December 31
              
              
              —
              
              
              $
              —
              
              
              
              —
              
              
              
              88,147,224January
                  1 – January 31
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              88,147,224February
                  1 – February 28
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              88,147,224Total
                  First Quarter
              
              
              —
              
              
              $
              —
              
              
              
              —
              
              
              
              88,147,224





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




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





**Item
      3.  Defaults Upon Senior Securities**


None.





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


None.





**Item
      5.  Other Information**


None.


37


**Item
      6. Exhibits**





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





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














38


**CHATTEM,
      INC.**


**SIGNATURES**








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











CHATTEM,
              INC.
              **(Registrant)**Dated:  
                  April 2, 2007
            By:
            /s/ Zan
              GuerryZan
              GuerryChairman
                and Chief Executive Officer 
 Dated:    April
                  2, 2007
              By:
              /s/ Robert
                E. BosworthRobert
                E. BosworthPresident
                    and Chief Operating Officer


39


**Chattem,
      Inc. and Subsidiaries**


**Exhibit
      Index**











Exhibit
                                Number
                            Description
                                of Exhibit31.1
                            Certification
                                required by Rule 13a-14(a) under the Securities Exchange
                                Act of
                                193431.2
                            Certification
                                required by Rule 13a-14(a) under the Securities Exchange
                                Act of
                                193432
                            Certification
                                required by Rule 13a-14(b) under the Securities Exchange
                                Act of 1934 and
                                18 U.S.C. Section
                                1350











40