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 29, 2008


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. YESþ   NO 





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





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





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). YES   NO þ




As
of April 1, 2008, 19,177,048 shares of the Company’s common stock, without par
value, were outstanding.











CHATTEM,
INC.





INDEX







PART I.  FINANCIAL
      INFORMATION
            PAGE
      NO.Item
      1.  Financial StatementsConsolidated
      Balance Sheets as of February 29, 2008 andNovember
      30, 2007
            3Consolidated
      Statements of Income for the ThreeMonths
      Ended February 29, 2008 and February 28, 2007
            5Consolidated
      Statements of Cash Flows for the Three MonthsEnded
      February 29, 2008 and February 28, 2007
            6Notes
      to Consolidated Financial Statements
            7Item
      2.  Management's Discussion and Analysis of Financial
      Conditionand
      Results of Operations
            28Item
      3.  Quantitative and Qualitative Disclosures About Market
      Risk
            37Item
      4.  Controls and Procedures
            37PART
      II.  OTHER INFORMATIONItem
      1. Legal Proceedings
            38Item
      1A. Risk Factors
            38Item
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
            38Item
      3. Defaults Upon Senior Securities
            38Item
      4. Submission of Matters to a Vote of Security Holders
            38Item
      5. Other Information
            38Item
      6. Exhibits
            39SIGNATURES
            40





2


PART 1. FINANCIAL
INFORMATION








Item 1. Financial
Statements








CHATTEM, INC. AND
SUBSIDIARIES





CONSOLIDATED BALANCE
SHEETS


(In
thousands)





ASSETS
            
            FEBRUARY
      29,
              2008
            
            
            NOVEMBER
      30,
              2007(Unaudited)CURRENT
      ASSETS:Cash
      and cash equivalents
            
            $
            11,619
            
            
            $
            15,407Accounts
      receivable, less allowances of $15,575 at
              February
      29, 2008 and $13,810 at November 30, 2007
            
            
            58,134
            
            
            
            43,753Inventories
            
            
            42,538
            
            
            
            43,265Deferred
      income taxes
            
            
            7,463
            
            
            
            6,750Prepaid
      expenses and other current assets
            
            
            5,806
            
            
            
            2,065Total
      current assets
            
            
            125,560
            
            
            
            111,240PROPERTY,
      PLANT AND EQUIPMENT, NET
            
            
            32,494
            
            
            
            32,349OTHER
      NONCURRENT ASSETS:Patents,
      trademarks and other purchased product rights, net
            
            
            616,865
            
            
            
            616,810Debt
      issuance costs, net
            
            
            14,223
            
            
            
            15,430Other
            
            
            4,800
            
            
            
            4,731Total
      other noncurrent assets
            
            
            635,888
            
            
            
            636,971TOTAL
      ASSETS
            
            $
            793,942
            
            
            $
            780,560







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
      29,
              2008
            
            
            NOVEMBER
      30,
              2007(Unaudited)CURRENT
      LIABILITIES:Current
      maturities of long-term debt
            
            $
            128,000
            
            
            $
            3,000Accounts
      payable and other
            
            
            20,682
            
            
            
            18,239Bank
      overdraft
            
            
            2,850
            
            
            
            7,584Accrued
      liabilities
            
            
            24,924
            
            
            
            21,537Total
      current liabilities
            
            
            176,456
            
            
            
            50,360LONG-TERM
      DEBT, less current maturities
            
            
            370,000
            
            
            
            505,000DEFERRED
      INCOME TAXES
            
            
            24,257
            
            
            
            21,056OTHER
      NONCURRENT LIABILITIES
            
            
            3,566
            
            
            
            2,436COMMITMENTS
      AND CONTINGENCIES (Note 19)SHAREHOLDERS’
      EQUITY:Preferred
      shares, without par value, authorized 1,000,
              none
      issued
            
            
            —
            
            
            
            —Common
      shares, without par value, authorized 100,000,
              issued
      and outstanding 19,177 at February 29, 2008 and
              19,092
      at November 30, 2007
            
            
            41,980
            
            
            
            36,800Retained
      earnings
            
            
            179,817
            
            
            
            165,655221,797
            
            
            
            202,455Cumulative
      other comprehensive income, net of tax:Interest
      rate hedge adjustment
            
            
            (3,320
            )
            
            
            (1,747
            )Foreign
      currency translation adjustment
            
            
            1,194
            
            
            
            1,008Unrealized
      actuarial gains and losses
            
            
            (8
            )
            
            
            (8
            )Total
      shareholders’ equity
            
            
            219,663
            
            
            
            201,708TOTAL
      LIABILITIES AND SHAREHOLDERS’
              EQUITY
            
            $
            793,942
            
            
            $
            780,560




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
      29,
            
            
            FEBRUARY
      28,2008
            
            
            2007TOTAL
      REVENUES
            
            $
            120,773
            
            
            $
            100,831COSTS
      AND EXPENSES:Cost
      of sales
            
            
            34,733
            
            
            
            30,980Advertising
      and promotion
            
            
            34,496
            
            
            
            28,787Selling,
      general and administrative
            
            
            15,466
            
            
            
            12,411Product
      recall expenses
            
            
            6,043
            
            
            
            –Acquisition
      expenses
            
            
            –
            
            
            
            1,171Total
      costs and expenses
            
            
            90,738
            
            
            
            73,349INCOME
      FROM OPERATIONS
            
            
            30,035
            
            
            
            27,482OTHER
      INCOME (EXPENSE):Interest
      expense
            
            
            (6,552
            )
            
            
            (7,236
            )Investment
      and other income, net
            
            
            137
            
            
            
            593Loss
      on early extinguishment of debt
            
            
            (526
            )
            
            
            –Total
      other income (expense)
            
            
            (6,941
            )
            
            
            (6,643
            )INCOME
      BEFORE INCOME TAXES
            
            
            23,094
            
            
            
            20,839PROVISION
      FOR INCOME TAXES
            
            
            8,221
            
            
            
            7,189NET
      INCOME
            
            $
            14,873
            
            
            $
            13,650NUMBER
      OF COMMON SHARES:
              Weighted
      average outstanding - basic
            
            
            19,106
            
            
            
            18,657Weighted
      average and potential dilutive outstanding
            
            
            19,788
            
            
            
            19,224NET
      INCOME  PER COMMON SHARE:Basic
            
            $
            .78
            
            
            $
            .73Diluted
            
            $
            .75
            
            
            $
            .71








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


5


CHATTEM, INC. AND
SUBSIDIARIES





CONSOLIDATED STATEMENTS OF
CASH FLOWS


(Unaudited
and in thousands)









FOR THE THREE
      MONTHS ENDEDFEBRUARY 29,
      2008
            
            
            FEBRUARY
      28, 2007OPERATING
      ACTIVITIES:Net
      income
            
            $
            14,873
            
            
            $
            13,650Adjustments
      to reconcile net income to net cash provided by
              operating
      activities:Depreciation
      and amortization
            
            
            2,119
            
            
            
            2,029Deferred
      income taxes
            
            
            4,433
            
            
            
            2,794Tax
      benefit realized from stock options exercised
            
            
            (1,812
            )
            
            
            (3,013
            )Stock–based
      compensation expense
            
            
            1,339
            
            
            
            1,204Loss
      on early extinguishment of debt
            
            
            526
            
            
            
            –Other,
      net
            
            
            112
            
            
            
            124Changes
      in operating assets and liabilities, net of effects from
      acquisitions:Accounts
      receivable and other
            
            
            (14,381
            )
            
            
            (23,212
            )Inventories
            
            
            737
            
            
            
            358Refundable
      income taxes
            
            
            –
            
            
            
            196Prepaid
      expenses and other current assets
            
            
            (3,746
            )
            
            
            680Accounts
      payable and accrued liabilities
            
            
            6,047
            
            
            
            15,127Net
      cash provided by operating activities
            
            
            10,247
            
            
            
            9,937INVESTING
      ACTIVITIES:Purchases
      of property, plant and equipment
            
            
            (1,271
            )
            
            
            (453
            )Acquisition
      of brands
            
            
            –
            
            
            
            (411,888
            )Increase
      in other assets, net
            
            
            (1,656
            )
            
            
            (26
            )Net
      cash used in investing activities
            
            
            (2,927
            )
            
            
            (412,367
            )FINANCING
      ACTIVITIES:Repayment
      of long-term debt
            
            
            (35,750
            )
            
            
            –Proceeds
      from long-term debt
            
            
            –
            
            
            
            300,000Proceeds
      from borrowings under revolving credit facility
            
            
            69,500
            
            
            
            39,000Repayments
      of revolving credit facility
            
            
            (43,750
            )
            
            
            (9,000
            )Bank
      overdraft
            
            
            (4,734
            )
            
            
            (3,719
            )Proceeds
      from exercise of stock options
            
            
            2,057
            
            
            
            4,457Repurchase
      of common shares
            
            
            (240
            )
            
            
            –Increase
      in debt issuance costs
            
            
            –
            
            
            
            (6,079
            )Tax
      benefit realized from stock options exercised
            
            
            1,812
            
            
            
            3,013Net
      cash (used in) provided by financing activities
            
            
            (11,105
            )
            
            
            327,672EFFECT
      OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
            
            
            (3
            )
            
            
            (20
            )CASH
      AND CASH EQUIVALENTS:Decrease
      for the period
            
            
            (3,788
            )
            
            
            (74,778
            )At
      beginning of period
            
            
            15,407
            
            
            
            90,527At
      end of period
            
            $
            11,619
            
            
            $
            15,749PAYMENTS
      FOR:Interest
            
            $
            2,932
            
            
            $
            688Taxes
            
            $
            6,104
            
            
            $
            4,787








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, 2007.  The accompanying unaudited consolidated
financial statements, in the opinion of management, include all adjustments
necessary for a fair presentation.  All such adjustments are of a
normal recurring nature.





2. CASH AND CASH
EQUIVALENTS





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





3. RECENT ACCOUNTING
PRONOUNCEMENTS





In July
2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes” (“FIN 48”), 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.  Additionally, in May
2007, the FASB published FASB Staff Position (“FSP”) No. FIN 48-1, “Definition
of Settlement in FASB Interpretation No. 48” (“FSP FIN 48-1”).  FSP
FIN 48-1 is an amendment to FIN 48.  It clarifies how an enterprise
should determine whether a tax position is effectively settled for the purpose
of recognizing previously unrecognized tax benefits.  The provisions
of FIN 48 and FSP FIN 48-1 are effective for fiscal years beginning after
December 15, 2006.  We adopted the provisions of FIN 48 and FSP FIN
48-1 at the beginning of the first quarter of fiscal 2008, and the details of
our adoption of FIN 48 are described in Note 17.




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.  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.  We adopted SFAS 157
effective December 1, 2007 as described in Note 8.




In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities” (“SFAS 159”).  SFAS 159
permits entities to choose to measure certain financial assets and liabilities
at fair value.  Unrealized gains and losses on items for which the
fair value option has been elected are reported in earnings. We adopted SFAS 159
effective December 1, 2007 without choosing to elect to measure certain
financial assets or liabilities at fair value that were not previously measured
at fair value.  Thus there was no impact to our consolidated financial
statements.




In
December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS
141R”).  SFAS 141R provides guidance to improve the relevance,
representational faithfulness and comparability of the information that a
reporting entity provides in its financial reports about its business
combinations and its effects.  SFAS 141R establishes principles and
requirements for how the acquirer recognizes and measures in its financial
statements the identifiable assets acquired, liabilities assumed, the intangible
assets acquired and determines what information to disclose to enable users of
the financial statements to evaluate the nature and financial effects of the
business combination.  The provisions of SFAS 141R are effective for
fiscal years beginning after December 15, 2008, with earlier application
prohibited.  Accordingly, we will apply the provisions of SFAS 141R
prospectively to business combinations consummated beginning in the first
quarter of fiscal 2010.





In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities” (“SFAS 161”).  SFAS 161 requires enhanced
disclosures about derivative and hedging activities.  SFAS 161 is
effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008, with early application encouraged, and we are
currently evaluating the impact.


7


4.  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 No. 123 (revised 2004), “Share-Based Payment”
(“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).





In the
first quarter of fiscal 2008 and 2007, we recorded compensation expense related
to stock options that reduced income from operations by $1,339 and $1,204,
provision for income taxes by $477 and $415, net income by $862 and $789, basic
net income per share by $.05 and $.04, and diluted net income per share by $.04
and $.04, respectively.  The stock option compensation expense was
included partly in cost of sales, advertising and promotion expenses and
selling, general and administrative expenses in the accompanying consolidated
statements of income.  We capitalized $193 and $174 of stock option
compensation cost as a component of the carrying cost of inventory on-hand as of
February 29, 2008 and February 28, 2007, respectively.





The
weighted average fair value of stock options at the date of grant during the
three months ended February 29, 2008 was $28.55.  The fair value of
each stock option grant was estimated on the date of grant using a Flex Lattice
Model.  The following assumptions were used to determine the fair
value of stock option grants during the three months ended February 29,
2008:




Three Months Ended
              February 29,
      2008Expected
      life
            6
      yearsVolatility
            34%Risk-free
      interest rate
            4.47%Dividend
      yield
            0%Forfeitures
            1.2%





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


8


A summary
of stock option activity for the three-months ended February 29, 2008 is
presented below:









Shares
      Under Option
            
            
            Weighted
      Average Exercise Price
            
            Weighted
              Average
              Remaining
              Contractual
              Life
            
            
            Aggregate
              Intrinsic ValueOutstanding
      at December 1, 2007
            
            
            1,458
            
            
            $
            40.43Granted
            
            
            3
            
            
            
            69.65Exercised
            
            
            (87
            )
            
            
            23.76Cancelled
            
            
            –
            
            
            
            –Outstanding
      at February 29, 2008
            
            
            1,374
            
            
            $
            41.53
            
            4.8
      years
            
            $
            52,586Exercisable
      at February 29, 2008
            
            
            675
            
            
            $
            33.30
            
            4.5
      years
            
            $
            31,422





The total
fair value of stock options that vested during the three months ended February
29, 2008 and February 28, 2007 was $1,356 and $1,215,
respectively.  The total intrinsic value of stock options exercised
during the three months ended February 29, 2008 and February 28, 2007 was $4,540
and $11,472, respectively.





As of
February 29, 2008, we had $11,417 of unrecognized compensation cost related to
stock options that will be recorded over a weighted average period of
approximately 2.4 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 29, 2008 and February 28, 2007 was $93
and $184, respectively.





Restricted share under the plans
activity is summarized as follows:





Number
      of Shares
            
            
            Weighted
      Average Grant Date FairValueNonvested
      at December 1, 2007
            
            
            9
            
            
            $
            33.11Granted
            
            
            –
            
            
            
            –Vested
            
            
            3
            
            
            
            28.51Forfeited
            
            
            –
            
            
            
            –Nonvested
      at February 29, 2008
            
            
            6
            
            
            $
            35.37





As of February 29, 2008, we had $235 of
unrecognized compensation cost related to restricted shares that will be
recorded over a weighted average period of approximately 0.9
years.


9


5.  EARNINGS PER
SHARE





The
following table presents the computation of earnings per share for the three
months ended February 29, 2008 and February 28, 2007, respectively:





2008
            
            
            2007NET
      INCOME
            
            $
            14,873
            
            
            $
            13,650NUMBER
      OF COMMON SHARES:Weighted
      average outstanding
            
            
            19,106
            
            
            
            18,657Issued
      upon assumed exercise
      of       outstanding stock
      options
            
            
            195
            
            
            
            549Issued
      upon assumed exercise of convertible
          notes
            
            
            484
            
            
            
            –Effect
      of issuance of restricted common
          shares
            
            
            3
            
            
            
            18Weighted
      average and
      potential       dilutive outstanding
      (1)
            
            
            19,788
            
            
            
            19,224NET
      INCOME PER COMMON SHARE:Basic
            
            $
            .78
            
            
            $
            .73Diluted
            
            $
            .75
            
            
            $
            .71





(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: 401 and 0 shares
for the three months ended February 29, 2008 and February 28, 2007,
respectively.





6.  LONG-TERM
DEBT





Long-term
debt consisted of the following as of February 29, 2008 and November 30,
2007:






2008
            
            
            2007Revolving
      Credit Facility due 2010 at a   variable rate of 5.70% and
      6.19% as of   February 29, 2008 and November 30,
        2007, respectively
            
            $
            55,750
            
            
            $
            30,0002.0%
      Convertible Senior Notes due 2013
            
            
            125,000
            
            
            
            125,0001.625%
      Convertible Senior Notes due 2014
            
            
            100,000
            
            
            
            100,000Term
      Loan due 2013 at a variable rate of    6.13% and 6.97%
      as of February 29, 2008   and November 30,2007
            
            
            109,750
            
            
            
            145,5007.0%
      Senior Subordinated Notes due 2014
            
            
            107,500
            
            
            
            107,500


Total
      long-term debt
            
            
            498,000
            
            
            
            508,000Less:  current
      maturities
            
            
            128,000
            
            
            
            3,000Total
      long-term debt, net of current maturities
            
            $
            370,000
            
            
            $
            505,000





In
February 2004, we entered into a Senior Secured Revolving Credit Facility with a
maturity date of February 2009 (the “Revolving Credit Facility”) with Bank of
America, N.A. that provided an initial borrowing capacity of $25,000 and an
additional $25,000, subject to successful syndication.  In March 2004,
we entered into a commitment agreement with a syndicate of commercial banks led
by Bank of America, N.A., as agent, that enabled us to borrow up to a total of
$50,000 under the Revolving Credit Facility and an additional $50,000, subject
to successful syndication.  In November 2005, we entered into an
amendment to our Revolving Credit Facility (the “Amended Revolving Credit
Facility”) that, among other things, increased our borrowing capacity under the
facility from $50,000 to $100,000, increased our flexibility to repurchase
shares of our stock, improved our borrowing rate under the facility and extended
the maturity date to November 2010.  Upon successful syndication, we
will be able to increase the borrowing capacity under the Amended Revolving
Credit Facility by $50,000 to an aggregate of $150,000.  In November
2006, we entered into an amendment to our Amended Revolving Credit Facility
that, among other things, permitted the sale of the 2.0% Convertible Senior
Notes due 2013 (the “2.0% Convertible Notes”).  In January 2007, we
completed an amendment to the Amended Revolving Credit Facility providing for up
to a $100,000 revolving credit facility and a


10


$300,000
term loan (the “Credit Facility”).  The 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 “accordion” features that permit us under certain
circumstances to increase our borrowings under the revolving credit facility by
$50,000 and to borrow an additional $50,000 as a term loan, subject to
successful syndication.  In April 2007, we entered into an amendment
to our Credit Facility that, among other things, permitted the sale of the
1.625% Convertible Senior Notes due 2014  (the “1.625% Convertible
Notes”) and reduced the applicable interest rates on the revolving credit
facility portion of our Credit Facility.





Borrowings
under the revolving credit facility portion of our Credit Facility bear interest
at LIBOR plus applicable percentages of 0.875% to 1.500% or the higher of the
federal funds rate plus 0.5% or the prime rate (the “Base Rate”).  The
applicable percentages are calculated based on our leverage ratio.  As
of February 29, 2008 and November 30, 2007, we had $55,750 and $30,000,
respectively, of borrowings outstanding under the revolving credit facility
portion of our Credit Facility.  As of April 1, 2008, we had $50,250
of borrowings outstanding under the revolving credit facility portion of our
Credit Facility and our borrowing capacity was $49,750.





The term
loan under the Credit Facility bears interest at either LIBOR plus 1.75% or the
Base Rate plus 0.75%.  The term loan borrowings are to be repaid in
increments of $750 each calendar quarter, with the first principal payment paid
June 2007.  The principal outstanding after scheduled repayment and
any unscheduled prepayments matures and is payable January 2013.  In
April 2007, we utilized the net proceeds from the 1.625% Convertible Notes and
borrowings under the revolving credit facility portion of our Credit Facility to
repay $128,000 of the term loan under the Credit Facility.   In
July 2007, we utilized borrowings under the revolving credit facility portion of
our Credit Facility to repay an additional $25,000 of the term loan under the
Credit Facility.  In connection with the term loan repayments during
April 2007 and July 2007, we retired a proportional share of the term loan debt
issuance costs and recorded the resulting loss on early extinguishment of debt
of $2,633 in fiscal 2007.  In January 2008, we utilized borrowings
under the revolving credit facility portion of our Credit Facility to repay an
additional $35,000 of the term loan under the Credit Facility.  In
connection with the term loan repayment in January, we retired a proportional
share of the term loan debt issuance costs and recorded the resulting loss on
early extinguishment of debt of $526 in the first quarter of fiscal
2008.





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





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





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





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





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





In
November 2006, we completed a private offering of $125,000 of the 2.0%
Convertible Notes to qualified institutional purchasers pursuant to Section 4(2)
of the Securities Act of 1933.  The 2.0% Convertible Notes bear
interest at an annual rate of 2.0%, payable semi-annually in May and November of
each year.  The 2.0% Convertible Notes are convertible into our common
stock at an initial conversion price of $58.92 per share, upon the occurrence of
certain events, including the closing price of our


11


common
stock exceeding 130% of the initial conversion price per share, or $76.59 per
share, for 20 of the last 30 consecutive trading days of the preceding fiscal
quarter (the “prescribed measurement period”).  Based on the closing
price of our common stock for the prescribed measurement period during the
quarter ended February 29, 2008, the contingent conversion threshold of $76.59
for the 2.0% Convertible Notes was exceeded.  As a result, the 2.0%
Convertible Notes are convertible at the option of the holder as of February 29,
2008 and, accordingly, have been classified as a current liability in our
accompanying consolidated balance sheet as of February 29, 2008.  The
evaluation of the classification of the 2.0% Convertible Notes will occur each
fiscal quarter.  The 2.0% Convertible Notes may be classified as
long-term debt in future quarters if the contingent conversion threshold is not
met in such quarters.





Upon
conversion, a holder will receive, in lieu of common stock, an amount of cash
equal to the lesser of (i) the principal amount of the 2.0% Convertible
Notes, or (ii) the conversion value, determined in the manner set forth in
the indenture governing the 2.0% Convertible Notes, of a number of shares equal
to the conversion rate. If the conversion value exceeds the principal amount of
the 2.0% Convertible Notes on the conversion date, we will also deliver, at our
election, cash or common stock or a combination of cash and common stock with
respect to the conversion value upon conversion. If conversion occurs in
connection with a change of control, we may be required to deliver additional
shares of our common stock by increasing the conversion rate with respect to
such notes. The maximum aggregate number of shares that we would be obligated to
issue upon conversion of the 2.0% Convertible Notes is 2,673.





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





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





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





In
November 2006, we entered into an interest rate swap (“swap”) agreement
effective January 2007.  The swap has decreasing notional principal
amounts beginning October 2007 and a swap rate of 4.98% over the life of the
agreement.  As of February 29, 2008, we had $146,250 of LIBOR based
borrowings hedged under the provisions of the swap.  During the three
months ended February 29, 2008, the decrease in fair value of the swap of
$1,614, net of tax, was recorded to other comprehensive income.  The
current portion of the fair value of the swap of $2,932 is included in
accrued liabilities, and the long-term portion of $2,565 is included in
noncurrent liabilities.  As of February 29, 2008, the swap was deemed
to be an effective cash flow hedge.  The fair value of the swap
agreement is valued by a third party.  The swap agreement terminates
in January 2010.





In April
2007, we entered into an interest rate cap agreement.  The cap has
decreasing notional principal amounts beginning May 2007 and a cap rate of 5.0%
over the life of the agreement.  We paid a $114 premium to enter into
the cap agreement.  As of February 29, 2008, the value of the cap, as
valued by a third party, is insignificant.  The cap agreement
terminates in September 2008.





In April
2007, we completed a private offering of $100,000 of the 1.625% Convertible
Notes to qualified institutional investors pursuant to Rule 144A under the
Securities Act of 1933.  The 1.625% Convertible Notes bear interest at
an annual rate of 1.625%, payable semi-annually in May and November of each
year.  The 1.625% Convertible Notes are convertible into our common
stock at an initial conversion price of $73.20 per share, upon the occurrence of
certain events, including the closing price of our common stock exceeding 130%
of the initial conversion price per share, or $95.16 per share, for the
prescribed measurement period.  The evaluation of the classification
of the 1.625% Convertible Notes will occur each fiscal quarter.





Upon
conversion, a holder will receive, in lieu of common stock, an amount of cash
equal to the lesser of (i) the principal amount of the 1.625% Convertible
Notes, or (ii) the conversion value, determined in the manner set forth in
the indenture governing the 1.625%  Convertible Notes, of a number of
shares equal to the conversion rate. If the conversion value


12


exceeds
the principal amount of the 1.625% Convertible Note on the conversion date, we
will also deliver, at our election, cash or common stock or a combination of
cash and common stock with respect to the conversion value upon conversion. If
conversion occurs in connection with a change of control, we may be required to
deliver additional shares of our common stock by increasing the conversion rate
with respect to such notes. The maximum aggregate number of shares that we would
be obligated to issue upon conversion of the 1.625% Convertible Notes is
1,694.





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





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





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





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





The
scheduled future maturities of long-term debt to be funded for the next five
successive fiscal years and those thereafter as of February 29, 2008 are as
follows:







2008
            
            $
            127,2502009
            
            
            3,0002010
            
            
            58,7502011
            
            
            3,0002012
            
            
            3,000Thereafter
            
            
            303,000$
            498,000





7.  ACQUISITION OF
BRANDS





In
January 2007, we acquired the U.S. rights to five leading consumer and OTC
brands from Johnson & Johnson (“J&J Acquisition”).  The
acquired brands were: ACT, an anti-cavity
mouthwash/mouth rinse; Unisom, an OTC sleep-aid;
Cortizone-10, 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 a $300,000 term loan provided under our Credit Facility,
borrowings under the revolving credit facility portion of our Credit Facility
and through the use of a portion of the proceeds derived from the 2.0%
Convertible Notes.  The purchase price of the J&J Acquisition was
$410,000 plus $1,573 of costs directly related to the
acquisition.  The purchase price related to $5,916 of inventory,
$1,781 of assumed liabilities, $463 of equipment, $403,061 of trademarks, which
were assigned an indefinite life, and $3,914 of distribution rights, which was
assigned a useful life of five years.  The value assigned each of the
acquired brands was as follows:  ACT, $163,167; Unisom, $95,181; Cortizone-10, $124,318; Kaopectate,


13


$11,653;
and Balmex,
$8,742.  Johnson & Johnson will continue to manufacture and supply
certain of the products to us for a period of up to 18 months from the close of
the acquisition, or such earlier date as we are able to move production to our
facilities.  The price we pay Johnson & Johnson for these products
is equivalent to the manufacturing cost, which includes all costs associated
with the manufacturing and delivery of the product.  Certain of the
products are manufactured and supplied under assumed agreements with third party
manufacturers.  During fiscal 2007, the manufacturing of certain
products was transferred to our facilities.  For a period of up to six
months from the close of the acquisition, Johnson & Johnson was to provide
transition services consisting of consumer affairs, distribution and collection
services (including related financial, accounting and reporting
services).  We terminated the distribution and collections services
effective April 2, 2007 and the consumer affairs services effective June 21,
2007.  The costs charged for these transition services approximated
the actual costs incurred by Johnson & Johnson.  During the year
ended November 30, 2007, we incurred $2,057 of expenses related to these
transition services.




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





PRO FORMA
CONSOLIDATED RESULTS OF OPERATIONS (Unaudited)





Three
      Months Ended February
      28, 2007Total
      revenue
            
            $
            110,012Net
      income
            
            
            14,432Earnings
      per share –  basic
            
            
            0.77Earnings
      per share –  diluted
            
            
            0.75







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




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





8.  FAIR VALUE
MEASUREMENTS





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





Level 1 -
Quoted market prices in active markets for identical assets or
liabilities;


Level 2 -
Inputs other than Level 1 inputs that are either directly or indirectly
observable; and


Level 3 -
Unobservable inputs developed using estimates and assumptions developed by us,
which reflect those that a market participant would use.





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


14


The
following table summarizes the financial instruments measured at fair value in
the accompanying consolidated balance sheet as of February 29,
2008:





Fair
      Value Measurements as of
              February 29, 2008Level 1
            
            
            Level 2
            
            
            Level 3
            
            
            TotalAssetsAvailable-for-sale
      securities (1)
            
            $
            508
            
            
            $
            –
            
            
            $
            –
            
            
            $
            508Interest
      rate cap (2)
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –LiabilitiesInterest
      rate swap (3)
            
            $
            –
            
            
            $
            5,497
            
            
            $
            –
            
            
            $
            5,497




(1)
            Our
      available-for-sale securities are included in the accompanying
      consolidated balance sheet as an other noncurrent asset using the “market
      approach” valuation technique. This method uses prices and other relevant
      information observable in market transactions involving identical or
      comparable assets or liabilities.


(2)
            The
      interest rate cap is valued at an insignificant amount in the accompanying
      consolidated balance sheet as of February 29, 2008 and matures September
      2008.  We value this financial instrument using the “Income
      Approach” valuation technique.  This method uses valuation
      techniques to convert future amounts to a single present
      amount.  The measurement is based on the value indicated by
      current market expectations about those future
  amounts.


(3)
            The
      total fair value of the interest rate swap is partially classified as a
      current and a noncurrent liability as of February 29, 2008 and matures
      January 2010.  This financial instrument is valued using the
      “Income Approach” valuation technique as described
  above.





SFAS 157
requires separate disclosure of assets and liabilities measured at fair value on
a recurring basis, as documented above, from those measured at fair value on a
nonrecurring basis.  As of February 29, 2008, no assets or liabilities
are measured at fair value on a nonrecurring basis.





9.  ADVERTISING
EXPENSES





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





10.  SHIPPING AND
HANDLING





Shipping
and handling costs of $3,997 and $2,401 are included in selling, general and
administrative expenses for the three months ended February 29, 2008 and
February 28, 2007, respectively.





11.  PATENTS,
TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS





The
carrying value of trademarks, which are not subject to amortization under the
provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”),
was $613,364 and $613,328 as of February 29, 2008 and November 30, 2007,
respectively.  The gross carrying amount of intangible assets subject
to amortization at February 29, 2008 and November 30, 2007, which consist
primarily of non-compete agreements and distribution rights, was $6,503 and
$6,278, respectively.  The related accumulated amortization of
intangible assets at February 29, 2008 and November 30, 2007 was $3,002 and
$2,797, respectively.  Amortization of our intangible assets subject
to amortization under the provisions of SFAS 142 for the three months ended
February 29, 2008 and February 28, 2007 was $205 and $190,
respectively.  Estimated annual amortization expense for these assets
for the years ended November 30, 2009, 2010, 2011, 2012 and 2013 is $913, $893,
$873, $873 and $88, respectively.





12. 
INVENTORIES





Inventories
consisted of the following as of February 29, 2008 and November 30,
2007:




15





2008
            
            
            2007Raw
      materials and work in process
            
            $
            16,499
            
            
            $
            17,892Finished
      goods
            
            
            26,039
            
            
            
            25,373Total
      inventories
            
            $
            42,538
            
            
            $
            43,265





13.  ACCRUED
LIABILITIES





Accrued
liabilities consisted of the following as of February 29, 2008 and November 30,
2007:





2008
            
            
            2007Interest
            
            $
            6,289
            
            
            $
            3,510Salaries,
      wages and commissions
            
            
            2,328
            
            
            
            6,209Product
      advertising and promotion
            
            
            3,584
            
            
            
            3,051Litigation
      settlement and legal fees
            
            
            1,785
            
            
            
            2,084Income
      taxes payable
            
            
            997
            
            
            
            3,643Product
      recall expenses
            
            
            5,716
            
            
            
            –Interest
      rate swap
            
            
            2,932
            
            
            
            1,274Other
            
            
            1,293
            
            
            
            1,766Total
      accrued liabilities
            
            $
            24,924
            
            
            $
            21,537





14.  COMPREHENSIVE
INCOME





Comprehensive
income consisted of the following components for the three months ended February
29, 2008 and February 28, 2007, respectively:





2008
            
            
            2007Net
      income
            
            $
            14,873
            
            
            $
            13,650Other
      – interest rate hedge adjustment
            
            
            (1,573
            )
            
            
            334Other
      – foreign currency translation adjustment
            
            
            186
            
            
            
            (71
            )Total
            
            $
            13,486
            
            
            $
            13,913





15.  STOCK
REPURCHASE





In the
three months ended February 29, 2008, we repurchased 4 shares of our common
stock for $240 at an average price per share of $64.93. The repurchased shares
were retired and returned to unissued.  As of April 1, 2008, the
current amount available under the authorization from the Board of Directors was
$64,306.




16.  POSTRETIREMENT
BENEFIT PLANS





DEFINED BENEFIT PENSION
PLAN





We have a
noncontributory defined benefit pension plan (the “Pension Plan”), which covers
substantially all employees as of December 31, 2000.  The Pension Plan
provides benefits based upon years of service and employee compensation to
employees who had completed one year of service prior to December 31,
2000.  On December 31, 2000, benefits and participation in the Pension
Plan were frozen.  Contributions to the Pension Plan are calculated by
an independent actuary and have been sufficient to provide benefits to
participants and meet the funding requirements of the Employee Retirement Income
Security Act (“ERISA”).  Plan assets as of February 29, 2008 and
November 30, 2007 were invested primarily in United States government and agency
securities and corporate debt and equity securities.


16


Net
periodic pension cost for the three months ended February 29, 2008 and February
28, 2007 comprised the following components:





2008
            
            
            2007Service
      cost
            
            $
            –
            
            
            $
            –Interest
      cost
            
            
            152
            
            
            
            153Expected
      return on plan assets
            
            
            (234
            )
            
            
            (220
            )Recognized
      net actuarial (gain)/loss
            
            
            –
            
            
            
            –Net
      periodic pension cost (benefit)
            
            $
            (82
            )
            
            $
            (67
            )





No
employer contributions were made for the three months ended February 29, 2008
and February 28, 2007, and no employer contributions are expected to be made for
the Pension Plan in fiscal 2008.





DEFINED
CONTRIBUTION PLAN





We
sponsor a defined contribution plan that covers substantially all
employees.  Eligible employees are allowed to contribute up to 15% of
their eligible annual compensation.  We make matching contributions of
25% on the first 6% of contributed compensation.  The cost of the
matching contribution totaled $88 and $73 for the three months ended February
29, 2008 and February 28, 2007, respectively.  In addition to matching
contributions, safe harbor contributions equaling 3% of eligible annual
compensation are made on behalf of eligible participants.  Safe harbor
contributions totaled $288 and $243 for the three months ended February 29, 2008
and February 28, 2007, respectively.  Total matching and safe harbor
contributions for fiscal 2008 are expected to approximate amounts funded in
fiscal 2007.  Total matching and safe harbor contributions in fiscal
2007 were $1,061.





POSTRETIREMENT
HEALTH CARE BENEFITS PLAN





We
maintain a postretirement health care benefits plan (the “Retiree Health Plan”)
for certain eligible employees over the age of 65.  On May 31, 2006,
Retiree Health Plan eligibility was restricted to current retirees and those
active employees that were retirement eligible as of that date (age 55 and 10
years of service or age 65). Contributions to the Retiree Health Plan are
limited to approximately $2 per participant per year and are paid monthly on a
fully insured basis.  Participants are required to pay any insurance
premium amount in excess of the $2 employer
contribution.   Employer contributions expected for fiscal 2008
are approximately $78.





Net
periodic postretirement health care benefits cost for the three months ended
February 29, 2008 and February 28, 2007, included the following
components:





2008
            
            
            2007Service
      cost
            
            $
            5
            
            
            $
            14Interest
      cost
            
            
            14
            
            
            
            18Amortization
      of prior service cost
            
            
            –
            
            
            
            4Recognized
      net actuarial(gain)/loss
            
            
            (24
            )
            
            
            (4
            )Net
      periodic postretirement benefits cost
            
            $
            (5
            )
            
            $
            32





17.  INCOME
TAXES





We
account for income taxes using the asset and liability approach as prescribed by
SFAS 109, FIN 48 and other applicable FSP’s and FASB
Interpretations.  This approach requires recognition of deferred tax
assets and liabilities for the expected future tax consequences of events that
have been included in our consolidated financial statements or tax
returns.  Using the enacted tax rates in effect for the year in which
the differences are expected to reverse, deferred tax assets and liabilities are
determined based on the differences between the financial reporting and the tax
basis of an asset or liability.  We record income tax expense in our
consolidated financial statements based on an estimated annual effective income
tax rate.  Our tax rate for the three months ended February 29, 2008
was 35.6%, as compared to 34.5% for the three months ended February 28,
2007.





Undistributed
earnings of Chattem Canada, our Canadian subsidiary, 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
accumulated 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).  For the three months ended February 29, 2008, Chattem
Canada recognized a loss of approximately $147.


17


We
adopted FIN 48 on December 1, 2007. The difference between the tax benefit
recognized in the financial statements for a position in accordance with FIN 48
and the tax benefit claimed in the tax return is referred to as an unrecognized
tax benefit.  In connection with the adoption of FIN 48, we recognized an
increase in the liability for unrecognized tax benefits of $1,595, which is
included in the accompanying consolidated financial statements as a reduction to
retained earnings of $711 and an increase to deferred tax assets of $884. 
We have a total unrecognized tax benefit of $2,180 as of December 1, 2007, which
includes an estimate of related interest and penalties of $312.  The total
amount of unrecognized tax benefits that, if recognized, would affect the
effective tax rate is $1,205.  We recognize interest and penalties related
to income tax matters as a component of the provision for income
taxes.





During
the first quarter of fiscal 2008 the total unrecognized tax benefit increased by
$2,722, to $4,902 primarily as a result of deductions in amended tax returns
related to certain elements of compensation.  It is reasonably possible
that the amount of unrecognized tax benefit could increase by approximately
$3,130, to approximately $8,032, during the next twelve months if certain
elements of compensation are deducted in our 2007 federal and state tax
returns.





We file
income tax returns in the U.S. federal jurisdiction and various state and
foreign jurisdictions. We are no longer subject to examinations by tax
authorities related to U.S. federal income taxes for fiscal years before 2004,
state income taxes for fiscal years before 2003 or non-U.S. income taxes for
fiscal years before 2002.





18.  PRODUCT SEGMENT
INFORMATION





Net
sales within our single healthcare business segment for the three months
ended February 29, 2008 and February 28, 2007 are as follows:




2008
            
            
            2007Medicated
      skin care
            
            $
            37,653
            
            
            $
            27,833Topical
      pain care
            
            
            25,315
            
            
            
            27,226Oral
      care
            
            
            15,772
            
            
            
            8,487Internal
      OTC
            
            
            11,210
            
            
            
            8,449Medicated
      dandruff shampoos
            
            
            10,579
            
            
            
            10,296Dietary
      supplements
            
            
            5,374
            
            
            
            8,030Other
      OTC and toiletry products
            
            
            5,412
            
            
            
            4,302Total
      domestic net sales
            
            
            111,315
            
            
            
            94,623International
      revenues
            
            
            9,458
            
            
            
            6,208Total
      revenues
            
            $
            120,773
            
            
            $
            100,831





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.  A total of 14 claimants with alleged injuries that occurred
after December 21, 1998 elected to opt-out of the class
settlement.  Subsequently, we have settled twelve of the opt-out
claims. The other two opt-outs have not filed lawsuits against us, and we
believe the applicable statutes of limitation have run against their claims.
Consequently, we are not currently defending any PPA products liability
claims.




In
accordance with the terms of the class action settlement, approximately $70,885
was initially funded into a settlement trust.  All claims in the
settlement have been resolved and expenses of the trust have been
paid.  On June 14, 2006, we filed a motion to dissolve the settlement
trust.  The court granted this motion on July 14,
2006.  Although the court granted our motion to dissolve the
settlement trust, we have continued the trust’s existence.  These
funds are available in the unlikely event an additional PPA products liability
lawsuit is filed against us.


18


We were
also named as a defendant in approximately 206 lawsuits relating to Dexatrim containing PPA which
involved 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 for indemnification in DELACO’s
bankruptcy.  We entered into a settlement agreement with DELACO dated
June 30, 2005 that resolved DELACO’s indemnity obligations to us (“the DELACO
Agreement”).  The DELACO Agreement was approved by the DELACO
bankruptcy court on July 28, 2005.  In accordance with the DELACO
bankruptcy plan, a settlement trust established under the plan paid us $8,750 on
March 17, 2006, which is included in our consolidated statement of income, net
of legal expenses, as litigation settlement for 2006.  The payment to
us by the DELACO settlement trust of $8,750 has conclusively compromised and
settled our indemnity claim filed in the DELACO bankruptcy. The confirmation of
the DELACO bankruptcy plan effectively released us from liability for all PPA
products liability cases with injury dates prior to December 21,
1998.




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





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





On
December 20, 2007, Avon Products, Inc. filed a patent infringement lawsuit
against us in the U.S. District Court for the Southern District of New York
alleging that our BullfrogMosquito Coast product infringes an Avon patent.  We dispute
this claim and plan to defend this lawsuit vigorously.  As of April 1,
2008, we have not been served with this lawsuit.





On
February 8, 2008, we initiated a voluntary nationwide recall of our Icy HotHeat Therapy
products, including consumer “samples” that were included on a limited
promotional basis in cartons of our 3 oz. Aspercreme
product.  The recall is being conducted to the consumer
level.  We recalled these products because we received some consumer
reports of first, second and third degree burns, as well as skin irritation
resulting from consumer use or possible misuse of the products.  As of
April 1, 2008, approximately 155 consumers have pending claims against us
alleging some type of personal injury.  We are not aware of any Heat
Therapy products liability lawsuits pending against us as of April 1,
2008.  We may receive lawsuits in the future alleging burns and/or
skin irritation from use of our Heat Therapy products.  The outcome of
any such potential litigation cannot be predicted.





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.





We
maintain insurance coverage for product liability claims relating to our
products under claims-made policies which are subject to annual
renewal.   For the current annual policy period beginning June 1,
2007, we maintain product liability insurance coverage in the amount of $30,000
through our captive insurance subsidiary, of which approximately $2,550 has been
funded as of April 1, 2008.  We also have $25,000 of excess coverage
through a third party reinsurance policy, which excludes coverage for our Dexatrim products containing
ephedrine.


19


REGULATORY




We were
notified in October 2000 that the FDA denied a citizen petition submitted by
Thompson Medical Company, Inc., the previous owner of Sportscreme and Aspercreme.  The
petition sought a determination that 10% trolamine salicylate, the active
ingredient in Sportscreme and Aspercreme, was clinically
proven to be an effective active ingredient in external analgesic 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 the 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 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 costly testing
and data analysis. Any preliminary expenditures may be shared with other patch
manufacturers. Because the submissions made into the FDA docket have been
forwarded from its OTC Division to its Dermatological Division within the Center
for Drug Evaluation and Research (“CDER”), we are uncertain as to when this
matter is likely to become final.  For example, the FDA could choose
to hold in abeyance a final ruling on alternative dose forms even if the
monograph is otherwise finalized.  If the final monograph excludes
such products, we will have to file a new drug application (“NDA”) for
previously marketed drugs in order to continue to market the Icy Hot and AspercremePatches, the Icy Hot Sleeve, the 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 a significant cost. 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 Dayproduct,
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


20


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





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





On
February 12, 2008, we recalled all lots of the medical device, Icy Hot Heat Therapy Air
Activated Heat patch (Back and Arm, Neck and Leg) distributed since December
2006.  The recall was due to adverse events reports which associated
the use of the products with temporary or medically reversible health
consequences, skin irritation and burns.  The recall was voluntary and
conducted with the full knowledge of the Food and Drug
Administration.  On February 5-8, 2008, FDA conducted a medical device
inspection of our manufacturing plant, manufacturing records, and consumer
complaint handling system.  On February 8, 2008, the FDA issued a
Form FDA-483 noting three inspectional observations pertaining to MDR reporting,
device correction reports, and corrective and preventive action
procedures.  We responded to the Form FDA-483 on February 14, 2008
committing to correct the cited observations.





In June
2007, the FDA published a final rule establishing regulations requiring current
good manufacturing practices for dietary supplements.  This final rule
becomes effective June 2008.





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 29, 2008 arose in conjunction with our Credit Facility
and our issuance of the 7.0% Subordinated Notes (See Note 6).  The
maximum amount of future payments the guarantors would be required to make under
the guarantees as of February 29, 2008 is $273,000.


21


Note
20
 CHATTEM, INC.
AND SUBSIDIARIES


CONSOLIDATING
BALANCE SHEETS






FEBRUARY
29, 2008


(Unaudited
and in thousands)








CHATTEM
            
            
            GUARANTOR
       SUBSIDIARY COMPANIES
            
            
            NON-GUARANTOR
      SUBSIDIARY
              COMPANIES
            
            
            ELIMINATIONS
            
            
            CONSOLIDATEDASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
            
            $
            332
            
            
            $
            512
            
            
            $
            10,775
            
            
            $
            —
            
            
            $
            11,619Accounts
      receivable, less allowances of $15,575
            
            
            52,120
            
            
            
            17,704
            
            
            
            6,014
            
            
            
            (17,704
            )
            
            
            58,134Interest
      receivable
            
            
            90
            
            
            
            650
            
            
            
            (73
            )
            
            
            (667
            )
            
            
            —Inventories
            
            
            35,928
            
            
            
            2,611
            
            
            
            3,999
            
            
            
            —
            
            
            
            42,538Deferred
      income taxes
            
            
            7,421
            
            
            
            —
            
            
            
            42
            
            
            
            —
            
            
            
            7,463Prepaid
      expenses and other current assets
            
            
            5,661
            
            
            
            —
            
            
            
            235
            
            
            
            (90
            )
            
            
            5,806Total
      current assets
            
            
            101,552
            
            
            
            21,477
            
            
            
            20,992
            
            
            
            (18,461
            )
            
            
            125,560PROPERTY,
      PLANT AND EQUIPMENT, NET
            
            
            31,050
            
            
            
            775
            
            
            
            669
            
            
            
            —
            
            
            
            32,494OTHER
      NONCURRENT ASSETS:Patents,
      trademarks and other purchased product rights, net
            
            
            3,501
            
            
            
            674,057
            
            
            
            1,597
            
            
            
            (62,290
            )
            
            
            616,865Debt
      issuance costs, net
            
            
            14,223
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            14,223Investment
      in subsidiaries
            
            
            333,036
            
            
            
            33,000
            
            
            
            66,860
            
            
            
            (432,896
            )
            
            
            —Note
      receivable
            
            
            —
            
            
            
            33,000
            
            
            
            —
            
            
            
            (33,000
            )
            
            
            —Other
            
            
            4,292
            
            
            
            —
            
            
            
            508
            
            
            
            —
            
            
            
            4,800Total
      other noncurrent assets
            
            
            355,052
            
            
            
            740,057
            
            
            
            68,965
            
            
            
            (528,186
            )
            
            
            635,888TOTAL
      ASSETS
            
            $
            487,654
            
            
            $
            762,309
            
            
            $
            90,626
            
            
            $
            (546,647
            )
            
            $
            793,942LIABILITIES AND SHAREHOLDERS’
      EQUITYCURRENT
      LIABILITIES:Current
      maturities of long-term debt
            
            $
            128,000
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            128,000Accounts
      payable and other
            
            
            18,695
            
            
            
            —
            
            
            
            1,987
            
            
            
            —
            
            
            
            20,682Bank
      overdraft
            
            
            2,850
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,850Accrued
      liabilities
            
            
            37,628
            
            
            
            857
            
            
            
            4,900
            
            
            
            (18,461
            )
            
            
            24,924Total
      current liabilities
            
            
            187,173
            
            
            
            857
            
            
            
            6,887
            
            
            
            (18,461
            )
            
            
            176,456LONG-TERM
      DEBT, less current maturities
            
            
            369,400
            
            
            
            (1,200
            )
            
            
            34,800
            
            
            
            (33,000
            )
            
            
            370,000DEFERRED
      INCOME TAXES
            
            
            (24,709
            )
            
            
            48,966
            
            
            
            —
            
            
            
            —
            
            
            
            24,257OTHER
      NONCURRENT LIABILITIES
            
            
            3,566
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            3,566INTERCOMPANY
      ACCOUNTS
            
            
            (267,422
            )
            
            
            259,761
            
            
            
            7,661
            
            
            
            —
            
            
            
            —SHAREHOLDERS’
      EQUITY:Preferred
      shares, without par value, authorized 1,000, none
    issued
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Common
      shares, without par value, authorized 100,000, issued and outstanding
      19,177
            
            
            41,980
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            41,980Share
      capital of subsidiaries
            
            
            —
            
            
            
            329,704
            
            
            
            39,804
            
            
            
            (369,508
            )
            
            
            —Dividends
            
            
            —
            
            
            
            (16,688
            )
            
            
            —
            
            
            
            16,688
            
            
            
            —Retained
      earnings
            
            
            179,817
            
            
            
            140,909
            
            
            
            (188
            )
            
            
            (140,721
            )
            
            
            179,817Total
            
            
            221,797
            
            
            
            453,925
            
            
            
            39,616
            
            
            
            (493,541
            )
            
            
            221,797Cumulative
      other comprehensive income, net of taxes:Interest
      rate cap adjustment
            
            
            (3,320
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (3,320
            )Foreign
      currency translation adjustment
            
            
            1,177
            
            
            
            —
            
            
            
            1,662
            
            
            
            (1,645
            )
            
            
            1,194Unrealized
      actuarial gains and losses
            
            
            (8
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (8
            )Total
      shareholders’ equity
            
            
            219,646
            
            
            
            453,925
            
            
            
            41,278
            
            
            
            (495,186
            )
            
            
            219,663TOTAL
      LIABILITIES AND SHAREHOLDERS’ EQUITY
            
            $
            487,654
            
            
            $
            762,309
            
            
            $
            90,626
            
            
            $
            (546,647
            )
            
            $
            793,942








22


Note 20


CHATTEM, INC.
AND SUBSIDIARIES


CONSOLIDATING
BALANCE SHEETS








NOVEMBER
30, 2007
 (In
thousands)




CHATTEM
            
            
            GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            NON-GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            ELIMINATIONS
            
            
            CONSOLIDATEDASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
            
            $
            4,685
            
            
            $
            590
            
            
            $
            10,132
            
            
            $
            —
            
            
            $
            15,407Accounts
      receivable, less allowances of $13,810
            
            
            37,492
            
            
            
            16,693
            
            
            
            6,261
            
            
            
            (16,693
            )
            
            
            43,753Interest
      receivable
            
            
            101
            
            
            
            625
            
            
            
            (84
            )
            
            
            (642
            )
            
            
            —Inventories
            
            
            36,220
            
            
            
            3,242
            
            
            
            3,803
            
            
            
            —
            
            
            
            43,265Deferred
      income taxes
            
            
            6,709
            
            
            
            —
            
            
            
            41
            
            
            
            —
            
            
            
            6,750Prepaid
      expenses and other current assets
            
            
            1,913
            
            
            
            —
            
            
            
            302
            
            
            
            (150
            )
            
            
            2,065Total
      current assets
            
            
            87,120
            
            
            
            21,150
            
            
            
            20,455
            
            
            
            (17,485
            )
            
            
            111,240PROPERTY,
      PLANT AND EQUIPMENT, NET
            
            
            30,902
            
            
            
            775
            
            
            
            672
            
            
            
            —
            
            
            
            32,349OTHER
      NONCURRENT ASSETS:Patents,
      trademarks and other purchased product rights, net
            
            
            3,482
            
            
            
            674,058
            
            
            
            1,560
            
            
            
            (62,290
            )
            
            
            616,810Debt
      issuance costs, net
            
            
            15,430
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            15,430Investment
      in subsidiaries
            
            
            336,936
            
            
            
            33,000
            
            
            
            66,860
            
            
            
            (436,796
            )
            
            
            —Note
      receivable
            
            
            —
            
            
            
            33,000
            
            
            
            —
            
            
            
            (33,000
            )
            
            
            —Other
            
            
            4,218
            
            
            
            —
            
            
            
            513
            
            
            
            —
            
            
            
            4,731Total
      other noncurrent assets
            
            
            360,066
            
            
            
            740,058
            
            
            
            68,933
            
            
            
            (532,086
            )
            
            
            636,971TOTAL
      ASSETS
            
            $
            478,088
            
            
            $
            761,983
            
            
            $
            90,060
            
            
            $
            (549,571
            )
            
            $
            780,560LIABILITIES AND SHAREHOLDERS’
      EQUITYCURRENT
      LIABILITIES:Current
      maturities of long-term debt
            
            $
            3,000
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            3,000Accounts
      payable
            
            
            16,439
            
            
            
            —
            
            
            
            1,800
            
            
            
            —
            
            
            
            18,239Bank
      overdraft
            
            
            7,584
            
            
            
            —
            
            
            
            —
            
            
            
            
            
            
            
            7,584Accrued
      liabilities
            
            
            33,561
            
            
            
            691
            
            
            
            4,770
            
            
            
            (17,485
            )
            
            
            21,537Total
      current liabilities
            
            
            60,584
            
            
            
            691
            
            
            
            6,570
            
            
            
            (17,485
            )
            
            
            50,360LONG-TERM
      DEBT, less current maturities
            
            
            504,400
            
            
            
            (1,200
            )
            
            
            34,800
            
            
            
            (33,000
            )
            
            
            505,000DEFERRED
      INCOME TAXES
            
            
            (23,976
            )
            
            
            45,032
            
            
            
            —
            
            
            
            —
            
            
            
            21,056OTHER
      NONCURRENT LIABILITIES
            
            
            2,436
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,436INTERCOMPANY
      ACCOUNTS
            
            
            (267,058
            )
            
            
            259,083
            
            
            
            7,975
            
            
            
            —
            
            
            
            —SHAREHOLDERS’
      EQUITYPreferred
      shares, without par value, authorized 1,000, none issued
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Common
      shares, without par value, authorized 100,000,
      issued 19,092
            
            
            36,800
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            36,800Share
      capital of subsidiaries
            
            
            —
            
            
            
            329,704
            
            
            
            39,804
            
            
            
            (369,508
            )
            
            
            —Dividends
            
            
            —
            
            
            
            (18,046
            )
            
            
            (9,000
            )
            
            
            27,046
            
            
            
            —Retained
      earnings
            
            
            165,655
            
            
            
            146,719
            
            
            
            8,430
            
            
            
            (155,149
            )
            
            
            165,655Total
            
            
            202,455
            
            
            
            458,377
            
            
            
            39,234
            
            
            
            (497,611
            )
            
            
            202,455Cumulative
      other comprehensive income, net of taxes:Interest
      rate hedge adjustment
            
            
            (1,747
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,747
            )Foreign
      currency translation adjustment
            
            
            1,002
            
            
            
            —
            
            
            
            1,481
            
            
            
            (1,475
            )
            
            
            1,008Unrealized
      actuarial gains and losses
            
            
            (8
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (8
            )Total
      shareholders’ equity
            
            
            201,702
            
            
            
            458,377
            
            
            
            40,715
            
            
            
            (499,086
            )
            
            
            201,708TOTAL
      LIABILITIES AND SHAREHOLDERS’ EQUITY
            
            $
            478,088
            
            
            $
            761,983
            
            
            $
            90,060
            
            
            $
            (549,571
            )
            
            $
            780,560





23
 
 Note
20
 CHATTEM,
INC. AND SUBSIDIARIES


CONSOLIDATING
STATEMENTS OF INCOME




FOR THE
THREE MONTHS ENDED FEBRUARY 29, 2008
 (Unaudited
and in thousands)
















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





































24


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
            
            
            12,211
            
            
            
            (42
            )
            
            
            242
            
            
            
            —
            
            
            
            12,411Acquisition
      expenses
            
            
            1,171
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,171Equity
      in subsidiary income
            
            
            (10,792
            )
            
            
            —
            
            
            
            —
            
            
            
            10,792
            
            
            
            —Total
      costs and expenses
            
            
            53,725
            
            
            
            5,153
            
            
            
            4,484
            
            
            
            9,987
            
            
            
            73,349INCOME
      FROM OPERATIONS
            
            
            34,492
            
            
            
            17,857
            
            
            
            853
            
            
            
            (25,720
            )
            
            
            27,482OTHER
      INCOME (EXPENSE):Interest
      expense
            
            
            (7,190
            )
            
            
            —
            
            
            
            (665
            )
            
            
            619
            
            
            
            (7,236
            )Investment
      and other income, net
            
            
            403
            
            
            
            636
            
            
            
            798
            
            
            
            (1,244
            )
            
            
            593Royalties
            
            
            (13,622
            )
            
            
            (1,306
            )
            
            
            —
            
            
            
            14,928
            
            
            
            —Corporate
      allocations
            
            
            743
            
            
            
            (727
            )
            
            
            (16
            )
            
            
            —
            
            
            
            —Total
      other income (expense)
            
            
            (19,666
            )
            
            
            (1,397
            )
            
            
            117
            
            
            
            14,303
            
            
            
            (6,643
            )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

























25


Note
20





CHATTEM,
INC. AND SUBSIDIARIES


CONSOLIDATING
STATEMENTS OF CASH FLOWS





FOR THE
THREE MONTHS ENDED FEBRUARY 29, 2008


(Unaudited
and in thousands)




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











26


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 exercised
            
            
            (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 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 exercised
            
            
            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: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

















27


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





The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the audited consolidated financial
statements and related notes thereto included in our 2007 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 medicated skin care, topical pain care,
oral care, internal OTC, medicated dandruff shampoos, dietary supplements and
other OTC and toiletry products. Our portfolio of products includes
well-recognized brands such as:





•
            Gold Bond, Balmexand
      Cortizone–
      medicated skin care;





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





•
            ACT and Herpecin-L– oral
      care;





•
            Unisom, Pamprin and Kaopectate–
      internal OTC;





•
            Selsun Blue and Selsun Natural–
      medicated dandruff shampoos;





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





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





Our
products target niche markets that are often outside the focus of larger
companies where we believe we can achieve and sustain significant market share
through product innovation and strong advertising and promotion support. Many of
our products are among the U.S. market leaders in their respective categories.
For example, our portfolio of topical pain care brands, our Cortizone-10 anti-itch
ointment, and our Gold
Bond medicated body powders have the leading U.S. market share in these
categories. We support our brands through extensive and cost-effective
advertising and promotion, the expenditures for which represented approximately
29% of our total revenues in the first quarter of fiscal 2008. We sell our
products nationally through mass merchandiser, drug and food channels,
principally utilizing our own sales force.





Our
experienced management team has grown our business by acquiring brands,
developing product line extensions and increasing market penetration of our
existing products.





Developments
During the First Quarter of Fiscal 2008





Products





In the
first quarter of fiscal 2008, we introduced the following product line
extensions: Cortizone-10 Intensive
Healing, Gold Bond
Ultimate Restoring Lotion, Gold Bond Ultimate Foot
Cream, Icy Hot PM
Lotion, Icy Hot PM
Patch, Aspercreme Heat
Pain Relieving Gel, Aspercreme Nighttime Lotion
and Dexatrim Max
Daytime Control.





Product
Recall





On
February 8, 2008, we initiated a voluntary nationwide recall of our Icy Hot Heat Therapy product.
Icy HotHeat Therapy is
an air-activated, self-heating disposable device for temporary relief of
muscular and joint pain.  We recalled these products because we
received some consumer reports of first, second and third degree burns and skin
irritation resulting from the use or possible misuse of the
product.  Based in part on consideration of on-hand factory inventory
and retail point of sales data, we estimated approximately $6.0 million of
recall expenses related to product returns, inventory obsolescence, destruction
costs, consumer refunds, legal fees and other estimated expenses.





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 29, 2008
            
            
            February 28, 2007TOTAL
      REVENUES
            
            
            100.0
            %
            
            
            100.0
            %COSTS
      AND EXPENSES:Cost
      of sales
            
            
            28.8
            
            
            
            30.7Advertising
      and promotion
            
            
            28.6
            
            
            
            28.5Selling,
      general and administrative
            
            
            12.8
            
            
            
            12.3Product
      recall expenses
            
            
            5.0
            
            
            
            —Acquisition
      expenses
            
            
            —
            
            
            
            1.2Total
      costs and expenses
            
            
            75.2
            
            
            
            72.7INCOME
      FROM OPERATIONS
            
            
            24.8
            
            
            
            27.3OTHER
      INCOME (EXPENSE):Interest
      expense
            
            
            (5.4
            )
            
            
            (7.2
            )Investment
      and other income, net
            
            
            0.1
            
            
            
            0.6Loss
      on early extinguishment of debt
            
            
            (0.4
            )
            
            
            —Total
      other income (expense)
            
            
            (5.7
            )
            
            
            (6.6
            )INCOME
      BEFORE INCOME TAXES
            
            
            19.1
            
            
            
            20.7PROVISION
      FOR INCOME TAXES
            
            
            6.8
            
            
            
            7.1NET
      INCOME
            
            
            12.3
            %
            
            
            13.6
            %





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 29, 2008 unaudited consolidated
financial statements:





Allowance
for Doubtful Accounts





As of
February 29, 2008, 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 2008, we performed a
detailed assessment of the collectibility of trade accounts receivable and did
not make any significant adjustments to our estimate of allowance for doubtful
accounts.  The balance of allowance for doubtful accounts was $0.4
million at both February 29, 2008 and November 30, 2007.





Revenue
Recognition





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




29


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 and an
estimate of inventory on hand at customers, an allowance for returns of $4.5
million was recorded as of November 30, 2007.  As of February 29,
2008, the allowance for Icy
Hot Pro-Therapy returns is $4.0 million.





Our
estimate of product returns for seasonal and non-seasonal products as of
February 29, 2008 was $1.5 million and $1.2 million, respectively, and $1.2
million and $1.3 million, respectively, as of November 30, 2007.  For
the three months ended February 29, 2008, we increased our estimate of returns
for seasonal products by $0.3 million, which resulted in a decrease to net sales
in our consolidated financial statements.  For the three months ended
February 29, 2008, we decreased our estimate of non-seasonal returns by
approximately $0.1 million, which resulted in an increase to net sales in our
consolidated financial statements.  During 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 a increase 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 29, 2008, the
coupon accrual and reserve for vendor allowances were $2.2 million and $7.3
million, respectively, and $1.9 million and $5.5 million, respectively, as of
November 30, 2007.  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, FIN 48 and other applicable FSP’s and FASB
Interpretations.  This approach requires recognition of deferred tax
assets and liabilities for the expected future tax consequences of events that
have been included in the consolidated financial statements or tax
returns.




30


Using the
enacted tax rates in effect for the year in which the differences are expected
to reverse, deferred tax assets and liabilities are determined based on the
differences between the financial reporting and the tax basis of an asset or
liability.  We adopted FIN 48 on December 1, 2007.  FIN 48
clarifies the accounting for uncertainty in income taxes recognized in the
financial statements in accordance with SFAS 109.  We record income
tax expense in our consolidated financial statements based on an estimated
annual effective income tax rate.  Our tax rate for the three months
ended February 29, 2008 was 35.6%, as compared to 34.5% for the three months
ended February 28, 2007.





Accounting
for Acquisitions and Intangible Assets





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





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





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





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





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





The value
of our intangible assets is exposed to future adverse changes if we experience
declines in operating results or experience significant negative industry or
economic trends.  We review our indefinite-lived intangible assets for
impairment at least annually by comparing the carrying value of the intangible
assets to its estimated fair value.  The estimate of fair value is
determined by discounting the estimate of future cash flows of the intangible
assets.  During the quarter ended November 30, 2007, we performed our
annual impairment testing of these assets and no impairment or adjustment was
required.





Fair
Value Measurements




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




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









31


Stock-Based
Compensation





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







Comparison
of Three Months Ended February 29, 2008 and February 28, 2007





To
facilitate discussion of our operating results for the three months ended
February 29, 2008 and February 28, 2007, we have included the following selected
data from our unaudited Consolidated Statements of Income:





Increase (Decrease)2008
            
            
            2007
            
            
            Amount
            
            
            Percentage(dollars
      in thousands)Domestic
      net sales
            
            $
            111,315
            
            
            $
            94,623
            
            
            $
            16,692
            
            
            
            17.6
            %International
      revenues
            
            
            9,458
            
            
            
            6,208
            
            
            
            3,250
            
            
            
            52.4Total
      revenues
            
            
            120,773
            
            
            
            100,831
            
            
            
            19,942
            
            
            
            19.8Cost
      of sales
            
            
            34,733
            
            
            
            30,980
            
            
            
            3,753
            
            
            
            12.1Advertising
      and promotion expense
            
            
            34,496
            
            
            
            28,787
            
            
            
            5,709
            
            
            
            19.8Selling,
      general and administrative expense
            
            
            15,466
            
            
            
            12,411
            
            
            
            3,055
            
            
            
            24.6Product
      recall expenses
            
            
            6,043
            
            
            
            —
            
            
            
            6,043
            
            
            
            100.0Acquisition
      expenses
            
            
            —
            
            
            
            1,171
            
            
            
            (1,171
            )
            
            
            (100.0
            )Interest
      expense
            
            
            6,552
            
            
            
            7,236
            
            
            
            (684
            )
            
            
            (9.5
            )Loss
      on early extinguishment of debt
            
            
            526
            
            
            
            —
            
            
            
            526
            
            
            
            100.0Net
      income
            
            
            14,873
            
            
            
            13,650
            
            
            
            1,223
            
            
            
            9.0





Domestic
Net Sales





Domestic
net sales in the first quarter of fiscal 2008 increased $16.7 million,
or 17.6%, to $111.3 million from $94.6 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)2008
            
            
            2007
            
            
            Amount
            
            
            Percentage(dollars
      in thousands)Medicated
      skin care
            
            $
            37,653
            
            
            $
            27,833
            
            
            $
            9,820
            
            
            
            35.3
            %Topical
      pain care
            
            
            25,315
            
            
            
            27,226
            
            
            
            (1,911
            )
            
            
            (7.0
            )Oral
      care
            
            
            15,772
            
            
            
            8,487
            
            
            
            7,285
            
            
            
            85.8Internal
      OTC
            
            
            11,210
            
            
            
            8,449
            
            
            
            2,761
            
            
            
            32.7Medicated
      dandruff shampoos
            
            
            10,579
            
            
            
            10,296
            
            
            
            283
            
            
            
            2.7Dietary
      supplements
            
            
            5,374
            
            
            
            8,030
            
            
            
            (2,656
            )
            
            
            (33.1
            )Other
      OTC and toiletry products
            
            
            5,412
            
            
            
            4,302
            
            
            
            1,110
            
            
            
            25.8Total
            
            $
            111,315
            
            
            $
            94,623
            
            
            $
            16,692
            
            
            
            17.6








Net sales
in the medicated skin care products category increased 35.3% for the first
quarter of fiscal 2008 compared to the prior year quarter as a result of our
ownership of the Cortizone-10 and Balmex brands for the three
month period of the first quarter of fiscal 2008 as compared to two months of
ownership in the first quarter of fiscal  2007, and increased net
sales of Gold Bond, led
by strong sales of Gold BondUltimate Softening Lotion and the launch of Gold BondRestoring Lotion in
the first quarter of fiscal 2008.





Net sales
in the topical pain care category decreased 7.0% for the first quarter of fiscal
2008 compared to the prior year quarter, as a result of the launch and initial
sell-in of Icy HotHeat
Therapyin the
first quarter of fiscal 2007 and the discontinuance of shipments of Icy Hot Heat Therapy
following the voluntary recall of the product announced on February 8,




32


2008.  These
factors were offset in part by the launch and initial sell-in of Icy HotPM Lotion, Icy HotPM Patch, AspercremeHeat Pain Gel and
Aspercreme Nighttime
Lotion in the first quarter of fiscal 2008.





Net sales
in the oral care products category increased 85.8% for the first quarter of
fiscal 2008 compared to the prior year quarter as a result of our ownership of
the ACT brand for the
three month period of the first quarter of fiscal 2008 as compared to two months
of ownership in the first quarter of fiscal 2007 and continued growth of ACT from additional product
distribution and media support.





Net sales
in the internal OTC category increased 32.7% for the first quarter of fiscal
2008 compared to the prior year quarter as a result of our ownership of the
Unisom and Kaopectate brands for the
three month period of the first quarter of fiscal 2008 as compared to two months
of ownership in the first quarter of fiscal 2007.





Net sales
in the medicated dandruff shampoos category increased 2.7% in the first quarter
of fiscal 2008 compared to the prior year quarter resulting from the launch of
Selsun Blue Naturalsin
the second quarter of fiscal 2007, offset by declines in the Selsun Salon line of
products.





Net sales
in the dietary supplements category decreased 33.1% for the first quarter of
fiscal 2008 compared to the prior year quarter as a result of a 46.6% decrease
in Dexatrim, resulting
from increased competitive pressures in the category and the decline in sales of
Dexatrim Max20.





Net sales
in the other OTC and toiletry products category increased 25.8% for the first
quarter of fiscal 2008 compared to the prior year quarter due primarily to the
timing of shipments of Bullfrog.





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





International
Revenues





For the
first quarter of fiscal 2008, international revenues increased $3.3 million, or
52.4%, compared to the first quarter of fiscal 2007, primarily due to increased
sales in the Latin American market and the impact of the brands acquired in the
J&J Acquisition on January 2, 2007 and the ACT Acquisition in the second
quarter of fiscal 2007.





Cost
of Sales





Cost of
sales in the first quarter of fiscal 2008 was $34.7 million, a 12.1% increase
over the same period of fiscal 2007, or 28.8% as a percentage of total revenues
for the first quarter of fiscal 2008 as compared to 30.7% in the prior year
quarter.  Gross margin for the first quarter of fiscal 2008 was 71.2%
compared to 69.3% in the prior year quarter.  The increase in gross
margin was largely attributable to the integration of manufacturing of certain
of the acquired brands from the J&J Acquisition in the fourth quarter of
fiscal 2007.





Advertising
and Promotion Expense





Advertising
and promotion expenses in the first quarter of fiscal 2008 increased $5.7
million, or 19.8%, as compared to the same quarter of fiscal 2007 and were
28.6% of total revenues in the first quarter of fiscal 2008 compared to 28.5%
for the prior year quarter.  The increase in expense results from an
increased planned media spend in fiscal 2008 and ownership of the brands
acquired in the J&J Acquisition for the three-month period of the first
quarter of fiscal 2008 as compared to two months of  ownership in the
first quarter of fiscal 2007.





Selling,
General and Administrative Expense





Selling,
general and administrative expenses increased $2.9 million, or 22.9%, compared
to the prior year quarter.  Selling, general and administrative
expenses were 12.8% and 12.3% of total revenues for the first quarter of fiscal
2008 and 2007, respectively.  The $2.9 million increase in expense is
largely attributable to the increased freight costs associated with higher
revenues.  In the first quarter of fiscal 2008, we absorbed certain
transition service costs paid to Johnson & Johnson related to freight and
administrative costs that were recorded as acquisition expenses in the first
quarter of fiscal 2007.





Product
Recall Expenses





The $6.0 million of product recall
expenses in the first quarter of fiscal 2008 related to the voluntary recall of
our Icy Hot Heat
Therapy product initiated in February 2008.  Based in part on
consideration of on-hand inventory and retail point of sales




33


data, the
$6.0 million of product recall expenses relate to product returns, inventory
obsolescence, destruction costs, consumer refunds, legal fees and other
estimated expenses.





Acquisition
Expenses





Acquisition
expenses of $1.2 million for the first quarter of fiscal 2007 reflect amounts
paid to Johnson & Johnson for transition services, including consumer
affairs, distribution and collection services, in connection with the J&J
Acquisition.  The distribution and collection services were terminated
in April 2007 and the consumer affairs services were terminated in June
2007.





Interest
Expense





Interest
expense decreased $0.7 million, or 9.5%, in the first quarter of fiscal 2008 as
compared to the prior year quarter, reflecting payments made to reduce debt
since the first quarter of fiscal 2007.  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





In January 2008, we utilized borrowings
under the revolving credit facility portion of our Credit Facility to repay
$35.0 million of the term loan under the Credit Facility.  In
connection with the term loan repayment, we retired a proportional share of the
term loan debt issuance costs and recorded the resulting loss on extinguishment
of debt of $0.5 million.





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
$10.2 million and $9.9 million was provided by operations in the first
quarter of fiscal 2008 and fiscal 2007, respectively.  The increase in
cash flows from operations in the first quarter of fiscal 2008 as compared to
the same prior year period was primarily attributable to the reduction in the
change in accounts receivable offset by a reduction in the change in accounts
payable and accrued liabilities.





Investing activities used cash of $2.9
million and $412.4 million in the first quarter of fiscal 2008 and fiscal 2007,
respectively.  The reduction in cash used for investing activities in
the first quarter of fiscal 2008 relates to the lack of an acquisition similar
to the J&J Acquisition in the prior year period.





Financing
activities used cash of $11.1 million and provided cash of $327.7 million in the
first quarter of fiscal 2008 and 2007, respectively.  The decrease in
cash provided was primarily attributable to repayment of debt in the current
year period compared to the borrowings under the term loan portion and revolving
credit facility of the Credit Facility in the prior year period which were used
to fund the J&J Acquisition.





Based
upon the closing price of our common stock for the prescribed measurement period
during the three months ended February 29, 2008, the contingent conversion
threshold of our 2.0% Convertible Notes was exceeded.  As a result, the
2.0% Convertible Notes are convertible at the option of the holder as of
February 29, 2008 and, accordingly, have been classified as a current liability
in our accompanying consolidated balance sheet as of February 29, 2008.  If
holders elect to convert, we would be required to settle the principal amount of
the notes in cash and the conversion premium in cash or shares of our common
stock.  We would fund the repayment with existing cash and cash equivalents
and additional borrowings.




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




As of
February 29, 2008, we had $55.8 million of borrowings outstanding under our
$100.0 million revolving credit facility portion of our Credit
Facility.





34


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
29, 2008 and February 28, 2007, these subsidiaries accounted for 5% and 5% of
total revenues, respectively, and 2% and 2% 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 29, 2008 and February 28, 2007
and are included in selling, general and administrative expenses in the
unaudited Consolidated Statements of Income.





Recent
Accounting Pronouncements





In July
2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes” (“FIN 48”), 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.  Additionally, in May
2007, the FASB published FASB Staff Position (“FSP”) No. FIN 48-1, “Definition
of Settlement in FASB Interpretation No. 48” (“FSP FIN 48-1”).  FSP
FIN 48-1 is an amendment to FIN 48.  It clarifies how an enterprise
should determine whether a tax position is effectively settled for the purpose
of recognizing previously unrecognized tax benefits.  The provisions
of FIN 48 and FSP FIN 48-1 are effective for fiscal years beginning after
December 15, 2006.  We adopted the provisions of FIN 48 and FSP FIN
48-1 at the beginning of the first quarter of fiscal 2008.




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.  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.  We adopted SFAS 157
effective December 1, 2007.




In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities” (“SFAS 159”).  SFAS 159
permits entities to choose to measure certain financial assets and liabilities
at fair value.  Unrealized gains and losses on items for which the
fair value option has been elected are reported in earnings. We adopted SFAS 159
effective December 1, 2007 without choosing to elect to measure certain
financial assets or liabilities at fair value that were not previously measured
at fair value.  Thus there was no impact to our consolidated financial
statements.




In
December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS
141R”).  SFAS 141R provides guidance to improve the relevance,
representational faithfulness and comparability of the information that a
reporting entity provides in its financial reports about its business
combinations and its effects.  SFAS 141R establishes principles and
requirements for how the acquirer recognizes and measures in its financial
statements the identifiable assets acquired, liabilities assumed, the intangible
assets acquired and determines what information to disclose to enable users of
the financial statements to evaluate the nature and financial effects of the
business combination.  The provisions of SFAS 141R are effective for
fiscal years beginning after December 15, 2008, with earlier application
prohibited.  Accordingly, we will apply the provisions of SFAS 141R
prospectively to business combinations consummated beginning in the first
quarter of fiscal 2010.





In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities” (“SFAS 161”).  SFAS 161 requires enhanced
disclosures about derivative and hedging activities.  SFAS 161 is
effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008, with early application encouraged, and we are
currently evaluating the impact.








35


Forward Looking
Statements





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





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


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


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


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


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


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


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


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


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


•
            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 Kaopectatebrands;


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


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


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


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


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


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


•
            our
      shareholder rights plan and 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;


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


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


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


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


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


•
            virtually
      all of our assets consists of intangibles;
and


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







36


Item 3.  
Quantitative and Qualitative Disclosures About Market Risk





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





Our
exposure to interest rate risk currently relates to amounts outstanding under
our Credit Facility.  Loans under the revolving credit facility
portion of our Credit Facility bear interest at LIBOR plus applicable
percentages of 0.875% to 1.50% or the higher of the federal funds rate plus
0.50% or the prime rate (the “Base Rate”).  The applicable percentages
are calculated based on our leverage ratio.  The term loan under our
Credit Facility bears interest at either LIBOR plus 1.75% or the Base Rate plus
0.75%.  As of February 29, 2008, $55.8 million was outstanding under
the revolving credit facility and $109.8 million was outstanding under the term
loan portion of our Credit Facility.  The variable rate for the
revolving credit facility was LIBOR plus 1.50%, or 5.70% as of February 29,
2008, and the variable rate for the term loan portion was LIBOR plus 1.75%, or
6.13%, as of February 29, 2008.  The 7.0% Subordinated Notes, the
1.625% Convertible Notes and the 2.0% Convertible Notes are fixed interest rate
obligations.




In
November 2006, we entered into an interest rate swap (“swap”) agreement
effective January 2007.  The swap has decreasing notional principal
amounts beginning in October 2007 and a swap rate of 4.98% over the life of the
agreement.  As of February 29, 2008, the decrease in fair value of
$1.6 million, net of tax, was recorded to other comprehensive income and the
swap was deemed to be an effective cash flow hedge.  The swap
agreement terminates in January 2010.




In April
2007, we entered into an interest rate cap (“cap”) agreement.  The cap
has decreasing notional principal amounts beginning in May 2007 and a rate of
5.0% over the life of the agreement.  As of February 29, 2008, the
value of the cap, as valued by a third party, is insignificant.  The
cap agreement terminates in September 2008.




The
impact on our results of operations of a one-point rate change on the April 1,
2008 outstanding revolving credit facility balance of $50.3 million and $109.0
million term loan balance of our Credit Facility for the next twelve months
would be approximately $1.0 million, net of tax.




We are
subject to risk from changes in the foreign exchange rates relating to our
Canadian, U.K., Irish and Greek 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 as a component of investment and other
income in the accompanying consolidated statements of income.  The
potential loss resulting from a hypothetical 10.0% adverse change in the quoted
foreign currency exchange rate amounts to approximately $1.2 million as of
February 29, 2008.




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 29, 2008 (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.








37


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, 2007, other than the addition of the following risk
factor.





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





On February 8, 2008, we initiated a
voluntary nationwide recall of our Icy Hot Heat Therapy
products.  The recall is being conducted to the consumer
level.  We recalled these products because we received some consumer
reports of first, second and third degree burns, as well as skin irritation
resulting from consumer use or possible misuse of the products.  We
may receive lawsuits in the future alleging skin irritation and/or burns from
use of our Heat Therapy products.  See our current Report on Form 8-K,
filed on February 14, 2008, for additional information.







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 2008 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
            
            
            —
            
            
            $
            —
            
            
            
            —
            
            
            
            64,546,467January
      1 – January 31
            
            
            3,700
            
            
            
            64.93
            
            
            
            3,700
            
            
            
            64,306,212February
      1 – February 29
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            64,306,212Total
      First Quarter
            
            
            3,700
            
            
            $
            64.93
            
            
            
            3,700
            
            
            
            64,306,212





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




(2)
            Effective
      November 29, 2005 our board of directors increased the total authorization
      to repurchase our common stock under our stock repurchase program to $30.0
      million.  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 repurchase
program.






Item 3.   Defaults
Upon Senior Securities


None.







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


None.







Item 5.   Other
Information


None.








38


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

























































39


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 8, 2008
              By:
              /s/ Zan
      GuerryZan
      GuerryChairman
      and Chief Executive Officer


Dated:    
      April 8, 2008
                By:
                /s/ Robert
      B. LongRobert
      B. LongVice
      President, Finance(Principal
      Financial Officer)









40


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













































41