UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10-K




ANNUAL
REPORT


PURSUANT
TO SECTION 13 OR 15(D) OF


THE
SECURITIES EXCHANGE ACT OF 1934




For
the fiscal year ended November 30, 2008




Commission
file number 0-5905






CHATTEM,
INC.


A
TENNESSEE CORPORATION




IRS
EMPLOYER IDENTIFICATION NO. 62-0156300






1715
WEST 38TH STREET


CHATTANOOGA,
TENNESSEE 37409


TELEPHONE:
423-821-4571




Securities
registered pursuant to Section 12(b) of the Act:


Title of Each Class
            
            Name
      of Each Exchange on
              Which RegisteredNone
            
            None




Securities
registered pursuant to Section 12(g) of the Act:




Common
Stock, without par value




Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.


YES  þ       NO   ̈




Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.


YES   ̈       NO  þ




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


YES  þ       NO   ̈




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein and will not be contained, to the best of
registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.   ̈




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 Act).    YES
      NO þ




As
of May 31, 2008, the aggregate market value of voting and non-voting shares held
by non-affiliates was $1,129,498,322.  For the sole purpose of this
computation, all executive officers and directors of the registrant have been
deemed to be affiliates of the registrant.




As
of January 22, 2009, 19,468,434 shares of common stock were
outstanding.






DOCUMENTS
INCORPORATED BY REFERENCE:




Portions
of the registrant’s Proxy Statement for the registrant’s 2009 Annual Meeting of
Shareholders (the “2009 Proxy Statement”) are incorporated by reference in Part
III of this Form 10-K to the extent described herein.







PART
I






Item
            
            Page1.
            Business
            31A.
            Risk
      Factors
            161B.
            Unresolved
      Staff Comments
            262.
            Properties
            263.
            Legal
      Proceedings
            264.
            Submission
      of Matters to a Vote of Securities Holders
            26PART
      II5.
            Market
      for the Registrant’s Common Equity, Related Shareholder Matters and Issuer
      Purchases of   Equity Securities
            276.
            Selected
      Financial Data
            297.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            297A.
            Quantitative
      and Qualitative Disclosures about Market Risk
            438.
            Financial
      Statements and Supplementary Data
            459.
            Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
            889A.
            Controls
      and Procedures
            889B.
            Other
      Information
            89PART
      III10.
            Directors,
      Executive Officers and Corporate Governance
            8911.
            Executive
      Compensation
            9112.
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Shareholder Matters
            9113.
            Certain
      Relationships and Related Transactions, and Director
      Independence
            9114.
            Principal
      Accounting Fees and Services
            91PART
      IV15.
            Exhibits
      and Financial Statement Schedules
            92




2


PART
I




Item 1.
Business




Except as
otherwise indicated, all references in this Form 10-K to “we”, “us”, “our” or
“Chattem” refer to Chattem, Inc. and our subsidiaries. In addition, in this Form
10-K, our fiscal years ended November 30, 2006, November 30, 2007 and November
30, 2008 are referred to as fiscal 2006, fiscal 2007 and fiscal 2008,
respectively.  Our fiscal year ending on November 30, 2009 is referred
to as fiscal 2009.  Brand names that are italicized in this Form 10-K
refer to trademarks that we own.




General




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




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




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




•
            ACT and Herpecin-L - oral
      care;




•
            Unisom, Pamprin and Kaopectate - internal
      OTC;




•
            Selsun Blue - medicated
      dandruff shampoos;




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




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




Our
products target niche markets that are often outside the focus of larger
companies where we believe we can achieve and sustain significant market share
through product innovation and strong advertising and promotion support. Many of
our products are among the U.S. market leaders in their respective categories.
For example, our portfolio of topical analgesic brands, our Cortizone-10 anti-itch
ointment and our Gold
Bond medicated body powders have the leading U.S. market share in their
respective categories. We support our brands through extensive and
cost-effective advertising and promotion. 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.  We will continue to seek opportunities to acquire
attractive brands in niche markets.






Competitive
Strengths




We
believe that the following key competitive strengths are critical to our
continuing success:




Diverse and broad
portfolio of well-recognized branded products.  We currently
market a diverse and broad portfolio of 26 brands in a variety of different
product categories. Our products are marketed under well-recognized brand names,
which include lcy Hot,
Gold Bond, Selsun Blue, ACT,
Cortizone-10 and Unisom.  Our
presence in diverse product categories reduces our exposure to changing consumer
demand or weakness in any single category.




Significant
presence in niche markets.  We acquire and develop brands that
compete in small to medium sized niche markets where we believe we can achieve
significant market presence and build brand equity. Our products often face less
competitive pressures because we focus on markets that are frequently outside
the core product areas of larger consumer products and pharmaceutical companies.
This focus provides us with the opportunity to develop strong brand equity,
identify and respond to consumer trends and leverage our strong selling and
distribution capabilities in these markets.




3


High margins and
efficient operating structure.  We are able to achieve high
gross margins as a result of our ability to build and maintain brand equity, our
significant market presence in niche markets and efficiencies in purchasing,
manufacturing and distribution. In addition, we seek to tightly control our
expenses, which strengthens our operating margins. Our high margins and
resulting strong cash flow allow us to withstand temporary fluctuations in our
product markets that could have adverse effects on our business.




Proven
advertising and promotion strategy.  We aggressively build
awareness and consumer loyalty of our brands through extensive and
cost-effective advertising strategies that emphasize the competitive strengths
of our products. We rely principally on television advertising and, to a lesser
extent, radio and print advertising and promotional programs. We strive to
achieve cost efficiencies in our advertising by being opportunistic in our
purchase of media and through control of our production costs. We also maintain
the flexibility to allocate purchased media time among our key brands to respond
quickly to changing consumer trends and to support our growing brands. We
believe our well-developed advertising and promotion platform allows us to
quickly and efficiently launch and support newly acquired brands and product
line extensions as well as increase market penetration of existing brands.
Advertising and promotion expenditures represented approximately 26% of our
total revenues in fiscal 2008. Given the importance of our products’ brand
equity we expect to maintain a significant level of spending on advertising and
promotion.




Established
national sales and distribution network.  We have an
established national sales and distribution network that sells to mass
merchandiser, drug and food retailers such as Wal-Mart Stores, Inc., Walgreens
Co. and The Kroger Co. In fiscal 2008, sales to our top ten customers
constituted approximately 74% of our total domestic gross sales, which allows us
to target our selling efforts to our key customers and tailor specific programs
to meet their needs.  Our fiscal 2008 sales to Wal-Mart Stores, Inc.
accounted for approximately 33% of our total domestic gross sales. Through
targeted sales and utilization of our established distribution network,
including our approximately 55 person sales force, we believe we can effectively
sell and distribute our products, including newly acquired brands and product
line extensions, while maintaining tight controls over our selling
expenses.




Focused new
product development.  We strive to increase the value of our
brands while obtaining an increased market presence through product line
extensions.  In fiscal 2008, our product development expenditures were
$5.7 million.  During the past several years, we have expanded our
product development staff and increased research and development
spending.  We rely on internal market research as well as consultants
to identify new product formulations and line extensions that we believe appeal
to the needs of consumers. In fiscal 2008, we introduced 11 new product line
extensions: Unisom
Sleep Melts, Cortizone-10 Intensive
Healing, Gold Bond
Ultimate Restoring Lotion, Gold Bond Ultimate Foot
Cream, Gold Bond
Ultimate Soothing Lotion, Icy
Hot PM Lotion, Icy
Hot PM Patch, Aspercreme Heat Pain
Relieving Gel, Aspercreme Nighttime Lotion,
Dexatrim Max Daytime
Control and Dexatrim
Max Complex 7.  We have 13 new product launches scheduled for fiscal
2009.






Business
Strategy




Our
strategy to achieve future growth is to generate new sales through strong
marketing and promotional programs, new product development and the acquisition
of new brands.




Brand management
and growth.  We seek to increase market share for our major
brands through focused marketing of our existing products and product line
extensions while maintaining market share for our smaller brands. Our marketing
strategy is to position our products to meet consumer preferences identified
through extensive use of market and consumer research. We intend to channel
advertising and promotion resources to those brands that we feel exhibit the
most potential for growth. We also seek continued growth through our new product
line extension activities as evidenced by our increased research and development
spending and the expansion of our product development staff.  In
addition, we continually evaluate the profit potential of and markets for our
brands and, in instances where our objectives are not realized, will dispose of
under-performing brands and redeploy the resulting cash assets.




Strategic
acquisitions.  We intend to identify and acquire brands in
niche markets where we believe we can achieve a significant market presence
through our established advertising and promotion platform, sales and
distribution network and research and development capabilities. We target brands
with sales that are responsive to increased advertising support, provide an
opportunity for product line extensions through our research and development
efforts and have the potential to meet our high gross margin
goals.  On January 2, 2007, we acquired the U.S. rights to the
following five consumer and OTC brands from Johnson & Johnson (“J & J
Acquisition”): ACT,
Unisom, Cortizone-10, Kaopectate and Balmex.  Also in
fiscal 2007, we acquired the worldwide trademark and rights to sell and market
ACT in Western Europe
from Johnson & Johnson (“ACT
Acquisition”).  We will continue to seek opportunities to
acquire attractive brands in niche markets.




4


Developments
During Fiscal 2008




Products




In fiscal
2008, we introduced the following product line extensions: Unisom Sleep Melts, Cortizone-10 Intensive
Healing, Gold Bond
Ultimate Restoring Lotion, Gold Bond Ultimate Foot
Cream, Gold Bond
Ultimate Soothing Lotion, Icy
Hot PM Lotion, Icy
Hot PM Patch, Aspercreme Heat Pain
Relieving Gel, Aspercreme Nighttime Lotion,
Dexatrim Max Daytime
Control and Dexatrim
Max Complex 7.




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, during the first quarter of fiscal 2008 we
recorded an estimate of approximately $6.0 million of recall expenses related to
product returns, inventory obsolescence, destruction costs, consumer refunds,
legal fees and other estimated expenses. Subsequent to our first fiscal quarter,
we increased our estimate of recall expenses by $0.3 million, to a total of $6.3
million, primarily as a result of additional legal fees and settlement
payments.  The remaining accrued liability for product recall expenses
was $0.8 million as of November 30, 2008.





Loss
on Early Extinguishment of Debt





During
the first quarter of fiscal 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.





Stock Repurchase





During
fiscal 2008, we repurchased 418,281 shares of our common stock under our stock
repurchase program for $26.3 million at an average price per share of
$62.94.





Litigation Settlement




During
the third quarter of fiscal 2008, we reached a settlement on all 26 known claims
alleging pulmonary arterial hypertension as a result of the ingestion of Dexatrim products in 1998
through 2003.  Included as litigation settlement in the consolidated
statements of income is the settlement of the 26 claims totaling $13.3 million
and $0.6 million of legal expenses, which were partially offset by $2.6 million
of proceeds from the Dexatrim litigation
settlement trust.




Subsequent Event




On
December 4, 2008, we issued an aggregate of 487,123 shares of our common stock
in exchange for $28.7 million in aggregate principal amount of our outstanding
2.0% Convertible Senior Notes due 2013 (“2.0% Convertible Notes”).  As
a result of this transaction, the balance of the remaining 2.0% Convertible
Notes was reduced to $96.3 million outstanding.


5


Products




We
currently market a diverse and broad portfolio of branded OTC healthcare
products, toiletries and dietary supplements in such categories as medicated
skin care, topical pain care, oral care, internal OTC, medicated dandruff
shampoos, dietary supplements and other OTC and toiletry products. Our branded
products by category consist of:




Category
      and Brands
              Product
      DescriptionMedicated
      Skin CareGold
      Bond
              Medicated
      powder, cream, lotion, first aid and foot care productsCortizone-10
              Hydrocortisone
      anti-itchBalmex
              Diaper
      rashTopical
      Pain CareIcy
      Hot
              Dual
      action muscular and arthritis pain relieverAspercreme
              Odor-free
      arthritis pain relieverFlexall
              Aloe-vera
      based pain relieverCapzasin
              Deep
      penetrating, odor-free arthritis pain relieverSportscreme
              Odor-free
      muscular pain relieverArthritis
      Hot
              Value-priced
      arthritis pain relieverOral
      CareACT
              Anti-cavity
      mouthwash/mouth rinseHerpecin-L
              Cold
      sore lip treatmentBenzodent
              Denture
      pain relief creamInternal
      OTCPamprin
              Menstrual
      pain relieverPrēmsyn
      PMS
              Premenstrual
      pain relieverUnisom
              OTC
      sleep-aidKaopectate
              Anti-diarrheal
      remedyMedicated
      Dandruff ShampoosSelsun
      Blue
              Medicated
      dandruff shampoosDietary
      SupplementsDexatrim
              Diet
      pillsGarlique
              Cholesterol
      health supplementMelatonex
              Natural
      sleep aidNew
      Phase
              Menopausal
      supplementOmnigest
      EZ
              Digestive
      aidOther
      OTC and Toiletry ProductsBullfrog
              SunscreensSun-In
              Spray-on
      hair lightenerUltraSwim
              Chlorine-removing
      shampoo and conditionerMudd
              Facial
      masque






Medicated
Skin Care




The Gold Bond brand competes in
numerous product categories with specially formulated products for both adults
and babies, including body powder, therapeutic hand and body lotions, foot care
and first aid.  Gold
Bond has long been the number one selling brand of medicated body powder
domestically, and its strong brand equity among consumers has allowed us to
successfully launch new line extensions, most recently under the Gold Bond Ultimate
line.




Initially
launched in fiscal 2003, Gold
Bond Ultimate Healing Skin Therapy Lotion helps to heal and nurture
extremely dry, cracked and irritated skin with seven intensive moisturizers plus
vitamins A, C and E. The Gold
Bond Ultimate line expanded into the everyday bath powder category with
the introduction of Gold
Bond Ultimate Comfort Body Powder in fiscal 2005. Gold




6


Bond Ultimate Comfort Body
Powder is a talc-free powder that provides freshness, odor protection and
moisture control and features the signature Ultimate fragrance.  In
fiscal 2006, we introduced Gold Bond Ultimate Softening
Lotion.  The new Ultimate Softening lotion is specially formulated to
soften rough, dry skin.  In fiscal 2008 we launched three additions to
the Gold Bond Ultimate
line: Restoring Lotion, Soothing Lotion and Foot Cream.




As part
of the J&J Acquisition in 2007, Cortizone-10 and Balmexjoined theGold Bondbrand in themedicated skin care
category.  Cortizone-10 is the leading
brand in the anti-itch category and helps to relieve itching associated with
various skin irritations including rashes, dry skin, eczema, poison ivy and
insect bites.  All Cortizone-10 products contain
1% hydrocortisone and are available in multiple forms.  The Cortizone-10 Crème with aloe
and Crème Plus with 10 moisturizers are designed to relieve itch fast and
moisturize the skin.  Cortizone-10 Intensive
Healing Formula, launched in January 2008, contains moisturizers, anti-oxidant
vitamins, and chamomile designed to moisturize for 24 hours and to help relieve
itchy skin.




Balmexis a line of diaper
rash products available in two formulas.  The primary formula contains
zinc oxide to treat and prevent diaper rash.  The second formula is a
petrolatum based product for treatment and prevention of diaper rash and other
skin irritations.




Topical
Pain Care




Our
topical pain care portfolio features six distinctly positioned brands. Our
flagship brand, Icy
Hot, is a leader in the external analgesic category and receives heavy
media support and strong advertising featuring NBA super-star Shaquille
O'Neal.  In fiscal 2008, we extended the Icy Hot brand with two new
products – Icy Hot PM
Lotion and Icy Hot PM
Patch – specifically designed to help relieve arthritis sufferers’ nighttime
pain.




Aspercreme provides odor-free
pain relief for sufferers of arthritis and other joint and muscle pain. In
fiscal 2008, this brand was extended with two new product
introductions:  Aspercreme Nighttime Lotion
offers maximum nighttime pain relief, and Aspercreme Heat Pain
Relieving Gel delivers fast-acting pain relief with a heat sensation in a
no-mess gel.  Capzasin is an arthritis pain
reliever that contains capsaicin.  Sportscreme is targeted at
serious athletes as well as “weekend warriors”.  Flexall is marketed toward
those who seek a menthol and aloe vera based pain reliever for conditions such
as back pain or muscle strain.  Arthritis Hot rounds out the
portfolio and competes against private label products at a value
price.




Oral
Care




Our oral
care brands include Herpecin-L, a lip care
product that treats cold sores and protects lips from the harmful rays of the
sun, and Benzodent, a
dental analgesic cream for pain related to dentures.  With the J&J
Acquisition, we added ACT, a line of anti-cavity
mouthwash and mouth rinses.  ACT is available in three
flavors of anti-cavity fluoride rinse and in the ACT Restoring line with four
flavors and multiple package sizes.  The ACT Restoring line of
products seeks to restore minerals to soft spots; strengthen enamel to prevent
tooth decay; and kill bad breath germs.  In 2009, we will launch the
ACT Total Care line of
mouthwashes which combines the consumer benefits of strong teeth, healthy gums
and fresh breath in two flavors – Icy clean mint and alcohol-free Fresh
mint.




Internal
OTC’s




We
compete in the menstrual analgesic category with two brands, Pamprin and Prēmsyn
PMS.  Pamprin, featuring four
distinct formulas, seeks to provide complete relief of a woman’s menstrual
symptoms, while Prēmsyn
PMS has one formula designed to address specific symptoms of premenstrual
syndrome.  Pamprin is available in four
formulas: Multi-Symptom, Cramp, All Day, and Max.




In
connection with the J&J Acquisition, the Unisom and Kaopectate brands joined the
internal OTC category in 2007.  Unisom is the leading single
ingredient brand in the OTC sleep aid category. Unisom is available in three
product forms: SleepTabs, with the active ingredient diphenhydramine; SleepGels,
which contains the active ingredient doxylamine; and Sleep Melts, launched in
fiscal 2008, which melts in your mouth.  Kaopectate is a well
established anti-diarrheal remedy.  Kaopectate is available in
Regular and Extra Strength and three flavors: regular, Peppermint and
Cherry.  In addition, Kaopectate offers a stool
softener under its brand banner.




7


Medicated
Dandruff Shampoos




TheSelsun Blue line of products
consists of three distinct product offerings, each using different active
medication and ingredients to provide unique formulas for the various consumer
segments in the marketplace.




The Selsun Blue base formula
contains the active ingredient selenium sulfide and is comprised of four
shampoos: Medicated, with a cooling clean feel; Moisturizing, with aloe and
moisturizers; 2-in-1, with a patented conditioning system; and Daily for more
sensitive scalp treatment.




Selsun Salon, launched in
2005, contains the active ingredient, pyrithione zinc, plus moisturizers and
nutrients for enhanced hair care.  All Selsun Salon products are
formulated with a blend of salon quality moisturizers, vitamins and nutrients to
provide great looking hair.




Selsun Natural, launched in
fiscal 2007, contains the active ingredient salicylic acid.  The two
shampoos (Artic Energy and Island Breeze) have a clear-looking formula with
moisturizers, botanicals and vitamins to provide gentler care of the hair and
scalp and help restore hair to its natural, healthy state.




Dietary
Supplements




Dexatrim is a leading brand
in the diet pill category that includes such products as Dexatrim Max, Dexatrim Max2O, Dexatrim Max Evening Appetite
Control, Dexatrim
Natural and, launched in fiscal 2008, Dexatrim Max Daytime Control
and DexatrimMax
Complex 7.




We also
compete in the dietary supplements category with our Sunsource line of
products.  All Sunsource products are specially formulated to provide
consumers with an all-natural, drug-free way to support their specific health
care goals.  Known for its support of cardiovascular health, Garlique leads the garlic
supplement category and is positioned as an odor-free, one-per-day supplement
that helps maintain cholesterol levels already within a healthy
range.




Other
OTC and Toiletry Products




The
majority of sales of our seasonal brands, Bullfrog, Sun-In and UltraSwim, typically occur
during the first three quarters of our fiscal year.  Bullfrog is a line of high
quality, high SPF waterproof sunblocks.  Included in the Bullfrog line is Bullfrog Mosquito Coast which
combines an SPF 30 sunblock with a DEET Free insect repellent, QuickGel
Sportspray, Superblock, Quik Stick, and Marathon Mist, a convenient continuous
spray sunblock product in children and adult versions.  In 2008 and
2009, theBullfrog line
is being enhanced with “UV Extender” which provides broader UVB and UVA
protection for the Quick Gel, Sportspray and Marathon Mist
products.  In addition, in 2009 Bullfrog Superblock will be
reformulated to provide SPF 50 protection for those seeking sun
protection.




Sun-In, a hair lightener, is
available in two varieties of spray-on and a highlighting gel.  UltraSwim is our niche line
of swimmers’ shampoos and conditioner.  Our other brands include Mudd, a line of specialty
masque products, and a variety of other smaller brands.






International
Business




Our
international business, which represented approximately 7%, 7% and 8% of our
total revenues in fiscal 2008, 2007 and 2006, respectively, has been
concentrated in Canada, an export market driven from our operations in Ireland,
the United Kingdom (“U.K.”), Greece and in Latin American countries in which
Selsun, ACT and certain
of our other products are sold.




Canada




Chattem
Canada, a wholly-owned subsidiary based in Mississauga, Ontario, Canada, markets
and distributes certain of our consumer products throughout Canada. The
manufacturing of these products is principally done in our facilities in
Chattanooga, Tennessee, while some packaging is done in Mississauga. Chattem
Canada utilizes a national broker for its sales efforts. Brands marketed and
sold in Canada include Icy
Hot, Selsun,
Gold Bond, Pamprin, Sun-In, UltraSwim and Aspercreme.




8


Europe




Our
European business is conducted through Chattem Global Consumer Products Limited
(“Chattem Global”), our Irish subsidiary, located in Limerick, Ireland; Chattem
(U.K.) Limited (“Chattem (U.K.)”), a wholly-owned subsidiary located in
Basingstoke, Hampshire, England; and Chattem Greece, a wholly-owned subsidiary
located in Alimos Attica, Greece.  Packaging and distribution
operations are conducted principally in Ireland with certain products sourced
from our U.S. operations. Chattem uses a national broker in the U.K., while
distributors are used to market and sell our products on the European continent
and elsewhere. Our products sold in Europe include Selsun, ACT, Sun-In, and Mudd. Cornsilk® is sold by
Chattem (U.K.) under a licensing arrangement with the owner of its registered
trademark, Coty, Inc. Spray Blond Spray-In Hair lightener is marketed only on
the European continent.  Certain of our OTC health care products are
sold by Chattem Global to customers in parts of Central Europe and the Middle
East.




Peru




In the
fourth quarter of fiscal 2008, we established Chattem Peru SRL (“Chattem Peru”),
a wholly-owned subsidiary located in Lima, Peru.  Chattem Peru sells
certain of our Selsun
products throughout Peru using third party distributors.




United
States Export




Our
United States export division services various distributors primarily located in
the Caribbean and Latin America. We distribute Selsun, ACT, Gold Bond, Dexatrim, Icy Hot, Aspercreme, Capzasin and Sportscreme into these
markets.




Selsun
International




We plan
to focus our efforts on expanding Selsun’s international
presence in existing key markets, such as Canada, Mexico, Brazil, the U.K. and
Australia.  In certain international markets, we sell Selsun through distributors
and receive a royalty based on a percentage of distributor sales.  We
have entered into distributor agreements with third party distributors for Selsun in various
international markets other than Canada and the U.K., where we engage national
brokers.






Marketing,
Sales and Distribution




Advertising
and Promotion




We
aggressively seek to build brand awareness and product usage through extensive
and cost effective advertising strategies that emphasize the competitive
strengths of our products. We allocate a significant portion of our revenues to
the advertising and promotion of our products. Expenditures for these purposes
were approximately 26%, 27% and 32% of total revenues in fiscal 2008, 2007 and
2006, respectively.




We seek
to increase market share for our major brands through focused marketing of our
existing products and product line extensions while maintaining market share for
our smaller brands. Our marketing strategy is to position our products to meet
consumer preferences identified through extensive use of market and consumer
research. We intend to channel advertising and promotion resources to those
brands that we feel exhibit the most potential for growth. We rely principally
on television advertising and to a lesser extent, radio and print advertising
and promotional programs. We strive to achieve cost efficiencies in our
advertising by being opportunistic in our purchase of media and controlling our
production costs. We also maintain the flexibility to allocate purchased media
time among our key brands to respond quickly to changing consumer trends and to
support our growing brands. We believe our well-developed advertising and
promotion platform allows us quickly and efficiently to launch and support newly
acquired brands and product line extensions as well as increase market
penetration of existing brands.




We work
directly with retailers to develop promotional calendars and campaigns for each
brand, customizing the promotion to the particular requirements of the
individual retailer. These programs, which include cooperative advertising,
temporary price reductions, in-store displays and special events, are designed
to obtain or enhance distribution at the retail level and to reach the ultimate
consumers of the product. We also utilize consumer promotions such as coupons,
samples and trial sizes to increase the trial and consumption of the
products.




9


Customers




Our
customers consist of mass merchandisers such as Wal-Mart Stores, Inc., drug
retailers such as Walgreens Co. and food retailers such as The Kroger Co. In
fiscal 2008, our ten largest customers represented approximately 74% of total
domestic gross sales, and our 20 largest customers represented approximately 84%
of total domestic gross sales, which allows us to target our selling efforts to
our key customers and customize programs to meet their needs.  Our
fiscal 2008 sales to Wal-Mart Stores, Inc. accounted for approximately 33% of
total domestic gross sales. No other customer accounts for more than 10% of our
total domestic gross sales.  No international retailers accounted for
more than 10% of our total international gross sales in fiscal
2008.  Consistent with industry practice, we do not operate under a
long-term written supply contract with any of our customers.




Sales
and Distribution




We have
an established national sales and distribution organization that sells to mass
merchandiser, drug and food retailers. We utilize our national sales network,
consisting primarily of our own sales force, to sell and distribute our
products, including newly acquired brands and product line extensions, while
maintaining tight controls over our selling expenses. Our experienced sales
force of approximately 55 people serves all direct buying accounts on an
individual basis.  For the more fragmented food channel and for the
smaller individual stores, we rely on a national network of regional brokers to
provide retail support. In excess of 95% of our domestic orders are received
electronically through our electronic data interchange, or EDI, system, and
accuracy for our order fulfillment has been consistently high. Our sales
department performs significant analysis helping both our sales personnel and
customers understand sales patterns and create appropriate promotions and
merchandising aids for our products. Although not contractually obligated to do
so, in certain circumstances, we allow our customers to return unsold
merchandise, and for seasonal products we provide extended payment terms to our
customers.




Internationally,
our products are sold by national brokers in Canada and the U.K. and by
distributors in Europe and Latin America. We have entered into distribution
agreements with third party distributors for Selsun in various
international markets except Canada and the U.K.




Most of
our products, including those manufactured by third party manufacturers, are
shipped from leased warehouses located in Chattanooga, Tennessee. We also use a
third party logistics service located in California to warehouse and distribute
our products to the west coast area of the United States. We use third party
common carriers to transport our products. We do not generally experience wide
variances in the amount of inventory we maintain. At present, we have no backlog
of customer orders and are promptly meeting customer requirements.




Manufacturing
and Quality Control




During
fiscal 2008, we manufactured products representing approximately 57% of our
domestic sales volume at our two Chattanooga, Tennessee, facilities. The balance
of our products are manufactured by third party contract manufacturers including
our Gold Bond medicated
powders, Icy Hot
patches and sleeves, ACT, Herpecin-L, and our dietary
supplements, including Dexatrim
products.  We contract with third party manufacturers to manufacture
products that are not compatible with our existing manufacturing facilities or
which can be more cost-effectively manufactured by others. In certain cases,
third party manufacturers are not obligated under contracts that fix the term of
their commitment. We believe we have adequate capacity to meet anticipated
demand for our products through our own manufacturing facilities and third party
manufacturers.




To
monitor the quality of our products, we maintain an internal quality control
system supported by onsite microbiology and analytical laboratories. We have
trained quality control technicians who test our products and processes and
guide the products through the manufacturing cycle. Consultants also are
employed from time to time to test our quality control procedures and the
compliance of our manufacturing operations with the United States Food and Drug
Administration (“FDA”) regulations. We audit our third party manufacturers to
monitor compliance with applicable current good manufacturing practices (“GMPs”)
as defined by FDA regulations.




We
purchase raw materials and packaging materials from a number of third party
suppliers primarily on a purchase order basis. Except for a select few active
ingredients used in our Pamprin and Prēmsyn
PMS products, we are not limited to a single source of supply for the
ingredients used in the manufacture of our products.  Sales of our
Pamprin and Prēmsyn
PMS products represented approximately 3% of our consolidated total
revenues in fiscal 2008.  In addition, we have a limited source of
supply for selenium sulfide, the active ingredient in Selsun Blue.  As a
result of the limited supply and increase in worldwide




10


demand
for selenium metal, a major component in the manufacture of selenium sulfide,
our cost of selenium sulfide has been and is expected to be
volatile.  We believe that our current and potential alternative
sources of supply will be adequate to meet future product
demands.  Sales of our Selsun Blue products
represented approximately 11% of our consolidated total revenues in fiscal
2008.




Research
and Development




We strive
to increase the value of our base brands and obtain an increased market presence
through product line extensions. We rely on internal market research as well as
consultants to identify new product formulations and line extensions that we
believe appeal to the needs of consumers. Our growth strategy includes an
emphasis on new product development as evidenced by our increased research and
development spending and the expansion of our product development
staff.  We currently employ approximately 34 people in our research
and development department and also engage consultants from time to time to
provide expertise or research in a particular product area. Our product
development expenditures were $5.7 million in fiscal 2008 and $5.5 million in
fiscal 2007.




Competition




We
compete in the OTC health care, toiletries and dietary supplements markets.
These markets are highly competitive and are characterized by the frequent
introduction of new products, including the migration of prescription drugs to
the OTC market, often accompanied by major advertising and promotional support.
Our competitors include large pharmaceutical companies such as Johnson &
Johnson, consumer products companies such as Procter & Gamble Co., and
dietary supplements companies such as GlaxoSmithKline and Nature’s Bounty, Inc.,
many of which have considerably greater financial and other resources and are
not as highly leveraged as we are. Our competitors may be better positioned to
spend more on research and development, employ more aggressive pricing
strategies, utilize greater purchasing power, build stronger vendor
relationships and develop broader distribution channels than us. In addition,
our competitors have often been willing to use aggressive spending on trade
promotions and advertising as a strategy for building market share at the
expense of their competitors, including us. The private label or generic
category has also become increasingly more competitive in certain of our product
markets. Our products continue to compete for shelf space among retailers who
are increasingly consolidating.




Trademarks
and Patents




Our
trademarks are of material importance to our business and among our most
important assets. We own all of our trademarks associated with brands that we
currently market. In fiscal 2008, substantially all of our total revenues were
from products bearing proprietary or licensed brand names. Accordingly, our
future success may depend in part upon the goodwill associated with our brand
names, particularly Gold
Bond, Selsun
Blue, Icy Hot,
ACT, Unisom and Cortizone-10.




Our
principal brand names are registered trademarks in the United States and certain
foreign countries. We maintain or have applied for patent and copyright
protection in the United States relating to certain of our existing and proposed
products and processes.  We also license from third parties other
intellectual property that is used in certain of our products. The sale of these
products relies on our ability to maintain and extend our supply and licensing
agreements with these third parties.




Government
Regulation




The U.S.
manufacturing, distribution, processing, formulation, packaging, labeling and
advertising of our products are subject to regulation by federal agencies,
including, but not limited to:




•   the
      Food & Drug Administration (the
“FDA”);


•   the
      Federal Trade Commission (the
“FTC”);


•   the
      Drug Enforcement Administration (the
“DEA”);


•   the
      Consumer Product Safety Commission (the
“CPSC”);


•   the
      United States Postal Service;


•   the
      Environmental Protection Agency (“EPA”);
and


•   the
      Occupational Safety and Health Administration
  (“OSHA”).




11


These
activities are also regulated by various agencies of the states, localities and
foreign countries in which our products are sold. In particular, the FDA
regulates the safety, manufacturing, labeling and distribution of OTC drugs,
medical devices, dietary supplements, functional toiletries, and skin care
products. In addition, the FTC has primary jurisdiction to regulate the
advertising of OTC drugs, medical devices, dietary supplements, functional
toiletries and skin care products.  In foreign countries these same
activities may be regulated by ministries of health, or other local regulatory
agencies.  The manner in which products sold in foreign countries are
registered, how they are formulated, or what claims may be permitted may differ
from similar products and practices in the U.S.




Under the
Federal Food, Drug, and Cosmetic Act (“FDC Act”) all “new drugs”, including OTC
products, are subject to pre-market approval by the FDA under the new drug
application (“NDA”) process. The FDC Act defines a “new drug” as a drug that is
not generally recognized among scientifically qualified experts as safe and
effective for use under the conditions stated in its labeling. A drug might also
be considered new if it has not been used, outside of clinical investigations,
to a material extent or for a material time under conditions described for a
product. A drug that is generally regarded as safe and effective is not a “new
drug” and therefore does not require pre-market approval.




The FDA
has adopted an administrative process, the OTC Drug Review, to determine which
active ingredients and indications are safe and effective for use in OTC
products. With the aid of independent expert advisory review panels, the FDA
develops rules, referred to as “monographs”, which define categories of safe and
effective OTC drugs. These monographs group drug ingredients into therapeutic
classes such as OTC external analgesics. Products that comply with monograph
conditions do not require pre-market approval from the FDA.




The FDA
has finalized monographs for certain categories of OTC drugs such as drug
products for the control of dandruff. If a product is marketed beyond the scope
of a particular final monograph and without an approved NDA, such as if the
manufacturer makes a label claim not covered by the monograph, the FDA will
consider the product to be unapproved and misbranded and can take enforcement
action against the drug company and product including, but not limited to,
issuing a warning letter or initiating a product seizure. In order to market a
product whose active ingredients are not permitted by a final monograph, a
company must submit an NDA to the FDA.




There are
several categories of OTC drugs, such as external analgesics, for which the FDA
has not completed its review. In such cases, the FDA has established tentative
final monographs. These tentative final monographs are similar to final
monographs in that they establish conditions under which OTC drugs can be
marketed for certain uses without FDA pre-marketing approval. The FDA generally
does not take enforcement action against an OTC drug subject to a tentative
final monograph unless there is a safety problem or a substantial effectiveness
question.




The
majority of our OTC drug products are regulated pursuant to the FDA monograph
system.  Many of our products are sold according to tentative final
monographs. Therefore, we face the risk that the FDA could take action if there
is a perceived safety or efficacy issue with respect to one of our product
categories or finalize these monographs with conditions as to which of our
products do not comply. If any of our products were found not to be in
compliance with a final monograph, we may be forced to reformulate or relabel
such products, if possible, or submit an NDA or an abbreviated NDA to continue
to market our existing formulation. The submission of an NDA would require the
preparation and submission of clinical tests, which would be time consuming and
expensive. We may not receive FDA approval of any NDA in a timely manner or at
all. If we were not able to reformulate or relabel our product or obtain FDA
approval of an NDA, we would be required to discontinue selling the affected
product. Changes in monographs could also require us to change our product
formulation or dosage form, revise our labeling, modify our production process
or provide additional scientific data, any of which would involve additional
costs and may be prohibitive. For our OTC drug products that are sold according
to final monographs, we cannot deviate from the conditions described in the
final monograph, such as changes in approved active ingredient levels or
labeling claims, unless we obtain pre-marketing approval from the
FDA.




We have
responded to certain questions received from the FDA with respect to efficacy of
pyrilamine maleate, one of the active ingredients used in certain of
the  Pamprin  Menstrual
Pain Relief 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 is not included
in the final monograph, we would be required to reformulate the products to
continue to provide the consumer with multi-symptom relief benefits. We believe
that any adverse finding by the FDA would likewise affect our principal
competitors in the menstrual product category and that finalization of the
menstrual products monograph is not imminent. Moreover, we have formulated
alternative Pamprin
products that fully comply with both the internal analgesic and menstrual
product monographs. Sales of our




12


Pamprin Menstrual Pain Relief
and Prēmsyn
PMS products represented approximately 3% of our consolidated total
revenues in fiscal 2008.




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 are working to develop alternate formulations for Sportscreme and Aspercreme in the event that
the FDA does not consider the available clinical data to conclusively
demonstrate the efficacy of trolamine salicylate when the OTC external analgesic
monograph is finalized. If 10% trolamine salicylate is not included in the final
monograph, we would likely be required to discontinue these products as
currently formulated after expiration of an anticipated grace period. If this
occurred, we believe we could market related products as homeopathic products
and could also reformulate them using other ingredients included in the FDA
monograph.  We believe that the monograph is unlikely to become final
and take effect before mid-2009. Sales of our Sportscreme and Aspercreme products
represented approximately 5% of our consolidated total revenues in fiscal
2008.




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




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.




The
Dietary Supplement Health and Education Act of 1994 (“DSHEA”) was enacted on
October 25, 1994. DSHEA amends the FDC Act by defining dietary supplements,
which include vitamins, minerals, amino acids, nutritional supplements, herbs
and botanicals, as a new category of food separate from conventional food. DSHEA
provides a regulatory framework to ensure safe, quality dietary supplements and
to foster the dissemination of accurate information about such products. Under
DSHEA, the FDA is generally prohibited from regulating dietary supplements as
food additives or as drugs unless product claims, such as claims that a product
may diagnose, mitigate, cure or prevent an illness, disease or malady, permit
the FDA to attach drug status to a product. In such case, the FDA could require
pre-market approval to sell the product. Manufacturers are not required to
obtain prior FDA approval before producing or selling a dietary supplement
unless the ingredient is considered “new” or was not on the market as of October
15, 1994.




The FDA
has promulgated regulations relating to the manufacturing process for drugs,
which are known as current GMP's.  In June 2007, the FDA published the
final rule on GMP’s for dietary supplements, with an effective date of June 25,
2008.  We source all of our dietary supplement products from outside
suppliers, including Dexatrim, New Phase, Garlique, Melatonex, and Omnigest. As part of its
regulatory authority, the FDA may periodically conduct audits of the physical
facilities, machinery, processes and procedures that we, or our suppliers, use
to manufacture products. The FDA may perform these






13


audits at
any time without advanced notice. As a result of these audits, the FDA may order
us, or our suppliers, to make certain changes in manufacturing facilities and
processes. We may be required to make additional expenditures to comply with
these orders or the new GMP requirements, or possibly discontinue selling
certain products until we, or our suppliers, comply with these orders and
requirements. As a result, our business could be adversely
affected.




In 1997,
the FDA published a proposed rule on the use of dietary supplements containing
ephedrine alkaloids. In June 2002, the United States Department of Health and
Human Services (“HHS”) proposed an expanded scientific evaluation of Ephedra
which led to the issuance of a report by the RAND-based Southern California
Evidence-Based Practice Center (the “RAND Report”). The RAND Report concluded
that ephedrine, ephedrine plus caffeine and Ephedra-containing dietary
supplements with or without herbs containing caffeine all promote modest amounts
of weight loss over the short term and use of Ephedra, or ephedrine plus
caffeine, is associated with an increased risk of gastrointestinal, psychiatric
and autonomic symptoms. The adverse event reports contained a smaller number of
more serious adverse events. Given the small number of such events, the RAND
Report concluded that further study would be necessary to determine whether
consumption of Ephedra, or ephedrine, may be causally related to these serious
adverse events. In connection with the RAND Report, HHS sought public comment on
whether additional measures are required concerning the sale and distribution of
dietary supplements containing ephedrine alkaloids.




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




The FDA
also regulates some of our products as cosmetics or drug-cosmetics. There are
fewer regulatory requirements for cosmetics than for drugs or dietary
supplements. Cosmetics marketed in the United States must comply with the FDC
Act, the Fair Packaging and Labeling Act and the FDA's implementing regulations.
Cosmetics must also comply with quality and labeling requirements proscribed by
the FDA. In addition, several of our products are subject to product packaging
regulation by the CPSC and the FDA.




Combination
products can be regulated via a memorandum of understanding between federal
agencies. In February 2006, we launched Bullfrog Mosquito Coast, a
combination of sunscreen and insect repellent. The sunscreen labeling is
regulated by the FDA in its sunscreen monograph, but the insect repellent,
IR-3535, and its labeling, require pre-market safety and efficacy testing and
approval by the EPA and all 50 states (and U.S. Territories).  Bullfrog Mosquito Coast
received approval from all states and the EPA prior to launch. Further, the FDA
announced its intention in its November, 2005 Unified Agenda to regulate, under
the monograph system, the combination of sunscreens and insect repellents in a
notice of proposed rulemaking yet to be published. Any final rule making is
years in the future and the FDA might grandfather existing products or otherwise
allow time for their compliance.




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 CHPA, presenting evidence that titanium dioxide presents “no
significant risk” to consumers.




Finally,
the FDA regulates the quality of all finished drug, medical device, and food
products under GMP's. As part of its regulatory authority, the FDA may
periodically conduct audits of the physical facilities, machinery, processes and
procedures that we, or our suppliers, use to manufacture products. The FDA may
perform these audits at any time without advanced notice. In February 2006, we
registered as a medical device manufacturer with the FDA in connection with our
sale of Icy Hot Pro
Therapy products. It might be expected that we could be audited as a new
device manufacturer under medical device GMP's. Working




14


with
consultants we have instituted medical device GMP's pursuant to applicable
portions of the medical device Quality System Regulation, or QSR. As a result of
any audits, the FDA may order us, or our suppliers, to make certain changes in
manufacturing facilities and processes. We may be required to make additional
expenditures to comply with these orders, or possibly discontinue selling
certain products until we, or our suppliers, comply with these orders. As a
result, our business could be adversely affected.  In December 2006,
the Dietary Supplement and Nonprescription Drug Consumer Protection Act was
signed into law with an effective date of December 22, 2007.  This new
law requires the mandatory reporting of serious adverse events and specific
record keeping requirements for dietary supplements and non-prescription drugs
marketed without an approved application.




The FDA
has broad regulatory and enforcement powers. If the FDA determines that we have
failed to comply with applicable regulatory requirements, it can impose a
variety of enforcement actions from public warning letters, fines, injunctions,
consent decrees and civil penalties to suspension or delayed issuance of
approvals, seizure or recall of our products, total or partial shutdown of
production, withdrawal of approvals or clearances already granted, and criminal
prosecution. The FDA can also require us to repair, replace or refund the cost
of devices that we manufactured or distributed. If any of these events were to
occur, it could materially adversely affect us.




Environmental
Matters




We
continually assess the compliance of our operations with applicable federal,
state and local environmental laws and regulations. Our policy is to record
liabilities for environmental matters when loss amounts are probable and
reasonably determinable. Our manufacturing site utilizes chemicals and other
potentially hazardous materials and generates both hazardous and non-hazardous
waste, the transportation, treatment, storage and disposal of which are
regulated by various governmental agencies. We have engaged environmental
consultants on a regular basis to assist with our compliance efforts. We believe
we are currently in compliance with all applicable environmental permits and are
aware of our responsibilities under applicable environmental laws. Any
expenditure necessitated by changes in law and permitting requirements cannot be
predicted at this time, although such costs are not expected to be material to
our financial position, results of operations or cash flows.




In late
2005, we began the manufacture of Bullfrog Mosquito Coast at
our Chattanooga, Tennessee plant. Bullfrog Mosquito Coast is a
combination of sunscreen and insect repellent. The EPA has primary jurisdiction
over insect repellants and combination insect repellant products containing
sunscreens, such as Bullfrog Mosquito Coast. Both
products and manufacturing establishments must be registered with the
EPA.




The
handling, disposal, and environmental exposure of the insect repellent, IR-3535,
is strictly regulated by the EPA under the Clean Waters Act.  Any
failure to comply with applicable regulations with respect to the use of IR-3535
might result in EPA action against us, including fines or injunctive
action.




Employees




As of
November 30, 2008, we employed approximately 488 people on a full-time basis and
10 people on a part-time basis in the United States. In addition, at the end of
fiscal 2008, we employed approximately 24 people at our foreign subsidiaries’
offices. Our employees are not represented by any organized labor union, and we
consider our labor relations to be good.




Market
Data




We use
market and industry data throughout this Annual Report on Form 10-K and the
documents incorporated by reference herein, which we have obtained from market
research, publicly available information and industry publications. These
sources generally state that the information that they provide has been obtained
from sources believed to be reliable, but that the accuracy and completeness of
such information are not guaranteed. The market and industry data is often based
on industry surveys and the preparers’ experience in the industry. Similarly,
although we believe that the surveys and market research that others have
performed are reliable, we have not independently verified this information. In
particular, market share information has been coordinated and prepared for us by
A.C. Nielsen at our request based on market segments that we defined and for
which we have paid customary fees. Therefore, such data, including the market
category delineations that form the basis for such data, are not necessarily
representative of results that would have been obtained from an independent
source.  Furthermore, the market share information prepared by A.C.
Nielsen does not include data from certain of our customers, most notably
Wal-Mart Stores, Inc.




15


Financial
Information on Products and Geographical Areas




For
financial information on our product categories and geographical areas, see note
11 to our consolidated financial statements.




Additional
Information




Our
internet website address is www.chattem.com. We make available free of charge on
or through our website our annual reports on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K, reports filed pursuant to Section 16,
the proxy statement to our annual shareholders meeting and all amendments to
those reports as soon as reasonably practicable after such material is
electronically filed with or furnished to the Securities and Exchange
Commission.  We also make available on our website our Code of
Business Conduct and Ethics, our Audit Committee Charter and our Compensation
Committee Charter.  The information found on our website shall not be
deemed incorporated by reference into this annual report on Form 10-K or filed
with the Securities and Exchange Commission and does not constitute a part of
this annual report on Form 10-K.






Item 1A.  Risk
Factors




Our
business is subject to a number of risks. Some of the risks associated with our
operations are described in the “Competition,” “Government Regulation,”
“Environmental,” and “Manufacturing and Quality Control” portions of this Form
10-K. In addition to the other information contained in this Form 10-K, the
following risk factors should be carefully considered.




We
face significant competition in the OTC health care, toiletries and dietary
supplements markets.




The OTC
health care, toiletries and dietary supplements markets are highly competitive
and are characterized by the frequent introduction of new products, including
the migration of prescription drugs to the OTC market, often accompanied by
major advertising and promotional support. These introductions may adversely
affect our business especially because we compete in categories in which product
sales are highly influenced by advertising and promotions. Our competitors
include large pharmaceutical companies such as Johnson & Johnson, consumer
products companies such as Procter & Gamble Co., and dietary supplements
companies such as GlaxoSmithKline and Nature’s Bounty, Inc., many of which have
considerably greater financial and other resources than we do and are not as
highly leveraged as we are. These competitors are thus better positioned to
spend more on research and development, employ more aggressive pricing
strategies, utilize greater purchasing power, build stronger vendor
relationships and develop broader distribution channels than us. In addition,
our competitors have often been willing to use aggressive spending on trade
promotions and advertising as a strategy for building market share at the
expense of their competitors including us. The private label or generic category
has also become increasingly more competitive in certain of our product markets.
If we are unable to continue to introduce new and innovative products that are
attractive to consumers or are unable to allocate sufficient resources to
effectively advertise and promote our products so that they achieve wide spread
market acceptance, we may not be able to compete effectively, and our operating
results and financial condition may be adversely affected.




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




A prolonged economic downturn or
recession in the United States or any of the other countries in which we do
significant business could materially and adversely affect our business,
financial condition and results of operations.  In particular, such a
downturn or recession could adversely impact (i) the level of spending by our
ultimate consumers, (ii) our ability to collect accounts receivable on a timely
basis from certain customers, (iii) the ability of certain suppliers to fill our
orders for raw materials, packaging or co-packed finished goods on a timely
basis and (iv) the mix of our products sales.




We
may be adversely affected by factors affecting our customers’
businesses.




Factors that adversely impact our
customers’ businesses may also have an adverse effect on our business,
prospects, results of operations, financial condition or cash
flows.  These factors may include:




16


•
            any
      credit risks associated with the financial condition of our
      customers;




•
            the
      effect of consolidation or weakness in the retail industry, including the
      closure of our customer’s retail stores and the uncertainty resulting
      therefrom; and




•
            inventory
      reduction initiatives and other factors affecting customer buying
      patterns, including any reduction in retail space commitment and practices
      used to control inventory
shrinkage.




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




In fiscal
2008, Wal-Mart Stores, Inc. represented approximately 33% of our total domestic
gross sales, our ten largest customers represented approximately 74% of our
total domestic gross sales and our 20 largest customers represented
approximately 84% of our total domestic gross sales. Consistent with industry
practice, we do not operate under a long-term written supply contract with
Wal-Mart Stores, Inc. or any of our other customers. Our business would
materially suffer if we lost Wal-Mart Stores, Inc. as a continuing major
customer or if our business with Wal-Mart Stores, Inc. significantly decreases.
The loss of sales to any other large customer could also materially and
adversely affect our financial results.




Our
acquisition strategy is subject to risk and may not be successful.




A
component of our growth strategy depends on our ability to successfully execute
acquisitions, which involves numerous risks including:




•
            not
      accurately identifying suitable products or brands for
      acquisition;




•
            difficulties
      in integrating the operations, technologies and manufacturing processes of
      the acquired products;




•
            the
      diversion of management’s attention from other business concerns;
      and




•
            incurring
      substantial additional
indebtedness.




Any
future acquisitions, or potential acquisitions, may result in substantial costs,
disrupt our operations or materially adversely affect our operating
results.




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 was 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
January 22, 2009, there were approximately 170 consumers with pending claims
against us and four product liability lawsuits pending against us alleging burns
and skin irritation from the use of Icy Hot Heat Therapy
products. We may receive additional lawsuits and/or claims in the future
alleging skin irritation and/or burns from use of our Heat Therapy
products.  The outcome of any such potential litigation cannot be
predicted.





We
may receive additional claims that allege personal injury from ingestion of
Dexatrim.





During the third quarter of fiscal
2008, we reached a settlement on all 26 known claims alleging pulmonary arterial
hypertension as a result of the ingestion of Dexatrim products in 1998
through 2003.  However, we may receive additional claims and some or
all of these potential claimants may file lawsuits against us.  If the
lawsuits are filed, we plan to vigorously defend these claims.  If
notwithstanding our defenses these or other product liability claims are
resolved in favor of the claimants, it could have a material adverse effect on
our results of operation and financial condition.







17


Litigation
may adversely affect our business, financial condition and results of
operations.




Our
business is subject to the risk of litigation by consumers, employees, suppliers
or others through private actions, class actions, administrative proceedings,
regulatory actions or other litigation.  The outcome of litigation,
particularly class action lawsuits and regulatory actions, is difficult to
assess or quantify.  Plaintiffs in these types of lawsuits may seek
recovery of very large or indeterminate amounts, and the magnitude of the
potential loss relating to such lawsuits may remain unknown for substantial
periods of time.  The cost to defend current and future litigation may
be significant.  There may also be adverse publicity associated with
litigation that could decrease customer acceptance of our products, regardless
of whether the allegations are valid or whether we are ultimately found
liable.  As a result, 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.




As of
November 30, 2008, our total long-term debt was $459.5 million.  In
the future, we may incur significant additional debt. Our debt could have
significant adverse effects on our business including:




•
            requiring
      us to dedicate a substantial portion of our available cash for interest
      payments and the repayment of
principal;




•
            limiting
      our ability to capitalize on significant business
      opportunities;




•
            making
      us more vulnerable to economic
downturns;




•
            limiting
      our ability to withstand competitive pressures;
  and




•
            making
      it more difficult for us to obtain additional financing on favorable
      terms.




If we are
unable to generate sufficient cash flow from operations in the future, we may
not be able to service our debt and may have to refinance all or a portion of
our debt, obtain additional financing or sell assets to repay such debt. We
cannot assure you that we will be able to obtain such refinancing, additional
financing or asset sale on favorable terms or at all.





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




In the past, we have discontinued
certain products and product lines which resulted in returns from customers and
asset write-offs.  We may suffer similar adverse consequences in the
future to the extent we discontinue products that do not meet expectations or no
longer satisfy consumer demand.  Product returns or write-offs would
reduce cash flow and earnings.  Product efficacy or safety concerns
could result in product recalls or declining sales, which also would reduce our
cash flow and earnings.




Our
product liability insurance coverage may be insufficient to cover existing or
future product liability claims.




An
inherent risk of our business is exposure to product liability claims by users
of our products. We have product liability insurance through our captive
insurance subsidiary and a third party reinsurance policy that provides coverage
for product liability claims. Our product liability insurance coverage for all
of our products consists of $30.0 million of coverage through our captive
insurance subsidiary, of which approximately $2.8 million is funded as of
January 22, 2009, and an additional $25.0 million of excess coverage through a
third party reinsurance policy.




All of
our insurance policies are subject to certain limitations that are generally
customary for policies of this type such as deductibles and exclusions for
exemplary and punitive damages. Since plaintiffs in product liability claims may
seek exemplary and punitive damages, if these damages were awarded, some of our
insurance coverage would not cover these amounts, and we may not have sufficient
resources to pay these damages.  Any amounts paid by our insurance to
satisfy product liabilities would decrease product liability insurance coverage
available for any other claims. If our liability for product liability claims is
significant, our existing insurance is likely to be insufficient to cover these
claims, and we may not have sufficient resources to pay the liabilities in
excess of our insurance coverage. Furthermore, our product liability insurance






18


provided
by third parties will expire at the end of each annual policy period, currently
in August of each year. We may incur significant additional costs to obtain
insurance coverage upon the expiration of our current policies and may not be
able to obtain coverage in the future in amounts equal to that which we
currently have or in amounts sufficient to satisfy future 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.




The
manufacturing, distributing, processing, formulating, packaging and advertising
of our products are subject to numerous and complicated federal, state and
foreign governmental regulations. Compliance with these regulations is difficult
and expensive. In particular, the FDA regulates the safety, manufacturing,
labeling and distributing of our OTC products, medical devices, and dietary
supplements. In addition, the FTC may regulate the promotion and advertising of
our drug products, particularly OTC versions and dietary
supplements.  The EPA regulates our Bullfrog Mosquito Coast
insect repellent products.  We are also regulated by various state
statutes, including the California Safe Drinking Water and Toxic Enforcement Act
of 1986.  If we fail to adhere to the standards required by these
federal and state regulations, or are alleged to have failed to adhere to such
regulations, our operating results and financial condition may be adversely
affected.




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




Our
success depends on our products’ appeal to a broad range of consumers whose
preferences cannot be predicted with certainty and are subject to change. If our
current products do not conform to consumer preferences, our sales may decline.
In addition, our growth depends upon our ability to develop new products through
product line extensions and product modifications, which involve numerous risks.
We may not be able to accurately identify consumer preferences and translate our
knowledge into customer-accepted products or successfully integrate these
products with our existing product platform or operations. We may also
experience increased expenses incurred in connection with product development,
marketing and advertising that are not subsequently supported by a sufficient
level of sales, which would negatively affect our margins. Furthermore, product
development may divert management’s attention from other business concerns,
which could cause sales of our existing products to suffer. We cannot assure you
that newly developed products will contribute favorably to our operating
results.




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




From time to time, we provide
projections to our shareholders and the investment community of our future
earnings.  Since we do not require long-term purchase commitments from
our major customers and the customer order and ship process is very short, it is
difficult for us to accurately predict the amount of our future sales and
related earnings.  Our projections are based on management’s best
estimate of sales using historical sales data and other information deemed
relevant.  These projections are highly subjective since sales to our
customers can fluctuate substantially based on the demands of their retail
customers and due to other risks described in this
report.  Additionally, changes in retailer inventory management
strategies could make inventory management more difficult.  Because
our ability to forecast sales is highly subjective, there is a risk that our
future earnings could vary materially from our projections.




We
may be adversely affected by fluctuations in buying decisions of mass
merchandiser, drug and food trade buyers and the trend toward retail trade
consolidation.




We sell
our products to mass merchandiser and food and drug retailers in the United
States. Consequently, our total revenues are affected by fluctuations in the
buying patterns of these customers. These fluctuations may result from wholesale
buying decisions, economic conditions and other factors. In addition, with the
growing trend towards retail consolidation, we are increasingly dependent upon a
few leading retailers, such as Wal-Mart Stores, Inc., whose bargaining strength
continues to grow due to their size. Such retailers have demanded, and may
continue to demand, increased service and order accommodations as well as price
and incremental promotional investment concessions. As a result, we may face
downward pressure on our prices and increased promotional expenses to meet these
demands, which would reduce our margins. We also may be negatively affected by
changes in the policies of our retail trade customers such as inventory
destocking, limitations on access to shelf space and other
conditions.








19


We
rely on third party manufacturers for a portion of our product portfolio,
including products under our Gold Bond, Icy Hot, Selsun, Dexatrim, ACT and Unisom brands.




We use
third party manufacturers to make products representing approximately 43% of our
fiscal 2008 sales volume, including our Gold Bond medicated powders
and foot spray, the Icy
Hot patches and sleeves, Herpecin-L, ACT mouthwash and mouthrinse,
Unisom products and our
line of dietary supplements including Dexatrim Max and,
internationally, our line of Selsun medicated dandruff
shampoos. In certain cases, third party manufacturers are not bound by fixed
term commitments in our contracts with them, and they may discontinue production
with little or no advance notice. Manufacturers also may experience problems
with product quality or timeliness of product delivery. We rely on these
manufacturers to comply with applicable current GMPs. The loss of a contract
manufacturer may force us to shift production to in-house facilities and
possibly cause manufacturing delays, disrupt our ability to fill orders or
require us to suspend production until we find another third party manufacturer.
We are not able to control the manufacturing efforts of these third party
manufacturers as closely as we control our business. Should any of these
manufacturers fail to meet our standards, we may face regulatory sanctions,
additional product liability claims or customer complaints, any of which could
harm our reputation and our business.




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




Our
dietary supplements consist of Dexatrim and our Sunsource
product line.  We are highly dependent upon consumers’ perceptions of
the benefit and integrity of the dietary supplements business as well as the
safety and quality of products in that industry. Injuries caused by dietary
supplements or unfavorable scientific studies or news relating to products in
this category, such as the December 30, 2003 consumer alert on the safety of
dietary supplements containing ephedrine alkaloids issued by the FDA and the
subsequent FDA rule banning the sale of supplements containing ephedrine
alkaloids that became effective on April 11, 2004, may negatively affect
consumers’ overall perceptions of products in this category, including our
products, which could harm the goodwill of these brands and cause our sales to
decline.




Our
business could be adversely affected if we are unable to successfully protect
our intellectual property or defend claims of infringement by
others.




Our
trademarks are of material importance to our business and are among our most
important assets. In fiscal 2008, substantially all of our total revenues were
from products bearing proprietary brand names. Accordingly, our future success
may depend in part upon the goodwill associated with our brand names,
particularly Gold Bond,
Selsun Blue, Icy Hot, ACT, Cortizone-10andUnisom.  Although our principal brand names are registered
trademarks in the United States and certain foreign countries, we cannot assure
you that the steps we take to protect our proprietary rights in our brand names
will be adequate to prevent the misappropriation of these registered brand names
in the United States or abroad. In addition, the laws of some foreign countries
do not protect proprietary rights in brand names to the same extent as do the
laws of the United States.  We cannot assure you that we will be able
to successfully protect our trademarks from infringement or otherwise. The loss
or infringement of our trademarks could impair the goodwill associated with our
brands, harm our reputation and materially adversely affect our financial
results.




We
license additional intellectual property from third parties that is used in
certain of our products, and we cannot assure you that these third parties can
successfully maintain their intellectual property rights. In addition, the sale
of these products relies on our ability to maintain and extend our licensing
agreements with third parties, and we cannot assure you that we will be
successful in maintaining these licensing agreements. Any significant impairment
of the intellectual property covered by these licenses, or in our rights to use
this intellectual property, may cause our sales to decline.




In
addition, our product line extensions are often based on new or unique delivery
methods for those products like our Icy Hot patches and sleeves.
These delivery methods may not be protected by intellectual property rights that
we own or license on an exclusive basis or by exclusive manufacturing
agreements. As a result, we may be unable to prevent any competitor or customer
from duplicating our delivery methods to compete directly with these product
line extensions, which could cause sales to suffer.




We are
defending and may have to defend in the future litigation and/or claims alleging
that we have infringed the intellectual property rights of others. Intellectual
property litigation can be extremely expensive.  If we were unable to
successfully defend against any claims that our products infringe the
intellectual property rights of others, we may be






20


forced to
pay significant damages and on-going royalties or reformulate, redesign or
remove our affected product from the market.  As a result,
intellectual property litigation could materially adversely affect our
business.




Because
most of our operations are located in Chattanooga, Tennessee, we are subject to
regional and local risks.




Approximately
57% of our domestic sales volume in fiscal 2008 was from products manufactured
in our two plants located in Chattanooga, Tennessee. We store the raw materials
used in our manufacturing activities in two warehouses that are also located in
Chattanooga. We package and ship most of our products from Chattanooga.
Additionally, our corporate headquarters are also located in Chattanooga, and
most of our employees live in the area. Because of this, we are subject to
regional and local risks, such as:




•
            changes
      in state and local government
regulations;




•
            severe
      weather conditions, such as floods, ice storms and
    tornadoes;




•
            natural
      disasters, such as fires and
earthquakes;




•
            power
      outages;




•
            nuclear
      facility incidents;




•
            spread
      of infectious diseases;




•
            hazardous
      material incidents; or




•
            any
      other catastrophic events in our
area.




If our
region, city or facilities were to suffer a significant disaster, our operations
are likely to be disrupted and our business would suffer.




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




Pamabrom,
pyrilamine maleate and compap, active ingredients used in our Pamprin and Prēmsyn
PMS products, are purchased from single sources of supply. Pamabrom is
sold only by Chattem Chemicals, Inc. (an unrelated company), pyrilamine maleate
is produced only in India and sold only by Lonza, Inc. and compap is sold only
by Mallinckrodt, Inc.  In addition, we have a limited source of supply
for selenium sulfide, the active ingredient in Selsun
Blue.  Financial, regulatory or other difficulties faced by
these source suppliers or significant changes in demand for these active
ingredients could limit the availability and increase the price of these active
ingredients. We may not be able to obtain necessary supplies in a timely manner,
and we may be required to pay higher than expected prices for these active
ingredients, which could adversely affect our gross margin from these products.
Any interruption or significant delay in the supply of these active ingredients
would impede our ability to manufacture these products, which would cause our
sales to decline. We would not be able to find an alternative supplier and would
either need to reformulate these products or discontinue their production. We
cannot assure you that we will be able to continue to purchase adequate
quantities of these active ingredients at acceptable prices in the
future.




We
are subject to the risk of doing business internationally.




In fiscal
2008, approximately 7% of our total consolidated revenues were attributable to
our international business.  We operate in regions and countries where
we have little or no experience, and we may not be able to market our products
in, or develop new products successfully for, these markets. We may also
encounter other risks of doing business internationally including:




•
            unexpected
      changes in, or impositions of, legislative or regulatory
      requirements;




21


•
            fluctuations
      in foreign exchange rates, which could cause fluctuations in the price of
      our products in foreign markets or cause fluctuations in the cost of
      certain raw materials purchased by
us;




•
            delays
      resulting from difficulty in obtaining export licenses, tariffs and other
      barriers and restrictions, potentially longer payment cycles, greater
      difficulty in accounts receivable collection and potentially adverse tax
      treatment;




•
            potential
      trade restrictions and exchange
controls;




•
            differences
      in protection of our intellectual property rights;
  and




•
            the
      burden of complying with a variety of foreign
  laws.




In
addition, we will be increasingly subject to general geopolitical risks in
foreign countries where we operate such as political and economic instability
and changes in diplomatic and trade relationships, which could affect, among
other things, customers’ inventory levels and consumer purchasing, which could
cause our results to fluctuate and our sales to decline. It has not been our
practice to engage in foreign exchange hedging transactions to manage the risk
of fluctuations in foreign exchange rates because of the limited nature of our
past international operations. Due to the significant expansion of our
international operations, our exposure to fluctuations in foreign exchange rates
has increased.




The
terms of our outstanding debt obligations limit certain of our
activities.




The terms
of the indenture under which our 7.0% Subordinated Notes are issued and our
Credit Facility impose operating and financial restrictions on us including
restrictions on:




•
            incurrence
      of additional indebtedness;




•
            dividends
      and restricted payments;




•
            investments;




•
            loans
      and guarantees;




•
            creation
      of liens;




•
            transactions
      with affiliates;




•
            use
      of proceeds from sales of assets and subsidiary stock;
  and




•
            certain
      mergers, consolidations and transfers of
assets.




The terms
of our Credit Facility also require us to comply with financial maintenance
covenants. In the future, we may have other indebtedness with similar or even
more restrictive covenants. These restrictions may impair our ability to respond
to changing business and economic conditions or to grow our business. In the
event that we fail to comply with these covenants, there could be an event of
default under the applicable debt instrument, which in turn could cause a cross
default to other debt instruments. As a result, all amounts outstanding under
our various debt instruments may become immediately due and
payable.




To
service our indebtedness, we will require a significant amount of
cash.




Our ability to make payments on our
indebtedness will depend on our ability to generate cash in the
future.  This, to a certain extent, is subject to general economic,
financial, competitive, regulatory and other factors that are beyond our
control.  We cannot assure you that our business will generate
sufficient cash flow from operations or that future borrowings will be available
to us under our secured Credit Facility in an amount sufficient to enable us to
pay our indebtedness or to fund our other liquidity needs.  We may
need to refinance all or a portion of our indebtedness on or before maturity,
sell assets, reduce or delay






22


capital
expenditures or seek additional financing.  We may not be able to
refinance any of our indebtedness on commercially reasonable terms or at
all.




Our
operations are subject to significant environmental laws and
regulations.




Our
manufacturing sites use chemicals and other potentially hazardous materials and
generate both hazardous and non-hazardous waste, the transportation, treatment,
storage and disposal of which are regulated by various governmental agencies and
federal, state and local laws and regulations. Under these laws and regulations,
we are exposed to liability primarily as an owner or operator of real property,
and as such, we may be responsible for the clean-up or other remediation of
contaminated property. Environmental laws and regulations can change rapidly,
and we may become subject to more stringent environmental laws and regulations
in the future, which may be retroactively applied to earlier
events.  Product line extensions, such as Bullfrog Mosquito Coast, or
acquisitions of new products, such as those acquired in the J&J Acquisition,
may also subject our business to new or additional environmental laws and
regulations.  In addition, compliance with new or more stringent
environmental laws and regulations could involve significant costs.




We
are dependent on certain key executives, the loss of whom could have a material
adverse effect on our business.




Our
future performance depends significantly upon the efforts and abilities of
certain members of senior management, in particular those of Zan Guerry, our
chairman and chief executive officer, and Robert E. Bosworth, our president and
chief operating officer. If we were to lose any key senior executive, our
business could be materially adversely affected.




Our
shareholder rights plan and charter contain provisions that may delay or prevent
a merger, tender offer or other change of control of us.




Provisions
of our shareholder rights plan and our restated charter, as well as certain
provisions of Tennessee corporation law, may deter unfriendly offers or other
efforts to obtain control over us and could deprive shareholders (including
holders of the Convertible Notes which may convert into common stock) of their
ability to receive a premium on their common stock.




Generally,
if any person attempts to acquire 15% or more of our common stock then
outstanding without the approval of our independent directors, pursuant to our
shareholder rights plan, our shareholders may purchase a significant amount of
additional shares of our common stock at 50% of the then applicable market
price. This threat of substantial dilution will discourage takeover attempts not
approved by our board despite significant potential benefits to our
shareholders.




Our
charter contains the following additional provisions, which may have the effect
of discouraging takeover attempts:




•
            our
      directors are divided into three classes, with only one class of directors
      elected at each annual meeting for a term of three years, making it
      difficult for new shareholders to quickly gain control of our board of
      directors;




•
            directors
      may be removed only for cause prior to the expiration of their terms;
      and




•
            we
      are prohibited from engaging in certain business combination transactions
      with any interested shareholder unless such transaction is approved by the
      affirmative vote of at least 80% of the outstanding shares of our common
      stock held by disinterested shareholders, unless disinterested members of
      our board of directors approve the transaction or certain fairness
      conditions are satisfied, in which case such transaction may be approved
      by either the affirmative vote of the holders of not less than 75% of our
      outstanding shares of common stock and the affirmative vote of the holders
      of not less than 66% of the outstanding shares of our common stock which
      are not owned by the interested shareholder, or by a majority of
      disinterested members of our board of directors, provided that certain
      quorum requirements are met.




The
Tennessee Business Combination Act prevents an interested shareholder, which is
defined generally as a person owning 10% or more of our voting stock, from
engaging in a business combination with us for five years following the date
such person became an interested shareholder unless before such person became an
interested shareholder, our board of directors approved the transaction in which
the interested shareholder became an interested shareholder or approved the
business combination, and the proposed business






23


combination
satisfied any additional applicable requirements imposed by law and by our
restated charter or bylaws. If the requisite approval for the business
combination or share acquisition has not been obtained, any business combination
is prohibited until the expiration of five years following the date such person
became an interested shareholder.




The
trading price of our common stock may be volatile.




The
trading price of our common stock could be subject to significant fluctuations
in response to several factors, some of which are beyond our
control.  Among the factors that could affect our stock price
are:




•
            our
      operating and financial performance and
  prospects;




•
            quarterly
      variations in key financial performance measures, such as earnings per
      share, net income and revenue;




•
            changes
      in revenue or earnings estimates or publication of research reports by
      financial analysts;




•
            announcements
      of new products by us or our
competitors;




•
            speculation
      in the press or investment
community;




•
            strategic
      actions by us or our competitors, such as acquisitions or
      restructurings;




•
            product
      liability claims;




•
            further
      issuance of convertible securities or common stock by us or sales of our
      common stock or other actions by investors with significant
      shareholdings;




•
            general
      market conditions for companies in our industry;
  and




•
            domestic
      and international economic, legal, political and regulatory factors
      unrelated to our performance.




The stock markets in general have
experienced substantial volatility that has often been unrelated to the
operating performance of particular companies.  These broad market
fluctuations may adversely affect the trading price of our common
stock.




We
have no current intention of paying dividends to holders of our common
stock.




We
presently intend to retain our earnings, if any, for use in our operations, to
repay our outstanding indebtedness and to repurchase our common stock and have
no current intention 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”).




Our
financial reporting complies with GAAP, and GAAP is subject to change over
time.  If new rules or interpretations of existing rules require us to
change our financial reporting, our financial condition and results from
operations could be adversely affected.




Identification
of a material weakness in our internal controls over financial reporting may
adversely affect our financial results.




We are
subject to ongoing obligations under the internal control provisions of the
Sarbanes-Oxley Act of 2002.  Those provisions require us to identify
and report material weaknesses in our system of internal controls over financial
reporting.  If such a material weakness is identified, it could
indicate a lack of controls adequate to generate accurate financial
statements.  We routinely assess our internal controls over financial
reporting, but we cannot assure you that we will be able to timely






24


remediate
any material weaknesses that may be identified in future periods, or maintain
all of the controls necessary for continued compliance.  Likewise, we
cannot assure you that we will be able to retain sufficient skilled finance and
accounting personnel, especially in light of the increased demand for such
personnel among publicly-traded companies.




The
convertible note hedge and warrant transactions may affect the value of our
common stock and our convertible notes.




In connection with the sale of our
convertible notes in November 2006 and April 2007, we entered into separate
convertible note hedge transactions.  These transactions are expected,
but are not guaranteed, to eliminate the potential dilution upon conversion of
the convertible notes.  We also entered into warrant
transactions.  In connection with hedging these transactions, the
counterparty:




•
            will
      enter into various over-the-counter derivative transactions with respect
      to our common stock, and may have purchased our common stock concurrently
      with and shortly after the pricing of the notes:
  and




•
            may
      have entered into, or may unwind, various over-the-counter derivatives
      and/or purchased or sold our common stock in secondary market transactions
      following the pricing of the notes (including during any conversion
      reference period related to a conversion of our convertible
      notes).




Such
activities could have the effect of increasing, or preventing a decline in, the
price of our common stock.  Such effect is expected to be greater in
the event we elect to settle converted convertible notes entirely in
cash.  The counterparty to these transactions is likely to modify its
hedge positions from time to time prior to conversion or maturity of the
convertible notes or termination of the transactions by purchasing and selling
shares of our common stock, other of our securities, or other instruments it may
wish to use in connection with such hedging.  In particular, such
hedging modification may occur during any conversion reference period for a
conversion of convertible notes, which may have a negative effect on the value
of the consideration received in relation to the conversion of those convertible
notes.  In addition, we intend to exercise options we hold under the
convertible note hedge transaction whenever convertible notes are
converted.  In order to unwind its hedge position with respect to
those exercised options, the counterparty to these transactions expects to sell
shares of our common stock in secondary market transactions or unwind various
over-the-counter derivative transactions with respect to our common stock during
the conversion reference period for the converted convertible
notes.




Conversion
of our convertible notes may dilute the ownership interest of existing
shareholders, including holders who had previously converted their convertible
notes.




The conversion of some or all of the
convertible notes may dilute the ownership interests of existing
shareholders.  All or a portion of the amounts payable upon conversion
of the convertible notes may, at our election, be paid in cash rather than in
the form of shares of common stock.  Any sales in the public market of
the common stock issued upon such conversion could adversely affect prevailing
market prices of our common stock.  In addition, the existence of the
convertible notes may encourage short selling by market participants because the
conversion of the convertible notes could depress the price of our common
stock.




Virtually
all of our assets consist of intangibles.




As our
financial statements indicate, a substantial portion of our assets consist of
intangibles, principally the trademarks, trade names and patents that we have
acquired.  In the event that the value of those assets became impaired
or our business is materially adversely affected in any way, we would not have
sufficient tangible assets that could be sold to repay our
liabilities.  As a result, our creditors and investors may not be able
to recoup the amount of the indebtedness that they have extended to us or the
amount they have invested in us.









25


Item 1B. Unresolved Staff
Comments




None




Item 2.  
Properties




Our
headquarters and administrative offices are located at 1715 West 38th Street,
Chattanooga, Tennessee. Our primary production facilities are in close proximity
to our headquarters on land owned by us. We lease our primary warehouse and
distribution centers in Chattanooga, Tennessee for our domestic consumer
products. The following table describes in detail the principal properties owned
and leased by us:




Total
      Area
              (Acres)
            
            Total
      Buildings
              (Square Feet)
            
            Use
            
            Square
              FeetOwned
      Properties:Chattanooga,
      Tennessee
            12.0
            
            
            117,600
            
            
            Manufacturing
              Office
      & Administration
            
            77,000
              40,600Chattanooga,
      Tennessee
            8.3
            
            
            78,500
            
            
            Manufacturing
              Office
              Product
      Development Center
            
            58,300
              10,200
              10,000Leased
      Properties:Chattanooga,
      Tennessee
            5.1
            
            
            139,000
            
            
            Warehousing
            
            139,000Chattanooga,
      Tennessee
            10.0
            
            
            150,350
            
            
            Warehousing
            
            150,350Chattanooga,
      Tennessee
            —
            
            
            43,000
            
            
            Manufacturing
            
            43,000Mississauga,
      Ontario, Canada
            0.3
            
            
            15,100
            
            
            Warehousing
              Office
      & Administration
              Packaging
            
            10,600
              3,000
              1,500Basingstoke,
      Hampshire, England
            
            
            
            2,143
            
            
            Office
      & Administration
            
            2,143Limerick,
      Ireland
            —
            
            
            2,100
            
            
            Office
      & Administration
            
            2,100Alimos
      Attica, Greece
            —
            
            
            194
            
            
            Office
      & Administration
            
            194




We are
currently operating our manufacturing facilities at approximately 70% of total
capacity. These manufacturing facilities are FDA registered and are capable of
further utilization through the use of a full-time second shift and the addition
of a third shift.




Item 3.   Legal
Proceedings




See note
12 of notes to consolidated financial statements included in Item 8 “Financial
Statements and Supplementary Data”.




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




None




26


PART II




Item 5.   Market
for the Registrant’s Common Equity, Related Shareholder Matters and Issuer
Purchases of Equity Securities




Market
Information




Our
common stock is traded on the Nasdaq Global Select Market under the symbol
“CHTT”. The table below sets forth the high and low closing sales prices of our
common stock as reported on the Nasdaq Global Select Market for the periods
indicated.




Fiscal
      2008
            
            High
            
            
            LowFirst
      Quarter
            
            $
            81.45
            
            
            $
            65.15Second
      Quarter
            
            
            79.58
            
            
            
            62.21Third
      Quarter
            
            
            70.12
            
            
            
            57.52Fourth
      Quarter
            
            
            79.84
            
            
            
            63.05Fiscal
      2007
            
            High
            
            
            LowFirst
      Quarter
            
            $
            58.45
            
            
            $
            48.18Second
      Quarter
            
            
            64.80
            
            
            
            50.23Third
      Quarter
            
            
            66.85
            
            
            
            56.16Fourth
      Quarter
            
            
            74.48
            
            
            
            62.17




Holders




As of
January 22, 2009, there were approximately 214 holders of record of our common
stock. The number of record holders does not include beneficial owners whose
shares are held in the names of banks, brokers, nominees or other
fiduciaries.




Dividends




We have
not paid dividends on our common stock during the past two fiscal years. We are
restricted from paying dividends by the terms of the indenture under which our
7.0% Subordinated Notes were issued and by the terms of our Credit
Facility.




Purchases
of Equity Securities by the Issuer and Affiliated Purchasers


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)
            
            
            Maximum
      Dollar Value of Shares that may yet be Purchased under the Plans or Programs (2)9/1/08-9/30/08
            
            
            —
            
            
            $
            —
            
            
            
            —
            
            
            $
            73,913,33610/1/08-10/31/08
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            73,913,33611/1/08-11/30/08
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            73,913,336Total
      Fourth Quarter
            
            
            —
            
            
            $
            —
            
            
            
            —
            
            
            
            73,913,336





(1)           Average
price paid per share includes broker commissions


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






27


Stock
Performance Graph




The following is a graph comparing the
cumulative total return to shareholders of the Company, assuming reinvestment of
dividends, for the five-year period ending November 30, 2008 with the return
from (i) the S&P 500 Index and (ii) a peer group of public companies engaged
in either the functional toiletries, cosmetics or non-prescription drug
business, for the same period.  The peer group consists of the
following selected comparable companies: Alberto-Culver Co., Church &
Dwight, Inc., Prestige Brands Holdings, Inc., Helen of Troy Ltd. and Elizabeth
Arden, Inc.












2003
            
            2004
            
            2005
            
            2006
            
            2007
            
            2008Chattem,
      Inc.
            $   100.00
            
            $  
      226.08
            
            $   198.30
            
            $   303.65
            
            $   442.62
            
            $   472.33S&P
      500
            $   100.00
            
            $   110.93
            
            $   118.08
            
            $   132.62
            
            $   139.97
            
            $     84.69Peer
      Group
            $   100.00
            
            $   116.12
            
            $   108.70
            
            $     89.04
            
            $   106.73
            
            $   106.39
















28


Item 6.   Selected
Financial Data




This
selected financial data should be read in conjunction with Item 7 “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” and
our consolidated financial statements and notes thereto included elsewhere in
this Annual Report on Form 10-K.




Year Ended November 30,2008
            
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004(dollars
      in thousand, except per share amount)INCOME
      STATEMENT DATA:Total
      revenues
            
            $
            454,879
            
            
            $
            423,378
            
            
            $
            300,548
            
            
            $
            279,318
            
            
            $
            258,155Operating
      costs and expenses
            
            
            329,843
            
            
            
            301,196
            
            
            
            217,804
            
            
            
            212,830
            
            
            
            228,292Income
      from operations
            
            
            125,036
            
            
            
            122,182
            
            
            
            82,744
            
            
            
            66,488
            
            
            
            29,863Other
      expense, net
            
            
            (25,121
            )
            
            
            (31,103
            )
            
            
            (13,454
            )
            
            
            (13,478
            )
            
            
            (27,709
            )Income
      before income taxes
            
            
            99,915
            
            
            
            91,079
            
            
            
            69,290
            
            
            
            53,010
            
            
            
            2,154Provision
      for income taxes
            
            
            33,629
            
            
            
            31,389
            
            
            
            24,178
            
            
            
            16,963
            
            
            
            703Net
      income
            
            $
            66,286
            
            
            $
            59,690
            
            
            $
            45,112
            
            
            $
            36,047
            
            
            $
            1,451PER
      SHARE DATA:Income
      per diluted share
            
            $
            3.42
            
            
            $
            3.08
            
            
            $
            2.34
            
            
            $
            1.77
            
            
            $
            .07BALANCE
      SHEET DATA:
              (At
      end of year)Total
      assets
            
            $
            792,972
            
            
            $
            780,560
            
            
            $
            415,313
            
            
            $
            367,214
            
            
            $
            372,642Long-term
      debt, less current maturities
            
            $
            456,500
            
            
            $
            505,000
            
            
            $
            232,500
            
            
            $
            145,500
            
            
            $
            200,000








Item 7.  
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 together with Item 6, “Selected Financial Data”, and
our consolidated financial statements and notes therein included elsewhere in
this annual report on Form 10-K.




This
discussion and analysis contains forward-looking statements that involve risks,
uncertainties and assumptions. The actual results may differ materially from
those anticipated in these forward-looking statements as a result of a number of
factors, including, but not limited to, those described in our filings with the
Securities and Exchange Commission.




Overview




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, Cortizone-10
      and Balmex -
      medicated skin care;




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




•
            ACT and Herpecin-L - oral
      care;




•
            Unisom, Pamprin and Kaopectate - internal
      OTC;




•
            Selsun Blue - medicated
      dandruff shampoos;




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




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




29


Our
products target niche markets that are often outside the focus of larger
companies where we believe we can achieve and sustain significant market share
through innovation and strong advertising and promotion support. Many of our
products are among the U.S. market leaders in their respective categories. For
example, our portfolio of topical analgesic brands, our Cortizone-10 anti-itch
ointment and our Gold
Bond medicated body powders have the leading U.S. market share in their
respective categories. We support our brands through extensive and
cost-effective advertising and promotion, the expenditures for which represented
approximately 26% of our total revenues in fiscal 2008. We sell our products
nationally through mass merchandiser, drug and food channels, principally
utilizing our own sales force.




Developments
During Fiscal 2008




Products





In fiscal
2008, we introduced the following 11 product line extensions: Unisom Sleep Melts, Cortizone-10 Intensive
Healing, Gold Bond
Ultimate Restoring Lotion, Gold Bond Ultimate Foot
Cream, Gold Bond
Ultimate Soothing Lotion, Icy
Hot PM Lotion, Icy
Hot PM Patch, Aspercreme Heat Pain
Relieving Gel, Aspercreme Nighttime Lotion,
Dexatrim Max Daytime
Control and Dexatrim
Max Complex 7.





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, during the first quarter of fiscal 2008 we
recorded an estimate of approximately $6.0 million of recall expenses related to
product returns, inventory obsolescence, destruction costs, consumer refunds,
legal fees and other estimated expenses.  Subsequent to our first
fiscal quarter, we increased our estimate of recall expenses by $0.3 million, to
a total of $6.3 million, primarily as a result of additional legal fees and
settlement payments.  The remaining accrued liability for product
recall expenses was $0.8 million as of November 30, 2008.





Loss
on Early Extinguishment of Debt





During
the first quarter of fiscal 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.





Stock
Repurchase





During
fiscal 2008, we repurchased 418,281 shares of our common stock under our stock
repurchase program for $26.3 million at an average price per share of
$62.94.





Litigation
Settlement





During
the third quarter of fiscal 2008, we reached a settlement on all 26 known claims
alleging pulmonary arterial hypertension as a result of the ingestion of Dexatrim products in 1998
through 2003.  Included as litigation settlement in the consolidated
statements of income is the settlement of the 26 claims totaling $13.3 million
and $0.6 million of legal expenses, which were partially offset by $2.6 million
of proceeds from the Dexatrim litigation
settlement trust.





Subsequent
Event





On
December 4, 2008 we issued an aggregate of 487,123 shares of our common stock in
exchange for $28.7 million in aggregate principal amount of our outstanding 2.0%
Convertible Senior Notes due 2013 (“2.0% Convertible Notes”).  Upon
completion of the transaction, the balance of the remaining 2.0% Convertible
Notes was reduced to $96.3 million outstanding.






30


Results
of Operations




The
following table sets forth for the periods indicated, certain items from our
consolidated statements of income expressed as a percentage of total
revenues:




Year Ended November 30,2008
            
            
            2007
            
            
            2006TOTAL
      REVENUES
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %COSTS
      AND EXPENSES:Cost
      of sales
            
            
            28.9
            
            
            
            30.5
            
            
            
            31.3Advertising
      and promotion
            
            
            26.0
            
            
            
            26.5
            
            
            
            32.0Selling,
      general and administrative
            
            
            13.7
            
            
            
            13.6
            
            
            
            15.6Product
      recall expenses
            
            
            1.4
            
            
            
            —
            
            
            
            —Acquisition
      expenses
            
            
            —
            
            
            
            0.5
            
            
            
            —Litigation
      settlement
            
            
            2.5
            
            
            
            —
            
            
            
            (6.4
            )Total
      costs and expenses
            
            
            72.5
            
            
            
            71.1
            
            
            
            72.5INCOME
      FROM OPERATIONS
            
            
            27.5
            
            
            
            28.9
            
            
            
            27.5OTHER
      INCOME (EXPENSE):Interest
      expense
            
            
            (5.6
            )
            
            
            (7.1
            )
            
            
            (3.9
            )Investment
      and other income, net
            
            
            0.2
            
            
            
            0.3
            
            
            
            0.4Loss
      on early extinguishment of debt
            
            
            (0.1
            )
            
            
            (0.6
            )
            
            
            (0.9
            )Total
      other income (expense)
            
            
            (5.5
            )
            
            
            (7.4
            )
            
            
            (4.4
            )INCOME
      BEFORE INCOME TAXES
            
            
            22.0
            
            
            
            21.5
            
            
            
            23.1PROVISION
      FOR INCOME TAXES
            
            
            7.4
            
            
            
            7.4
            
            
            
            8.1NET
      INCOME
            
            
            14.6
            %
            
            
            14.1
            %
            
            
            15.0
            %




Critical
Accounting Estimates




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 November 30, 2008 consolidated financial
statements:




Allowance
for Doubtful Accounts




As of
November 30, 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 year ended November 30, 2008, we performed an
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 November 30, 2008 and 2007.




Revenue
Recognition




Revenue
is recognized when our products are shipped and title transfers 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






31


products
for a variety of reasons including products damaged in transit, discontinuance
of a particular size or form of product and shipping errors.  As sales
are recorded, we accrue an estimated amount for product returns, as a reduction
of these sales, based upon our historical experience and consideration of
discontinued products, product 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 for product
returns when the customer provides appropriate supporting documentation that the
product is properly destroyed or 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.




Our
estimate of product returns for seasonal and non-seasonal products was $1.4
million and $1.3 million as of November 30, 2008, and $1.2 million and $1.3
million as of November 30, 2007 and November 30, 2006.  Due to higher
sales volume during fiscal 2008, we increased our estimate of seasonal returns
by approximately $0.2 million, which resulted in a decrease to net sales in our
consolidated financial statements.  Higher sales volume in fiscal 2007
offset by customers returning seasonal products earlier in the season resulted
in our estimate of returns for seasonal products remaining consistent as
compared to fiscal 2006.  During fiscal 2008 and 2007, our estimate of
non-seasonal returns remained consistent as compared to fiscal 2007 and 2006,
respectively.  Each percentage point change in the seasonal return
rate would impact net sales by approximately $0.2 million.  Each
percentage point change in the non-seasonal return rate would impact net sales
by approximately $0.6 million.




At
November 30, 2006, based on consideration of the sales of Icy Hot Pro Therapy
performing below expectations, review of retail point of sales data throughout
fiscal 2006 and an estimate of inventory on hand at customers, we estimated
returns of Icy Hot Pro
Therapy as of November 30, 2006 of $3.3 million, which was included as a
reduction of net sales.  During fiscal 2007, we continued to monitor
Icy Hot Pro Therapy
retail sales and inventory levels on-hand at customers and increased the
specific reserve for Icy Hot
Pro Therapy by $4.5 million as of November 30, 2007, which is included as
a reduction of net sales in our consolidated financial statements.  As
of November 30, 2007, the allowance remaining for Icy Hot Pro Therapyreturns
was $4.5 million.  During fiscal 2008, based on a revised estimate of
inventory held by customers, we reduced the estimated remaining liability for
returns by $1.5 million, which resulted in an increase to net sales in our
consolidated financial statements.  As of November 30, 2008, the
allowance remaining for Icy
Hot Pro Therapyreturns is $0.7 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






32


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 are often variable based on the number of units actually
sold.  As of November 30, 2008, the coupon accrual and reserve for
vendor allowances were $1.8 million and $4.9 million, respectively, and $1.9
million and $5.5 million, respectively, as of November 30, 2007.  Each
percentage point change in promotional program participation would impact net
sales by $0.2 million and advertising and promotion expense by an insignificant
amount.




Income
Taxes





We
account for income taxes using the asset and liability approach as prescribed by
SFAS 109, FIN 48, FSP FIN 48-1 and other applicable FSP’s and FASB
Interpretations.  This approach requires recognition of deferred tax
assets and liabilities for the expected future tax consequences of events that
have been included in 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 adopted FIN 48, as amended by FSP
FIN 48-1, on December 1, 2007.  FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in the financial statements in accordance
with SFAS 109.  In connection with the adoption of FIN 48, we
recognized an increase in the unrecognized tax benefits of $1.6 million, which
is included in the consolidated financial statements as a reduction to retained
earnings of $0.7 million and an increase to deferred tax assets of $0.9
million.  We had a total unrecognized tax benefit of $2.2 million as
of December 1, 2007.  Our effective tax rate was 33.7% for fiscal
2008, as compared to 34.5% in fiscal 2007 and 34.9% in fiscal 2006.





Accounting
for Acquisitions and Intangible Assets





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





We
account for our intangible assets in accordance with SFAS No. 142, “Goodwill and
Other Intangible Assets” (“SFAS 142”).  Under SFAS 142, intangible
assets with indefinite useful lives are not amortized but are reviewed for
impairment at least annually. Intangible assets with finite lives are amortized
over their estimated useful lives using the straight-line method.





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





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





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





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





33


In
January 2007, we completed the acquisition of the U.S. rights to five consumer
and OTC brands from Johnson & Johnson (“J&J
Acquisition”).  The acquired brands were: ACT, Unisom, Cortizone-10, Kaopectate, and Balmex.  In May
2007, we acquired the worldwide trademark and rights to sell and market ACT in Western Europe from
Johnson & Johnson (“ACT
Acquisition”).





Fair
Value Measurements




On
December 1, 2007, we adopted SFAS 157 as it pertains to financial assets and
liabilities, which 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 157-2 defers the date of SFAS 157 for nonfinancial assets
and liabilities and is effective in our fiscal 2009.




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




Stock-Based
Compensation





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





For
additional information regarding our significant accounting policies, see note 2
of notes to consolidated financial statements.

















34


Fiscal
2008 Compared to Fiscal 2007




To
facilitate discussion of our operating results for the years ended November 30,
2008 and 2007, we have included the following selected data from our
consolidated statements of income:




For the Year Ended November
    30,Increase ( Decrease)2008
            
            
            2007
            
            
            Amount
            
            
            Percentage(dollars
      in thousands)Domestic
      net sales
            
            $
            423,088
            
            
            $
            393,493
            
            
            $
            29,595
            
            
            
            7.5
            %International
      revenues (including royalties)
            
            
            31,791
            
            
            
            29,885
            
            
            
            1,906
            
            
            
            6.4Total
      revenues
            
            
            454,879
            
            
            
            423,378
            
            
            
            31,501
            
            
            
            7.4Cost
      of sales
            
            
            131,620
            
            
            
            129,055
            
            
            
            2,565
            
            
            
            2.0Advertising
      and promotion expense
            
            
            118,093
            
            
            
            112,206
            
            
            
            5,887
            
            
            
            5.2Selling,
      general and administrative expense
            
            
            62,590
            
            
            
            57,878
            
            
            
            4,712
            
            
            
            8.1Product
      recall expenses
            
            
            6,269
            
            
            
            —
            
            
            
            6,269
            
            
            
            100.0Acquisition
      expenses
            
            
            —
            
            
            
            2,057
            
            
            
            (2,057
            )
            
            
            (100.0
            )Litigation
      settlement
            
            
            11,271
            
            
            
            —
            
            
            
            11,271
            
            
            
            100.0Interest
      expense
            
            
            25,310
            
            
            
            29,930
            
            
            
            (4,620
            )
            
            
            (15.4
            )Loss
      on early extinguishment of debt
            
            
            526
            
            
            
            2,633
            
            
            
            (2,107
            )
            
            
            (80.0
            )Net
      income
            
            
            66,286
            
            
            
            59,690
            
            
            
            6,596
            
            
            
            11.1




Domestic
Net Sales




Domestic
net sales for fiscal 2008 increased $29.6 million, or 7.5%, to $423.1 million
from $393.5 million in fiscal 2007. A comparison of domestic net sales for the
categories of products included in our portfolio of OTC healthcare products is
as follows:




For the Year Ended November
    30,Increase ( Decrease)2008
            
            
            2007
            
            
            Amount
            
            
            Percentage(dollars
      in thousands)Medicated
      skin care
            
            $
            141,942
            
            
            $
            123,456
            
            
            $
            18,486
            
            
            
            15.0
            %Topical
      pain care
            
            
            96,779
            
            
            
            95,858
            
            
            
            921
            
            
            
            1.0Oral
      care
            
            
            62,872
            
            
            
            48,863
            
            
            
            14,009
            
            
            
            28.7Internal
      OTC
            
            
            48,006
            
            
            
            45,043
            
            
            
            2,963
            
            
            
            6.6Medicated
      dandruff shampoos
            
            
            35,737
            
            
            
            36,934
            
            
            
            (1,197
            )
            
            
            (3.2
            )Dietary
      supplements
            
            
            19,491
            
            
            
            26,121
            
            
            
            (6,630
            )
            
            
            (25.4
            )Other
      OTC and toiletry products
            
            
            18,261
            
            
            
            17,218
            
            
            
            1,043
            
            
            
            6.1Total
            
            $
            423,088
            
            
            $
            393,493
            
            
            $
            29,595
            
            
            
            7.5







Net sales
growth in the medicated skin care category increased $18.5 million, or 15.0%, in
fiscal 2008 compared to fiscal 2007 as a result of the launch of Gold Bond Ultimate Restoring
Lotion and Cortizone-10
Intensive Healing in the first quarter of fiscal 2008, the continued success of
Gold Bond Ultimate
Softening Lotion and our ownership of the Cortizone-10 and Balmex brands for the entire
twelve month period of fiscal 2008 compared to only eleven months of ownership
in fiscal 2007.





Net sales
in the topical pain care category increased $0.9 million, or 1.0%, in fiscal
2008 compared to fiscal 2007, principally due to increases in Icy Hot and Aspercreme, led by the new
products introduced in the first quarter of fiscal 2008, Icy Hot PM Lotion, Icy Hot PM Patch, Aspercreme Heat Pain Gel and
Aspercreme Nighttime
Lotion, offset by declines in Capzasin and the
discontinuance of shipments of Icy HotHeat Therapy
following our February 8, 2008 voluntary recall of the product. Excluding sales
of Icy Hot Heat Therapy
andIcy Hot Pro Therapy, sales in the
category increased 6.9% compared to the prior year period.





35


Net sales
in the oral care category increased $14.0 million, or 28.7%, in fiscal 2008
compared to fiscal 2007.  The increase primarily results from our
ownership of the ACT
brand for the entire twelve month period of fiscal 2008 compared to only eleven
months of ownership in fiscal 2007 and an expanded distribution
base.





Net sales
in the internal OTC category increased $3.0 million, or 6.6%, in fiscal 2008
compared to fiscal 2007 as a result of our ownership of the Unisom and Kaopectate brands for the
entire twelve month period of fiscal 2008 compared to only eleven months of
ownership in fiscal 2007 and the introduction of UnisomSleepMelts in the
second quarter of fiscal 2008.





Net sales
in the medicated dandruff shampoos category decreased $1.2 million, or 3.2%, in
fiscal 2008 compared to fiscal 2007 primarily due to declining sales of SelsunSalon, which were
partially offset by a full year of sales of Selsun Blue Naturals, which
began shipping in the second quarter of fiscal 2007.





Net sales
in the dietary supplements category decreased $6.6 million, or 25.4%, in fiscal
2008 compared to fiscal 2007.  Net sales of Dexatrim decreased 36.9%
primarily resulting from increased competitive pressures in the diet-aid
category, a decline in sales of Dexatrim Max2O and increased returns of
Dexatrim mainly from
several retailers discontinuing Dexatrim Max2O, partially offset by the
launch of Dexatrim Max
Daytime Control in the first quarter of fiscal 2008 and Dexatrim Max Complex 7, which
began shipping in the third quarter of fiscal 2008.





Net sales
in the other OTC and toiletry products category increased $1.0 million, or 6.1%,
in fiscal 2008 compared to fiscal 2007 driven primarily by an increase in fourth
quarter shipments of Bullfrog as a result of
expanded distribution in key retailers and the early season shipments of
upgraded product formulas for the 2009 suncare season.





Domestic
sales variances were principally the result of changes in unit sales volume with
the exception of certain products for which we implemented a unit sales price
increase effective April 2008.




International
Revenues




For
fiscal 2008, international revenues increased $1.9 million, or 6.4%, to $31.8
million from $29.9 million in fiscal 2007.  The increase was primarily
due to favorable exchange rates that increased net sales approximately $1.5
million in fiscal 2008 and a full twelve months of ownership of ACT internationally in fiscal
2008 compared to seven months of ownership in fiscal 2007.




Cost
of Sales




Cost of
sales in fiscal 2008 increased $2.6 million, or 2.0%, to $131.6 million from
$129.1 million in fiscal 2007.  Cost of sales as a percentage of total
revenues was 28.9% for fiscal 2008 as compared to 30.5% for fiscal
2007.  The decrease in cost of sales as a percentage of total revenues
was primarily due to the integration of manufacturing of certain of the acquired
brands from the J&J Acquisition in the fourth quarter of fiscal 2007,
partially offset by an increase in fuel costs in 2008 resulting in higher
inbound freight expense.




Advertising
and Promotion Expense




Advertising
and promotion expenses in fiscal 2008 increased $5.9 million, or 5.2%, to $118.1
million from $112.2 million in fiscal 2007 and were 26.0% of total revenues for
fiscal 2008 compared to 26.5% for fiscal 2007.  The increase in
advertising and promotion expenses results from higher expenditures for
advertising and promotion in fiscal 2008 in connection with the ownership of the
brands acquired in the J&J Acquisition for the entire twelve month period of
fiscal 2008 as compared to eleven months of ownership in fiscal
2007.




Selling,
General and Administrative Expense




Selling,
general and administrative expenses increased $4.7 million, or 8.1%, to $62.6
million from $57.9 million in fiscal 2007.  Selling, general and
administrative expenses were 13.7% and 13.6% of total revenues for fiscal 2008
and fiscal




36


2007,
respectively.  The increase in selling, general and administrative
expenses as a percentage of total revenues was largely attributable to the
absorption of transition service costs similar to those paid to Johnson &
Johnson related to freight and administrative costs that were recorded as
acquisition expenses in fiscal 2007 and an increase in fuel costs in 2008
resulting in higher outbound freight expense.




Product
Recall Expenses




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, during the first quarter of fiscal 2008 we
recorded an estimate of approximately $6.0 million of recall expenses related to
product returns, inventory obsolescence, destruction costs, consumer refunds,
legal fees and other estimated expenses.  Subsequent to our first
fiscal quarter, we increased our estimate of recall expenses by $0.3 million, to
a total of $6.3 million, primarily as a result of additional legal fees and
settlement payments.  The remaining accrued liability for product
recall expenses was $0.8 million as of November 30, 2008.





Acquisition
Expenses




Acquisition
expenses for fiscal 2007 reflect the costs incurred for transition services,
including consumer affairs, distribution and collection services, related to the
J&J Acquisition.  The distribution and collection services were
terminated in April 2007 and the consumer affairs services were terminated in
June 2007.




Litigation
Settlement




During
the third quarter of fiscal 2008, we reached a settlement on all 26 known claims
alleging pulmonary arterial hypertension as a result of the ingestion of Dexatrim products in 1998
through 2003.  Included as litigation settlement in the consolidated
statements of income is the settlement of the 26 claims totaling $13.3 million
and $0.6 million of legal expenses, which were partially offset by $2.6 million
of proceeds from the Dexatrim litigation
settlement trust.





Interest
Expense




Interest
expense decreased $4.6 million, or 15.4%, in fiscal 2008 compared to fiscal 2007
reflecting a reduction in the principal portion of debt since August 31,
2007.  Until our indebtedness is reduced substantially, interest
expense will continue to represent a significant percentage of our income from
operations.





Loss
on Early Extinguishment of Debt




During the first quarter of fiscal
2008, we utilized borrowings under the revolving credit facility portion of our
Credit Facility to repay $35.0 million of the term loan under the Credit
Facility.  In connection with the term loan repayment, we retired a
proportional share of the term loan debt issuance costs and recorded the
resulting loss on extinguishment of debt of $0.5 million.  In 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 $128.0 million 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 $25.0 million of the term loan under
the Credit Facility.  In connection with the term loan repayments, we
retired a proportional share of the term loan debt issuance costs and recorded
the resulting loss on early extinguishment of debt of $2.6 million during fiscal
2007.





Income
Taxes




The
effective tax rate decreased from 34.5% in fiscal 2007 to 33.7% in fiscal 2008
primarily as a result of higher inventory contributions and an increase in the
statutory percentage used to determine the tax deduction related to domestic
production activities.








37


Fiscal
2007 Compared to Fiscal 2006




To
facilitate discussion of our operating results for the years ended November 30,
2007 and 2006, we have included the following selected data from our
consolidated statements of income:




For the Year Ended November
    30,Increase (Decrease)2007
            
            
            2006
            
            
            Amount
            
            
            Percentage(dollars
      in thousands)Domestic
      net sales
            
            $
            393,493
            
            
            $
            276,397
            
            
            $
            117,096
            
            
            
            42.4
            %International
      revenues (including royalties)
            
            
            29,885
            
            
            
            24,151
            
            
            
            5,734
            
            
            
            23.7Total
      revenues
            
            
            423,378
            
            
            
            300,548
            
            
            
            122,830
            
            
            
            40.9Cost
      of sales
            
            
            129,055
            
            
            
            94,036
            
            
            
            35,019
            
            
            
            37.2Advertising
      and promotion expense
            
            
            112,206
            
            
            
            96,071
            
            
            
            16,135
            
            
            
            16.8Selling,
      general and administrative expense
            
            
            57,878
            
            
            
            46,989
            
            
            
            10,889
            
            
            
            23.2Acquisition
      expenses
            
            
            2,057
            
            
            
            —
            
            
            
            2,057
            
            
            
            100.0Litigation
      settlement
            
            
            —
            
            
            
            (19,292
            )
            
            
            (19,292
            )
            
            
            (100.0
            )Interest
      expense
            
            
            29,930
            
            
            
            11,725
            
            
            
            18,205
            
            
            
            155.3Loss
      on early extinguishment of debt
            
            
            2,633
            
            
            
            2,805
            
            
            
            (172
            )
            
            
            (6.1
            )Net
      income
            
            
            59,690
            
            
            
            45,112
            
            
            
            14,578
            
            
            
            32.3






Domestic
Net Sales




Domestic
net sales for fiscal 2007 increased $117.1 million, or 42.4%, as compared to
fiscal 2006.   A comparison of domestic net sales for the
categories of products included in our portfolio of OTC healthcare products is
as follows:




For the Year Ended November
      30,Increase (Decrease)2007
            
            
            2006
            
            
            Amount
            
            
            Percentage(dollars
      in thousands)Medicated
      skin care
            
            $
            123,456
            
            
            $
            67,238
            
            
            $
            56,218
            
            
            
            83.6
            %Topical
      pain care
            
            
            95,858
            
            
            
            101,396
            
            
            
            (5,538
            )
            
            
            (5.5
            )Oral
      care
            
            
            48,863
            
            
            
            6,773
            
            
            
            42,090
            
            
            
            621.5Internal
      OTC
            
            
            45,043
            
            
            
            11,958
            
            
            
            33,085
            
            
            
            276.7Medicated
      dandruff shampoos
            
            
            36,934
            
            
            
            37,742
            
            
            
            (808
            )
            
            
            (2.1
            )Dietary
      supplements
            
            
            26,121
            
            
            
            35,081
            
            
            
            (8,960
            )
            
            
            (25.5
            )Other
      OTC and toiletry products
            
            
            17,218
            
            
            
            16,209
            
            
            
            1,009
            
            
            
            6.2Total
            
            $
            393,493
            
            
            $
            276,397
            
            
            $
            117,096
            
            
            
            42.4







Net sales
growth in the medicated skin care products category was a result of the
acquisition of Cortizone-10 and Balmex in the first fiscal
quarter of fiscal 2007 (brands acquired in the J&J Acquisition) and a 20%
sales increase of the total Gold Bond franchise in fiscal
2007 as compared to fiscal 2006, led by increases of 35%, 19% and 8% in the
lotion, foot care and powder lines, respectively.  The increase in the
Gold Bondlotion line
was led by a full year of sales for Ultimate Softening Lotion, which was
launched in the fourth quarter of fiscal 2006.




The
decline in net sales in the topical pain care category was primarily
attributable to reduced sales of Icy Hot Pro Therapy, which
was originally launched in fiscal 2006.  Contributing to the decrease
in net sales was a $4.5 million charge for expected returns of Icy Hot Pro Therapy recorded
in the fourth quarter of fiscal 2007, which resulted in lower net sales and
reduced gross margins.  Sportscreme and Aspercreme experienced sales
declines of 31% and 9%, respectively, in fiscal 2007.  This decrease
was offset in part by the launch of Icy HotHeat Therapy in
fiscal 2007 and a 7% increase in the base Icy Hot business, led by the
launch in fiscal 2007 of the Icy Hot XL Back Patch and
Icy Hot Vanishing Scent
Cream.




38


The net
sales growth in the oral care category was attributable to ACT, which was acquired as
part of the J&J Acquisition.




The net
sales growth in the internal OTC category was attributable to Unisom and Balmex, which were acquired
as part of the J&J Acquisition.




The
decline in net sales in the medicated dandruff shampoos category was a result of
lower sales of Selsun
Salon in fiscal 2007 when compared to fiscal 2006, the product’s first
full year of sales.  The overall decline was offset in part by a 3%
increase in Selsun Bluesales, partially as a result of the launch of Selsun Blue Naturals in
fiscal 2007.




The
decline in net sales in the dietary supplements category in fiscal 2007 was a
result of a 29% sales decrease of Dexatrim, resulting from
increased competitive pressures in the category and the decline in sales of
Dexatrim Max2O after its
initial launch in fiscal 2006.  Also contributing to the decline were
23% lower Garlique
sales and a 33% decline in New
Phase sales.




The
higher net sales in the other OTC and toiletry products category was due
principally to the introduction of Bullfrog Marathon Mist in
fiscal 2007.




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




International
Revenues




For
fiscal 2007, international revenues increased $5.7 million, or 23.7%, as
compared to fiscal 2006, primarily due to the brands acquired in the J&J
Acquisition and the ACT
Acquisition in fiscal 2007.  Sales variances for international
operations were principally the result of changes in unit sales
volumes.




Cost
of Sales




Cost of
sales in fiscal 2007 increased $35.0 million, or 37.2%, to $129.1 million from
$94.0 million in fiscal 2006.  Cost of sales as a percentage of total
revenues was 30.5% for fiscal 2007 as compared to 31.3% for fiscal
2006.  The decrease in cost of sales as a percentage of total revenues
was attributable to an increase in sales of products with lower cost of sales in
fiscal 2007 as compared to fiscal 2006, offset by an estimate recorded for
potentially obsolete inventory related to our Icy Hot Pro Therapyline of
products.  Based on our evaluation of the carrying value of Icy Hot Pro Therapyinventory
in fiscal 2007 and fiscal 2006, including a review of retail point of sale data,
on hand inventory and purchase commitments, a reserve was recorded for
potentially obsolete inventory of $2.5 million and $2.0 million during the
fourth quarter of fiscal 2007 and 2006, respectively, which increased cost of
sales in our consolidated financial statements.




Advertising
and Promotion Expense




Advertising
and promotion expenses for fiscal 2007 increased $16.1 million, or 16.8%, as
compared to the same period in fiscal 2006 and were 26.5% and 32.0% of total
revenues in fiscal 2007 and 2006, respectively.  The decrease in
advertising and promotion expense as a percentage of revenue for the current
period reflected higher advertising and promotion spending, as a percentage of
revenue, for Icy Hot Pro
Therapy and Selsun
Salon during the fiscal 2006 launch period.




Selling,
General and Administrative Expense




Selling,
general and administrative expenses for fiscal 2007 increased $10.9 million, or
23.2%, as compared to fiscal 2006 and were 13.6% and 15.6% of total revenues
fiscal 2007 and 2006, respectively.  The decrease as a percentage of
revenue was attributable to increased revenue from the brands acquired in fiscal
2007 without commensurate increases in selling, general and administrative
expenses.










39


Acquisition
Expenses




Acquisition
expenses for fiscal 2007 reflect the costs incurred for transition services,
including consumer affairs, distribution and collection services, related to the
J&J Acquisition.  The distribution and collection services were
terminated in April 2007 and the consumer affairs services were terminated in
June 2007.




Litigation
Settlement




Litigation
settlement for fiscal 2006 reflected the $8.8 million recovery from the DELACO
settlement trust in the first quarter of 2006, the $10.7 million recovery from
the settlement trust in the third quarter of 2006 in the Dexatrim litigation
settlement and net legal expenses related to the Dexatrim litigation of $0.2
million.  No corresponding benefit was recorded in fiscal
2007.




Interest
Expense




Interest
expense increased $18.2 million, or 155.3%, in fiscal 2007 as compared to fiscal
2006 as a result of additional indebtedness incurred to finance the J&J
Acquisition.  Until our indebtedness is reduced substantially,
interest expense will continue to represent a significant percentage of our
total revenues.




Loss
on Early Extinguishment of Debt




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 $128.0 million 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
$25.0 million of the term loan under the Credit Facility.  In
connection with the term loan repayments, we retired a proportional share of the
term loan debt issuance costs and recorded the resulting loss on early
extinguishment of debt of $2.6 million.  Our $75.0 million of Floating
Rate Senior Notes were fully redeemed in the first quarter of fiscal 2006,
resulting in a loss on early extinguishment of debt of $2.8
million.




Liquidity
and Capital Resources




We have
historically funded 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.




Net cash provided by operations in
fiscal 2008 increased $5.5 million to $92.2 million as compared to $86.7 million
in fiscal 2007.  The increase was primarily the result of higher net
income, an increase in deferred taxes, a decrease in inventory as the
integration of manufacturing of certain of the acquired brands from the J&J
Acquisition has been completed and a decrease in the change in accounts
receivable as compared to the fiscal 2007 change in accounts receivable as a
result of the fiscal 2007 revenue increase from the J&J
Acquisition.  The increase was partially offset by a reduction in the
change in accounts payable and accrued liabilities as compared to the fiscal
2007 change in accounts payable and accrued liabilities as a result of the
J&J Acquisition.





Investing
activities used cash of $6.2 million and $420.2 million in fiscal 2008 and 2007,
respectively.  The decrease in cash used in investing activities was a
result of lower purchases of equipment for manufacturing operations in fiscal
2008 and the absence of an acquisition in fiscal 2008 like the J&J
Acquisition in fiscal 2007.




Financing
activities used cash of $69.1 million and provided cash of $257.9 million in
fiscal 2008 and 2007, respectively.  In fiscal 2008, the financing
activities cash was used to reduce borrowings outstanding under our Credit
Facility and repurchase shares of our common stock.  In fiscal 2007,
the financing activities cash was provided to fund the J&J Acquisition and
was partially offset by cash used to reduce borrowings outstanding under our
Credit Facility and repurchase shares of our common stock.




As of
November 30, 2008, our total debt was $459.5 million, consisting of the 7.0%
Subordinated Notes of $107.5 million, the 2.0% Convertible Notes of $125.0
million, the 1.625% Convertible Notes of $100.0 million, $107.5 million
outstanding






40


from a
term loan under our Credit Facility and $19.5 million outstanding under our
Amended Revolving Credit Facility.  In November 2006, we entered into
an interest rate swap with decreasing notional principal amounts beginning in
October 2007 and a swap rate of 4.98% over the life of the
agreement.  As of November 30, 2008, we were in compliance with all
covenants in our Credit Facility.




During
fiscal 2008, we repurchased 0.4 million shares of our common stock for $26.3
million.  Effective April 30, 2008, our Board of Directors increased
the authorization to repurchase up to an additional $100.0 million of our common
stock under the terms of a stock repurchase program, and there remains $73.9
million available under such authorization to repurchase shares.




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




Contractual
Obligations




The
following data summarizes our contractual obligations as of November 30,
2008.  We had no commercial obligations as of November 30,
2008.




Payments due byContractual Obligations:
            
            Total
            
            
            Within 1 year
            
            
            2-3 years
            
            
            4-5 years
            
            
            After 5 years(dollars
      in thousands)Long-term
      debt
            
            $
            459,500
            
            
            $
            3,000
            
            
            $
            25,500
            
            
            $
            223,500
            
            
            $
            207,500Interest
      payments
            
            
            90,133
            
            
            
            19,325
            
            
            
            36,820
            
            
            
            29,413
            
            
            
            4,575Operating
      leases
            
            
            887
            
            
            
            547
            
            
            
            267
            
            
            
            49
            
            
            
            24Purchase
      commitments
            
            
            47,816
            
            
            
            18,302
            
            
            
            27,855
            
            
            
            1,106
            
            
            
            553Endorsements
            
            
            5,000
            
            
            
            1,850
            
            
            
            3,150
            
            
            
            —
            
            
            
            —Total
            
            $
            603,336
            
            
            $
            43,024
            
            
            $
            93,592
            
            
            $
            254,068
            
            
            $
            212,652






Purchase
orders or contracts for the purchase of inventory and other goods and services
are not included in the table above.  We are not able to determine the
aggregate amount of such purchase orders that represent contractual obligations,
as purchase orders may represent authorizations to purchase rather than binding
agreements.  Our purchase orders are based on our current distribution
needs and are fulfilled by our vendors within short time
horizons.  Other than as presented in the table above, we do not have
significant agreements for the purchase of inventory or other goods specifying
minimum quantities or fixed prices that exceed our expected requirements for
three months.  We have also excluded from the table above the
liability for unrecognized tax benefits due to the uncertainty of payment and
amount of payment per period.  As of November 30, 2008, we have a
gross liability for unrecognized tax benefits, including interest, of $1.3
million (see Note 7 to the consolidated financial statements).




Interest
payments consist of interest at the November 30, 2008 effective rate of 6.07%
per annum on the $19.5 million revolving credit facility portion of our Credit
Facility due 2010, the November 30, 2008 effective rate of 6.57% per annum on
the $107.5 million term loan portion of our Credit Facility due 2013, the 7.0%
Subordinated Notes due 2014, the 2.0% Convertible Notes due 2013 and the 1.625%
Convertible Notes due 2014.




We have
no existing off-balance sheet financing arrangements.






Foreign
Operations




Historically,
our primary foreign operations have been conducted through our Canadian and
United Kingdom (“U.K.”) subsidiaries.  Since November 1, 2004, our
European business has been conducted through Chattem Global Consumer Products
Limited, a wholly-owned subsidiary located in Limerick, Ireland.  In
connection with the ACT
Acquisition, we have been conducting business in Greece through Chattem Greece,
a wholly-owned subsidiary located in Alimos Attica, Greece.  In the
fourth quarter of fiscal 2008, we established Chattem Peru SRL (“Chattem Peru”)
a wholly-owned subsidiary located in Lima,




41


Peru.  Chattem
Peru utilizes third party distributors to sell certain of our Selsun Blue products
throughout Peru.  The functional currencies of these subsidiaries are
Canadian dollars, British pounds 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 fiscal 2008 and 2007, these
subsidiaries accounted for 7% of total consolidated revenues, respectively, and
2% of total consolidated assets, respectively.  It has not been our
practice to hedge our assets and liabilities in Canada, the U.K., Ireland,
Greece, and Peru or our intercompany transactions due to the inherent risks
associated with foreign currency hedging transactions and the timing of payments
between us and our foreign subsidiaries.  Historically, gains or
losses from foreign currency transactions have not had a material impact on our
operating results.  Losses of $1.0 million and gains of $0.3 million
from foreign currency transactions for the years ended November 30, 2008 and
2007, respectively, are included in selling, general and administrative expenses
in the consolidated statements of income.




Recent
Accounting Pronouncements




See note
2 of notes to consolidated financial statements included in Item 8 “Financial
Statements and Supplementary Data.”




Forward
Looking Statements




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







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


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


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


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


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


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


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


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


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


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


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


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


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


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






42


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


•
            we
      rely on third party manufacturers for a portion of our product portfolio,
      including products under our Gold Bond, Icy Hot, Selsun, Dexatrim, ACT, Unisom and Cortizone-10brands;


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


•
            our
      business could be adversely affected if we are unable to successfully
      protect our intellectual property or defend claims of infringement by
      others;


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


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


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


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


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


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


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


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


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


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


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


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


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


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


•
            virtually
      all of our assets consists of intangibles;
and


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






Item 7A. 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 November 30, 2008, $19.5 million was outstanding under
the revolving credit facility and $107.5 million was outstanding under the term
loan portion of our Credit Facility.  The variable rate for the
revolving credit facility was LIBOR plus 1.25%, or 6.07% as of November 30,
2008, and the variable rate for the term loan portion was LIBOR plus 1.75%, or
6.57%, as of November 30, 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 November 30, 2008, the decrease in fair value of
$0.1 million, net of tax, was recorded to other comprehensive
income.  The swap was deemed to be an effective cash flow
hedge.  The swap agreement terminates in January 2010.




43


The
impact on our results of operations of a one-point rate change on the January
22, 2009 outstanding term loan balance of our Credit Facility of $106.8 million
for the next twelve months would be approximately $0.7 million, net of tax. As
of January 22, 2009, we had no borrowings outstanding under the revolving credit
facility portion of our Credit Facility.




We are
subject to risk from changes in the foreign exchange rates relating to our
Canadian, U.K., Irish, Grecian and Peruvian subsidiaries. Assets and liabilities
of these subsidiaries are translated to U.S. dollars at year-end exchange rates.
Income and expense items are translated at average rates of exchange prevailing
during the year.  Translation adjustments are accumulated as a
separate component of shareholders' equity. Gains and losses, which result from
foreign currency transactions, are included in selling, general and
administrative expenses on our consolidated statements of income.  The
potential loss resulting from a hypothetical 10.0% adverse change in the quoted
foreign currency exchange rate amounts to approximately $1.2 million as of
November 30, 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.


























































44


Item 8.   
Financial Statements and Supplementary Data




REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To the
Board of Directors and Shareholders of


Chattem,
Inc.:





We have
audited the accompanying consolidated balance sheets of Chattem, Inc. (a
Tennessee corporation) and subsidiaries (the Company) as of November 30, 2008
and 2007, and the related consolidated statements of income, shareholders’
equity and cash flows for each of the three years in the period ended November
30, 2008. Our audits of the basic financial statements included the financial
statement schedule listed in the index appearing under Item 15 (a)(2). 
These consolidated financial statements and financial statement schedule are the
responsibility of the Company's management.  Our responsibility is to
express an opinion on these consolidated financial statements and financial
statement schedule based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements.An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that
our audits provide a reasonable basis for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Chattem, Inc. and
subsidiaries as of November 30, 2008 and 2007, and the results of their
operations and their cash flows for each of the three years in the period ended
November 30, 2008, in conformity with accounting principles generally accepted
in the United States of America.  Also in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.





As
discussed in Note 7 of the consolidated financial statements, the Company has
adopted Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an
interpretation of FASB Statement No. 109,” as amended by FSP FIN 48-1, “Definition of
Settlement in FASB Interpretation No. 48, ”issued by the
Financial Accounting Standards Board, in fiscal 2008.





The
Company has adopted Statement of Financial Accounting Standards No. 158,
“Employers’ Accounting for Defined Benefit Pension and Other Postretirement
Plans,” in fiscal 2007.





The
Company has adopted Statement of Financial Accounting Standards No. 123(R),
“Share-Based Payments,” in fiscal 2006.





We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Chattem, Inc. and subsidiaries’ internal
control over financial reporting as of November 30, 2008, based on criteria
established in Internal
Control—Integrated Frameworkissued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO)and our report dated
January 29, 2009, expressed an unqualified opinion on the effectiveness of
internal control over financial reporting.







/s/ GRANT
THORNTON LLP




Charlotte,
North Carolina


January
29, 2009




45


Consolidated
Balance Sheets


November
30, 2008 and 2007


(In
thousands)






ASSETS
            
            2008
            
            
            2007CURRENT
      ASSETS:
              Cash
      and cash equivalents
            
            $
            32,310
            
            
            $
            15,407Accounts
      receivable, less allowances of $9,718 in 2008 and $13,810  in
      2007
            
            
            49,417
            
            
            
            43,753Inventories,
      net
            
            
            40,933
            
            
            
            43,265Deferred
      income taxes
            
            
            3,968
            
            
            
            6,750Prepaid
      expenses and other current assets
            
            
            2,451
            
            
            
            2,065Total
      current assets
            
            
            129,079
            
            
            
            111,240PROPERTY,
      PLANT AND EQUIPMENT, NET
            
            
            32,243
            
            
            
            32,349OTHER
      NONCURRENT ASSETS:Patents,
      trademarks and other purchasedproduct
      rights, net
            
            
            616,670
            
            
            
            616,810Debt
      issuance costs, net
            
            
            12,253
            
            
            
            15,430Other
            
            
            2,727
            
            
            
            4,731Total
      other noncurrent assets
            
            
            631,650
            
            
            
            636,971TOTAL
      ASSETS
            
            $
            792,972
            
            
            $
            780,560






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














46


Consolidated
Balance Sheets


November
30, 2008 and 2007


(In
thousands)






LIABILITIES
      AND SHAREHOLDERS' EQUITY
            
            2008
            
            
            2007CURRENT
      LIABILITIES:Current
      maturities of long-term debt
            
            $
            3,000
            
            
            $
            3,000Accounts
      payable
            
            
            18,116
            
            
            
            18,239Bank
      overdrafts
            
            
            1,184
            
            
            
            7,584Accrued
      liabilities
            
            
            21,293
            
            
            
            21,537Total
      current liabilities
            
            
            43,593
            
            
            
            50,360LONG-TERM
      DEBT, less current maturities
            
            
            456,500
            
            
            
            505,000DEFERRED
      INCOME TAXES
            
            
            35,412
            
            
            
            21,056OTHER
      NONCURRENT LIABILITIES
            
            
            1,609
            
            
            
            2,436COMMITMENTS
      AND CONTINGENCIES  (Note 12)SHAREHOLDERS'
      EQUITY:Preferred
      shares, without par value, authorized 1,000, none issued
            
            
            —
            
            
            
            —Common
      shares, without par value, authorized 100,000, issued and
      outstanding 18,978 in 2008 and 19,092 in 2007
            
            
            28,926
            
            
            
            36,800Retained
      earnings
            
            
            231,230
            
            
            
            165,655260,156
            
            
            
            202,455Accumulated
      other comprehensive income (loss), net of taxesInterest
      rate hedge adjustment
            
            
            (1,787
            )
            
            
            (1,747
            )Foreign
      currency translation adjustment
            
            
            (968
            )
            
            
            1,008Unrealized
      actuarial gains and losses
            
            
            (1,543
            )
            
            
            (8
            )Total
      shareholders' equity
            
            
            255,858
            
            
            
            201,708TOTAL
      LIABILITIES AND SHAREHOLDERS' EQUITY
            
            $
            792,972
            
            
            $
            780,560




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












47


Consolidated
Statements of Income


For
the Years Ended November 30, 2008, 2007 and 2006


(In
thousands, except per share amounts)






2008
            
            
            2007
            
            
            2006TOTAL
      REVENUES
            
            $
            454,879
            
            
            $
            423,378
            
            
            $
            300,548COSTS
      AND EXPENSES:Cost
      of sales
            
            
            131,620
            
            
            
            129,055
            
            
            
            94,036Advertising
      and promotion
            
            
            118,093
            
            
            
            112,206
            
            
            
            96,071Selling,
      general and administrative
            
            
            62,590
            
            
            
            57,878
            
            
            
            46,989Product
      recall expenses
            
            
            6,269
            
            
            
            —
            
            
            
            —Acquisition
      expenses
            
            
            —
            
            
            
            2,057
            
            
            
            —Litigation
      settlement
            
            
            11,271
            
            
            
            —
            
            
            
            (19,292
            )Total
      costs and expenses
            
            
            329,843
            
            
            
            301,196
            
            
            
            217,804INCOME
      FROM OPERATIONS
            
            
            125,036
            
            
            
            122,182
            
            
            
            82,744OTHER
      INCOME (EXPENSE):Interest
      expense
            
            
            (25,310
            )
            
            
            (29,930
            )
            
            
            (11,725
            )Investment
      and other income, net
            
            
            715
            
            
            
            1,460
            
            
            
            1,076Loss
      on early extinguishment of debt
            
            
            (526
            )
            
            
            (2,633
            )
            
            
            (2,805
            )Total
      other income (expense)
            
            
            (25,121
            )
            
            
            (31,103
            )
            
            
            (13,454
            )INCOME
      BEFORE INCOME TAXES
            
            
            99,915
            
            
            
            91,079
            
            
            
            69,290PROVISION
      FOR INCOME TAXES
            
            
            33,629
            
            
            
            31,389
            
            
            
            24,178NET
      INCOME
            
            $
            66,286
            
            
            $
            59,690
            
            
            $
            45,112NUMBER
      OF COMMON SHARES:Weighted
      average outstanding, basic
            
            
            18,980
            
            
            
            18,927
            
            
            
            19,036Weighted
      average and potential dilutive outstanding
            
            
            19,364
            
            
            
            19,350
            
            
            
            19,262NET
      INCOME PER COMMON SHARE:Basic
            
            $
            3.49
            
            
            $
            3.15
            
            
            $
            2.37Diluted
            
            $
            3.42
            
            
            $
            3.08
            
            
            $
            2.34






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










48


Consolidated
Statements of Shareholders' Equity


For
the Years Ended November 30, 2008, 2007 and 2006


(In
thousands)


Common
              Shares
            
            
            Retained
              Earnings
            
            
            Unamortized
              Value
      of
              Restricted
              Common
              Shares
      Issued
            
            
            Accumulated
              Other
              Comprehensive
              Income (Loss)
            
            
            TotalBalance,
      November 30, 2005
            
            $
            63,876
            
            
            $
            60,853
            
            
            $
            (1,818
            )
            
            $
            (284
            )
            
            $
            122,627Comprehensive
      income (loss):Net
      income
            
            
            —
            
            
            
            45,112
            
            
            
            —
            
            
            
            —
            
            
            
            45,112Interest
      rate hedge adjustment, net of taxes of $323
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (514
            )
            
            
            (514
            )Foreign
      currency translation adjustment
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (38
            )
            
            
            (38
            )Total
      comprehensive income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            44,560Stock-based
      compensation expense
            
            
            5,594
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            5,594Stock
      options exercised
            
            
            2,480
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,480Tax
      benefit realized from stock option plans
            
            
            982
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            982Stock
      repurchases
            
            
            (39,332
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (39,332
            )Payment
      for purchase of note hedge, net of tax benefit
            
            
            (19,994
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (19,994
            )Proceeds
      from issuance of warrant
            
            
            18,581
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            18,581Issuance
      of 2 common shares for non-employee directors’
compensation
            
            
            83
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            83Adjustment
      from unamortized value of restricted common shares issued to common
      shares
            
            
            (1,818
            )
            
            
            —
            
            
            
            1,818
            
            
            
            —
            
            
            
            —Balance,
      November 30, 2006
            
            $
            30,452
            
            
            $
            105,965
            
            
            $
            —
            
            
            $
            (836
            )
            
            $
            135,581Comprehensive
      income (loss):Net
      income
            
            
            —
            
            
            
            59,690
            
            
            
            —
            
            
            
            —
            
            
            
            59,690Interest
      rate hedge adjustment, net of taxes of $671
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,150
            )
            
            
            (1,150
            )Foreign
      currency translation adjustment
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,247
            
            
            
            1,247Total
      comprehensive income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            59,787Adjustment
      to initially apply SFAS 158 and recognize postretirement loss, net of
      taxes of $9
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (8
            )
            
            
            (8
            )Stock-based
      compensation expense
            
            
            6,208
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            6,208Stock
      options exercised
            
            
            16,661
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            16,661Tax
      benefit realized from stock option plans
            
            
            7,938
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            7,938Stock
      repurchases
            
            
            (23,601
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (23,601
            )Payment
      for purchase of note hedge, net of tax benefit
            
            
            (18,408
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (18,408
            )Proceeds
      from issuance of warrant
            
            
            17,430
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            17,430Issuance
      of 2 common shares for non-employee directors’
compensation
            
            
            120
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            120Balance,
      November 30, 2007
            
            $
            36,800
            
            
            $
            165,655
            
            
            $
            —
            
            
            $
            (747
            )
            
            $
            201,708




49








Common
              Shares
            
            
            Retained
              Earnings
            
            
            Unamortized
              Value
      of
              Restricted
              Common
              Shares
      Issued
            
            
            Accumulated
              Other
              Comprehensive
              Income
      (Loss)
            
            
            TotalBalance,
      November 30, 2007
            
            $
            36,800
            
            
            $
            165,655
            
            
            $
            —
            
            
            $
            (747
            )
            
            $
            201,708Comprehensive
      income (loss):Net
      income
            
            
            —
            
            
            
            66,286
            
            
            
            —
            
            
            
            —
            
            
            
            66,286Interest
      rate hedge adjustment, net of taxes of $69
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (40
            )
            
            
            (40
            )Foreign
      currency translation adjustment
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,976
            )
            
            
            (1,976
            )Unrealized
      actuarial gains and losses, net of taxes of $945
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,535
            )
            
            
            (1,535
            )Total
      comprehensive income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            62,735Stock-based
      compensation expense
            
            
            6,255
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            6,255Stock
      options exercised
            
            
            8,372
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            8,372Tax
      benefit realized from stock option plans
            
            
            3,709
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            3,709Stock
      repurchases
            
            
            (26,327
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (26,327
            )Issuance
      of 2 common shares for non-employee directors’
compensation
            
            
            117
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            117Net
      cumulative effect of adoption of FIN 48
            
            
            —
            
            
            
            (711
            )
            
            
            —
            
            
            
            —
            
            
            
            (711
            )Balance,
      November 30, 2008
            
            $
            28,926
            
            
            $
            231,230
            
            
            $
            —
            
            
            $
            (4,298
            )
            
            $
            255,858






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































50


Consolidated
Statements of Cash Flows


For
the Years Ended November 30, 2008, 2007 and 2006


(In
thousands)






2008
            
            
            2007
            
            
            2006OPERATING
      ACTIVITIES:Net
      income
            
            $
            66,286
            
            
            $
            59,690
            
            
            $
            45,112Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
      and amortization
            
            
            8,386
            
            
            
            8,843
            
            
            
            5,835Deferred
      income taxes
            
            
            18,139
            
            
            
            12,718
            
            
            
            413Stock-based
      compensation expense
            
            
            5,970
            
            
            
            5,622
            
            
            
            4,745Loss
      on early extinguishment of debt
            
            
            526
            
            
            
            2,633
            
            
            
            2,805Tax
      benefit realized from stock options exercised
            
            
            (3,709
            )
            
            
            (8,291
            )
            
            
            (1,627
            )Other,
      net
            
            
            (1,463
            )
            
            
            (189
            )
            
            
            384Changes
      in operating assets and liabilities, net of acquisitions:Accounts
      receivable
            
            
            (5,664
            )
            
            
            (13,901
            )
            
            
            12,341Inventories
            
            
            2,331
            
            
            
            (5,820
            )
            
            
            (7,621
            )Refundable
      income taxes
            
            
            —
            
            
            
            —
            
            
            
            2,834Prepaid
      expenses and other current assets
            
            
            (391
            )
            
            
            1,249
            
            
            
            579Accounts
      payable and accrued liabilities
            
            
            1,747
            
            
            
            24,180
            
            
            
            (11,378
            )Net
      cash provided by operating activities
            
            
            92,158
            
            
            
            86,734
            
            
            
            54,422INVESTING
      ACTIVITIES:Purchases
      of property, plant and equipment
            
            
            (4,621
            )
            
            
            (6,295
            )
            
            
            (4,705
            )Acquisitions
      of brands
            
            
            —
            
            
            
            (415,765
            )
            
            
            —(Increase)
      decrease in other assets, net
            
            
            (1,534
            )
            
            
            1,910
            
            
            
            (2,111
            )Net
      cash used in investing activities
            
            
            (6,155
            )
            
            
            (420,150
            )
            
            
            (6,816
            )FINANCING
      ACTIVITIES:Repayment
      of long-term debt
            
            
            (38,000
            )
            
            
            (154,500
            )
            
            
            (75,000
            )Proceeds
      from long-term debt
            
            
            —
            
            
            
            400,000
            
            
            
            125,000Proceeds
      from borrowings under revolving credit facility
            
            
            151,500
            
            
            
            159,000
            
            
            
            75,500Repayments
      of revolving credit facility
            
            
            (162,000
            )
            
            
            (129,000
            )
            
            
            (75,500
            )Bank
      overdraft
            
            
            (6,400
            )
            
            
            1,760
            
            
            
            5,824Repurchase
      of common shares
            
            
            (26,327
            )
            
            
            (23,601
            )
            
            
            (39,332
            )Proceeds
      from exercise of stock options
            
            
            8,372
            
            
            
            16,661
            
            
            
            2,480Purchase
      of note hedge
            
            
            —
            
            
            
            (29,500
            )
            
            
            (32,042
            )Proceeds
      from issuance of warrants
            
            
            —
            
            
            
            17,430
            
            
            
            18,581Increase
      in debt issuance costs
            
            
            —
            
            
            
            (9,383
            )
            
            
            (9,099
            )Debt
      retirement costs
            
            
            —
            
            
            
            —
            
            
            
            (1,501
            )Premium
      paid on interest rate cap agreement
            
            
            —
            
            
            
            (114
            )
            
            
            (687
            )Proceeds
      from sale of interest rate cap
            
            
            —
            
            
            
            909
            
            
            
            —Tax
      benefit realized from stock options exercised
            
            
            3,709
            
            
            
            8,291
            
            
            
            1,627Net
      cash (used in) provided by financing activities
            
            
            (69,146
            )
            
            
            257,953
            
            
            
            (4,149
            )EFFECT
      OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
            
            
            46
            
            
            
            343
            
            
            
            (257
            )CASH
      AND CASH EQUIVALENTS:Increase
      (decrease) for the year
            
            
            16,903
            
            
            
            (75,120
            )
            
            
            43,200At
      beginning of year
            
            
            15,407
            
            
            
            90,527
            
            
            
            47,327At
      end of year
            
            $
            32,310
            
            
            $
            15,407
            
            
            $
            90,527




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




51


Notes
to Consolidated Financial Statements




All
monetary and share, other than per share, amounts are expressed in thousands.
Our fiscal years ended November 30, 2006, November 30, 2007 and November 30,
2008 are referred to herein as fiscal 2006, fiscal 2007 and fiscal 2008,
respectively.




(1)           NATURE OF
OPERATIONS




Chattem,
Inc. and its wholly-owned subsidiaries (“we”, “us”, “our” or “Chattem”) market
and manufacture branded over-the-counter (“OTC”) health care
products.  The products are sold primarily through mass merchandisers,
independent and chain drug stores, drug wholesalers and food stores in the
United States (“U.S.”) and in various markets in approximately 80 countries
throughout the world.




(2)           SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES




BASIS
OF CONSOLIDATION




The
accompanying consolidated financial statements include the accounts of Chattem
and its wholly-owned subsidiaries.  All significant intercompany
transactions and balances have been eliminated.




CASH
AND CASH EQUIVALENTS




We
consider all short-term deposits and investments with original maturities of
three months or less to be cash equivalents.  Short-term cash
investments are placed with high credit quality financial institutions or in low
risk, liquid instruments.  Cash denominated in foreign currency was
$6,302 and $6,783 as of November 30, 2008 and 2007, respectively.




INVENTORIES




Inventory
costs include materials, labor and factory overhead.  Inventories are
valued at the lower of cost using the first-in, first-out (“FIFO”) method or
market.  We estimate reserves for inventory obsolescence based on our
judgment of future realization.  As of November 30, 2007, we had a
specific reserve of $2,531 forIcy Hot Pro Therapy obsolete inventory.  As of November 30,
2008, that reserve has been reduced to an insignificant amount due to inventory
donations made in fiscal 2008.




PROPERTY,
PLANT AND EQUIPMENT




Property,
plant and equipment are recorded at cost.  Depreciation is computed
using the straight-line method over the estimated useful lives of 7 to 40 years
for buildings and improvements and 3 to 15 years for machinery and
equipment.  Expenditures for maintenance and repairs are charged to
expense as incurred.  Depreciation expense for fiscal 2008, fiscal
2007 and fiscal 2006 was $4,560, $4,735 and $4,191, respectively.




PATENTS,
TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS




The costs
of acquired patents and other purchased product rights are capitalized and
amortized over their respective useful lives, generally 5 years.




The
provisions of Statement of Financial Accounting Standards (“SFAS”) No. 142,
“Goodwill and Other Intangible Assets” (“SFAS 142”), require certain
fair-value-based tests of the carrying value of indefinite-lived intangible
assets at least annually.




Under
SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets”, we
evaluate whether events and circumstances have occurred that indicate the
remaining useful life of finite-lived assets might warrant revision or that the
remaining balance may not be recoverable.  When factors indicate that
finite-lived assets should have been evaluated for possible impairment, we use
an estimate of the future undiscounted net cash flows of the related assets over
the remaining lives of the assets in measuring whether the carrying values of
finite-lived assets were recoverable.




52


DEBT
ISSUANCE COSTS




We have
incurred debt issuance costs in connection with our long-term
debt.  These costs are capitalized and amortized over the term of the
related debt.  Amortization expense related to debt issuance costs was
$2,651, $2,719 and $693 in fiscal 2008, fiscal 2007 and fiscal 2006,
respectively.  Accumulated amortization of these costs was $6,434 and
$3,900 at November 30, 2008 and 2007, respectively.    On
July 25, 2006, we successfully completed the consent solicitation from the
holders of the 7.0% Subordinated Notes resulting in a consent fee of $5,619,
which is being amortized as additional interest expense through 2014, the
remaining term of the 7.0% Subordinated Notes.  In November 2006, we
completed a private offering of $125,000 of 2.0% Convertible Senior Notes due
2013 (“2.0% Convertible Notes”) resulting in the capitalization of debt issuance
costs of $3,465 in fiscal 2006 and $517 in fiscal 2007, which is being amortized
as additional interest expense through 2013.  In January 2007, we
completed an amendment to the Amended Revolving Credit Facility resulting in the
capitalization of debt issuance costs of $5,507, which is being amortized as
additional interest expense through 2013.  In April 2007, we completed
an amendment to our Credit Facility resulting in additional debt issuance costs
of $625, which is being amortized through 2010 as additional interest
expense.  In April 2007, we completed a private offering of $100,000
of 1.625% Convertible Senior Notes due 2014 (“1.625% Convertible Notes”)
resulting in the capitalization of debt issuance costs of $2,734, which is being
amortized as additional interest expense through 2014.  During fiscal
2006 we recorded a loss on early extinguishment of debt of $2,805 due to the
early redemption of our $75,000 Floating Rate Senior Notes.  During
2007, we repaid $153,000 of the term loan under the Credit Facility, retiring a
proportional share of the related debt issuance costs and recording a loss on
extinguishment of debt of $2,633.  During 2008, we repaid an
additional $35,000 of the term loan under the Credit Facility.  In
connection with the term loan repayment, we retired a proportional share of the
term loan debt issuance costs and recorded the resulting loss on early
extinguishment of debt of $526 in fiscal 2008.




BANK
OVERDRAFT




Bank
overdraft represents outstanding checks in excess of current cash
levels.  We fund bank overdrafts from our short-term investments and
our operating cash flows.




PRODUCT
DEVELOPMENT




Product
development costs relate primarily to the development of new products and are
expensed as incurred.  Such expenses were $5,672, $5,525 and $4,241 in
fiscal 2008, 2007 and 2006, respectively, and are included in selling, general
and administrative expenses on our consolidated statements of
income.




ADVERTISING
EXPENSES




The cost
of advertising is expensed in the fiscal year in which the related advertising
takes place.  Production and communication costs are expensed in the
period in which the related advertising begins running.  Advertising
expense for fiscal 2008, 2007 and 2006 was $76,405, $74,510 and $64,411,
respectively.  At November 30, 2008 and 2007, we reported $1,251 and
$759, respectively, of advertising paid for in fiscal 2008 and fiscal 2007,
which will run or did run in the next fiscal year.  These amounts are
included in prepaid expenses and other current assets in the consolidated
balance sheets.




FOREIGN
CURRENCY TRANSLATION




Assets
and liabilities of our Canadian, United Kingdom (“U.K.”), Irish, Grecian and
Peruvian 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
(losses) which result from foreign currency transactions amounted to $(982),
$295 and $(21) in fiscal 2008, 2007 and 2006, respectively, and are included in
selling, general and administrative expenses on our consolidated statements of
income.




USE
OF ESTIMATES




The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period.  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
consolidated financial statements for fiscal 2008, 2007 and 2006:




53


Allowance
For Doubtful Accounts




As of
November 30, 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 year ended November 30, 2008, we performed an
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 $419 at
November 30, 2008 and 2007.




Revenue
Recognition




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




Our
estimate of product returns for seasonal and non-seasonal products was $1,376
and $1,270 as of November 30, 2008, $1,174 and $1,254 as of November 30, 2007
and $1,204 and $1,321 as of November 30, 2006.  Due to higher sales
volume during fiscal 2008, we increased our estimate of seasonal returns by
$202, which resulted in a decrease to net sales in our consolidated financial
statements.  Higher sales volume in fiscal 2007 offset by customers
returning seasonal product earlier in the season resulted in our estimate of
returns for seasonal products remaining consistent as compared to fiscal
2006.  During fiscal 2008 and 2007, our estimate of non-seasonal
returns remained consistent as compared to fiscal 2007 and 2006,
respectively.  Each percentage point change in the seasonal return
rate would impact net sales by approximately $200.  Each percentage
point change in the non-seasonal return rate would impact net sales by
approximately $550.




At
November 30, 2006, based on consideration of the sales of Icy Hot Pro Therapy
performing below expectations, review of retail point-of-sale data throughout
fiscal 2006 and an estimate of inventory on hand at customers, we estimated
returns of Icy Hot Pro
Therapy as of November 30, 2006 of $3,339, which was included as a
reduction of net sales.  During fiscal 2007, we continued to monitor
Icy Hot Pro Therapy
retail sales and inventory levels on-hand at customers and increased the
specific reserve for Icy Hot
Pro Therapy returns by $4,522 as of November 30, 2007, which is included
as a reduction of net sales in our consolidated financial
statements.  As of November 30, 2007, the allowance remaining for
Icy Hot Pro Therapyreturns was $4,479.  During fiscal 2008, based on a revised
estimate of inventory held by customers, we reduced the estimated remaining
liability for returns by $1,500, which resulted in an increase to net sales in
our consolidated financial statements.  As of November 30, 2008, the
allowance remaining for Icy
Hot Pro Therapy returns is $718.




54


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 cost of these programs is often variable based on the
number of units actually sold.  As of November 30, 2008, the coupon
accrual and reserve for vendor allowances were $1,756 and $4,907, respectively,
and $1,895 and $5,513, respectively, as of November 30, 2007.  Each
percentage point change in promotional program participation would impact net
sales by approximately $200 and advertising and promotion expense by an
insignificant amount.




Income
Taxes




We
account for income taxes using the asset and liability approach as prescribed by
SFAS No. 109, “Accounting for Income Taxes”, Financial Accounting Standards
Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income
Taxes” (“FIN 48”), FASB Staff position No. FIN 48-1, “Definition of Settlement
in FASB Interpretation No. 48” (FSP FIN 48-1”) and other applicable FSP’s and
FASB Interpretations.  This approach requires recognition of deferred
tax assets and liabilities for the expected future tax consequences of events
that have been included in the consolidated financial statements or tax
returns.  Using the enacted tax rates in effect for the year in which
the differences are expected to reverse, deferred tax assets and liabilities are
determined based on the differences between the financial reporting and the tax
basis of an asset or liability. We adopted FIN 48, as amended by FSP FIN 48-1,
on December 1, 2007.  FIN 48 clarifies the accounting for uncertainty
in income taxes recognized in the financial statements in accordance with SFAS
109.  Our estimated annual effective income tax rate during fiscal
2008 was 33.7%, as compared to 34.5% in fiscal 2007 and 34.9% in fiscal
2006.




DERIVATIVE
FINANCIAL INSTRUMENTS




We
entered into an interest rate cap agreement effective June 2004 as a means of
managing our interest rate exposure and not for trading
purposes.  During fiscal 2007, the interest rate cap was sold for
$353.  As a result, $49 was recorded as additional interest expense in
the accompanying consolidated statement of income.




In
November 2006, we entered into an interest rate cap agreement effective January
2007 as a means of managing our interest rate exposure and not for trading
purposes.  During fiscal 2007, the interest rate cap was sold for
$555.  As a result, $50 was recorded as additional interest expense in
the accompanying consolidated statement of income.




In
November 2006, we entered into an interest rate swap agreement effective January
2007 as a means of managing our interest rate exposure and not for trading
purposes.  In accordance with SFAS 133, as of November 30, 2008, the
interest rate swap was deemed to be an effective cash flow hedge and the change
in fair value of $52, net of tax, was recorded to other comprehensive
income.




55


In April
2007, we entered into an interest rate cap agreement effective May 2007 as a
means of managing our interest rate exposure and not for trading
purposes.  We paid a premium of $114 to enter into the cap agreement,
which was amortized over the life of the agreement.  The interest rate
cap expired in fiscal 2008.




CONCENTRATIONS
OF CREDIT RISK




Financial
instruments, which subject us to concentrations of credit risk, consist
primarily of accounts receivable and short-term cash investments.  Our
exposure to credit risk associated with nonpayment of accounts receivable is
affected by conditions or occurrences within the retail industry.  As
a result, we perform ongoing credit evaluations of our customers' financial
position but generally require no collateral from our customers.  Our
largest customer accounted for 33%, 33% and 36% of domestic sales in fiscal
2008, 2007 and 2006, respectively.  That same customer accounted for
33%, 28% and 31% of domestic accounts receivable as of November 30, 2008, 2007
and 2006, respectively.  No other customer exceeded 10% of our
domestic sales or accounts receivable as of November 30, 2008, 2007 and
2006.  No international retailers accounted for more than 10% of our
international revenues.  Our ten largest customers represented
approximately 74% of total revenues during fiscal 2008, and approximately 73% of
our total domestic accounts receivable at November 30, 2008.




OTHER
CONCENTRATIONS




We
purchase raw materials and packaging materials from a number of third party
suppliers primarily on a purchase order basis.  Except for pamabrom,
pyrilamine maleate and compap, active ingredients used in our Pamprin and Prēmsyn
PMS products, we are not limited to a single source of supply for the
ingredients used in the manufacture of our products.  Net sales of
Pamprin and Prēmsyn
PMS products in fiscal 2008 represented $12,128 of our consolidated total
revenues in that year.  In addition, we have a limited source of
supply for selenium sulfide, the active ingredient in Selsun Blue.  As a
result of the limited supply and increase in worldwide demand, prices have been
and are expected to be volatile.  We believe that our current sources
of supply and potential alternative sources will be adequate to meet future
product demands.




SHIPPING
AND HANDLING COSTS




Shipping
and handling costs of $15,479, $12,105 and $8,947 for fiscal 2008, 2007 and
2006, respectively, are included in selling, general and administrative expenses
on our consolidated statements of income.




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.





We
account for stock-based compensation under the provisions of SFAS No. 123
(revised 2004), “Share-Based Payment” (“SFAS 123R”), which requires the
recognition of the cost of employee services received in exchange for an award
of equity instruments in the financial statements and is measured based on the
grant date fair value of the award.  SFAS 123R also requires the stock
option compensation expense to be recognized over the period during which an
employee is required to provide service in exchange for the award (the vesting
period).







56


The
following table represents the impact of stock-based compensation expense on our
consolidated statements of income during fiscal 2008, 2007 and 2006
respectively:





For the Year ended
      November 30,2008
            
            
            2007
            
            
            2006Income
      from operations
            
            $
            5,970
            
            
            $
            5,622
            
            
            $
            4,745Provision
      for income taxes
            
            
            2,012
            
            
            
            1,940
            
            
            
            1,656Net
      income
            
            $
            3,958
            
            
            $
            3,682
            
            
            $
            3,089Basic
      net income per share
            
            $
            0.21
            
            
            $
            0.19
            
            
            $
            0.16Diluted
      net income per share
            
            $
            0.20
            
            
            $
            0.19
            
            
            $
            0.16









The fair
value of each option award is estimated on the date of grant using the Flex
Lattice Model that uses the assumptions noted in the following
table.  The risk-free interest rate is based on the yield of an
applicable term Treasury instrument, the expected life of the option is based on
historical exercise behavior and the option’s expected volatility is based on
the historical volatility of our common stock price.




For the Year Ended November
      30,2008
            
            
            2007
            
            
            2006Risk-free
      interest rate
            
            
            3.84%
            
            
            
            4.47%
            
            
            
            4.48%Expected
      dividend yield
            
            
            0%
            
            
            
            0%
            
            
            
            0%Expected
      volatility
            
            
            36%
            
            
            
            34%
            
            
            
            43%Expected
      life (years)
            
            
            6
            
            
            
            6
            
            
            
            6







RECENT
ACCOUNTING PRONOUNCEMENTS




In July
2006, the FASB issued FIN 48, which clarifies the accounting for uncertainty in
income taxes recognized in the financial statements in accordance with 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 issued an amendment
to FIN 48.  FSP FIN 48-1 clarifies how an enterprise is to 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 were effective for fiscal years beginning after December 15,
2006.   As described in Note 7, we adopted the provisions of FIN
48, as amended by FSP FIN 48-1, effective December 1, 2007.




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 when 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 (data not based on market observable information), 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.  As described in Note 6, we adopted SFAS 157 as it pertains
to financial assets and liabilities effective December 1, 2007.




In
February 2008, the FASB issued FSP No. SFAS 157-2, “Effective
Date of FASB Statement No. 157” (“FSP 157-2”).  FSP 157-2
defers the effective date of SFAS 157 for nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair
value in the financial statements on a recurring basis (at least annually), to
fiscal years and interim periods within those fiscal years, beginning after
November 15, 2008, or our fiscal 2009.  We are currently
evaluating the impact of adopting the provisions of FSP 157-2.




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.




57


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





In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities – An Amendment of FASB Statement No. 133” (“SFAS
161”).  SFAS 161 requires enhanced disclosures for derivative and
hedging activities.  SFAS 161 is effective for financial statements
issued for fiscal years and interim periods beginning after November 15, 2008,
or our fiscal 2009.  We do not expect SFAS 161 to have a material
effect on our consolidated financial statements.





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




In May
2008, the FASB issued FSP Accounting Principles Board Opinion No. 14-1,
“Accounting for Convertible Debt Instruments That May Be Settled in Cash upon
Conversion (Including Partial Cash Settlement)” (“FSP 14-1”).  FSP
14-1 requires issuers of convertible debt instruments that may be settled in
cash to separately account for the liability and equity components in a manner
that will reflect the entity’s nonconvertible debt borrowing rate when interest
cost is recognized in periods subsequent to adoption.  Upon adoption
of FSP 14-1, we will allocate a portion of the proceeds received from the
issuance of our convertible notes between a liability and equity component by
determining the fair value of the liability component using our non-convertible
debt borrowing rate.  The difference between the proceeds of the notes
and the fair value of the liability component will be recorded as a discount on
the debt with a corresponding offset to paid-in-capital.  The
resulting discount will be accreted by recording additional non-cash interest
expense over the expected life of the convertible notes using the effective
interest rate method.  We are currently assessing the impact of
adopting FSP 14-1 on our consolidated financial statements, however we expect
there to be a dilutive effect on our earnings per share.  The
provisions of FSP 14-1 are to be applied retrospectively to all periods
presented upon adoption and are effective for fiscal years beginning after
December 15, 2008, or our fiscal 2010, and interim periods within those fiscal
years.





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











58


(3)           SHAREHOLDERS'
EQUITY




COMPUTATION
OF EARNINGS PER SHARE




The
following table presents the computation of per share earnings for the years
ended November 30, 2008, 2007 and 2006, respectively:




For the year
      ended November 30,2008
            
            
            2007
            
            
            2006NET
      INCOME:
            
            $
            66,286
            
            
            $
            59,690
            
            
            $
            45,112NUMBER
      OF COMMON SHARES:Weighted
      average outstanding
            
            
            18,980
            
            
            
            18,927
            
            
            
            19,036Issued
      upon assumed exercise ofoutstanding
      stock options
            
            
            53
            
            
            
            345
            
            
            
            209Issued
      upon assumed exercise ofconvertible
      notes
            
            
            328
            
            
            
            69
            
            
            
            —Effect
      of issuance of restricted common shares
            
            
            3
            
            
            
            9
            
            
            
            17Weighted
      average and potential dilutive outstanding (1)
            
            
            19,364
            
            
            
            19,350
            
            
            
            19,262NET
      INCOME PER COMMON SHARE:Basic
            
            $
            3.49
            
            
            $
            3.15
            
            
            $
            2.37Diluted
            
            $
            3.42
            
            
            $
            3.08
            
            
            $
            2.34




(1)Because
their effects are anti-dilutive, excludes shares issuable under stock option
plans whose grant price was greater than the average market price of common
shares outstanding as follows: 609 shares in fiscal 2008, 249 shares in fiscal
2007 and 797 shares in fiscal 2006.
















59


STOCK
OPTIONS




We have
granted stock options to key employees and non-employee directors under the
plans described in Note 2.  A summary of the activity of stock options
during fiscal 2008, 2007 and 2006 is presented below:






2008
            
            2007
            
            2006Shares
              UnderOption
            
            Weighted Average ExercisePrice
            
            Shares
              UnderOption
            
            Weighted Average ExercisePrice
            
            Shares
              UnderOption
            
            Weighted Average ExercisePriceOutstanding
      at beginning of year
            1,458
            
            $      40.43
            
            1,936
            
            $      27.63
            
            1,753
            
            $      23.94Granted
            368
            
            70.85
            
            427
            
            60.05
            
            449
            
            37.87Exercised
            (303)
            
            27.69
            
            (824)
            
            20.23
            
            (174)
            
            14.26Cancelled
            (13)
            
            58.82
            
            (81)
            
            43.36
            
            (92)
            
            32.49Outstanding
      at end of year
            1,510
            
            $      50.23
            
            1,458
            
            $      40.43
            
            1,936
            
            $      27.63Options
      exercisable at year-end
            607
            
            $      37.74
            
            571
            
            $      29.56
            
            972
            
            $      22.45Weighted
      average fair value of options granted
            
            
            $     27.97
            
            
            
            $     24.63
            
            
            
            $     16.75Fair
      value of options granted
            
            
            $   10,277
            
            
            
            $   10,505
            
            
            
            $     7,520Fair
      value of options vested
            
            
            $     5,970
            
            
            
            $     5,665
            
            
            
            $     4,882Intrinsic
      value of options exercised
            
            
            $   13,994
            
            
            
            $   33,574
            
            
            
            $     4,518




As of
November 30, 2008, the aggregate intrinsic value of stock options outstanding
was $32,541 and the weighted average remaining contractual life was five
years.  The aggregate intrinsic value of stock options exercisable was
$20,660 and the weighted average remaining contractual life was four
years.




As of
November 30, 2008, we had $15,961 of unrecognized compensation cost related to
stock options that will be recorded over a weighted average period of
approximately three years.




A summary
of the exercise prices for options outstanding under our stock-based
compensation plans at November 30, 2008 is presented below:




Range
      of
              Exercise
      Prices
            
            Shares
      Under
              Option
            
            Weighted Average Exercise Price
            
            Weighted Average Remaining Life in Years
            
            Shares
              Exercisable
            
            Weighted
              Average
              Exercise
      Price
              of Shares Exercisable$  4.66 - $28.39
            
            174
            
            $  21.27
            
            4.69
            
            174
            
            $  21.27$33.00 - $38.07
            
            363
            
            37.79
            
            3.46
            
            171
            
            37.81$42.09 - $59.73
            
            244
            
            43.74
            
            3.61
            
            174
            
            42.73$59.77 - $59.77
            
            351
            
            59.77
            
            4.40
            
            85
            
            59.77$62.21 - $71.83
            
            378
            
            70.77
            
            6.15
            
            3
            
            68.57Total
            
            1,510
            
            50.23
            
            4.52
            
            607
            
            37.74






60


PREFERRED
SHARES




We are
authorized to issue up to 1,000 preferred shares in series and with rights
established by the board of directors.  At November 30, 2008 and 2007,
no shares of any series of preferred stock were issued and
outstanding.




STOCK
REPURCHASE




On April
30, 2008, our Board of Directors increased the authorization to a total of
$100,000 of our common stock under the terms of our existing stock repurchase
program.




In fiscal
2008, 418 shares at a cost of $26,327 were repurchased, in fiscal 2007, 400
shares were repurchased at a cost of $23,601 and in fiscal 2006, 1,172 shares at
a cost of $39,332 were repurchased.  The repurchased shares were
retired and returned to unissued.  As of January 22, 2009, the current
amount available under the authorization from the Board of Directors was
$73,913.




SHAREHOLDER
RIGHTS PLAN




On
January 26, 2000, our board of directors adopted a shareholder rights
plan.  Under the plan, rights were constructively distributed as a
dividend at the rate of one right for each share of our common stock, without
par value, held by shareholders of record as of the close of business on
February 11, 2000.  As a result of the two-for-one split of our common
stock on November 29, 2002, there is now one-half (1/2) right associated with
each share of common stock outstanding.  Each right initially will
entitle shareholders to buy one one-hundredth of a share of a new Series A
Junior Participating Preferred Stock at an exercise price of $90.00 per right,
subject to adjustment.  The rights generally will be exercisable only
if a person or group acquires beneficial ownership of 15% or more of our common
stock.  If the rights are triggered, the resulting issued shares would
be included in the calculation of diluted earnings per
share.   The rights will expire on February 11,
2010.  As of November 30, 2008, no person or group has acquired
beneficial ownership of 15% of our common stock, therefore, no rights have been
exercised.




RESTRICTED
STOCK ISSUANCE




We issued
50 restricted shares of common stock to certain employees in fiscal
2005.  The market value of these shares on the dates of issuance was
$1,769.  These amounts are being amortized using the straight-line
method over respective four year periods from the date of issuance as additional
compensation expense.  Amortization expense for restricted stock
issued was $286, $565 and $712 in fiscal 2008, 2007 and 2006, respectively, with
the unamortized value of $43 and $328 being included as a component of
shareholders’ equity in the November 30, 2008 and 2007 consolidated balance
sheets, respectively.  The unamortized value of the restricted shares
remaining as of November 30, 2008 will be recorded in the first quarter of
fiscal 2009.  The shares issued in fiscal 2005 reduced the number of
shares available for issuance under our 2003 Stock Incentive Plan.  No
restricted shares of common stock were issued in fiscal 2008, 2007, and
2006.




A summary
of our nonvested restricted stock activity as of November 30, 2008 is presented
below:




Nonvested Restricted
      Stock
            
            Number of shares
            
            
            Weighted
      Average Grant-Date Fair
      ValueNonvested
      at November 30, 2007
            
            
            9
            
            
            $
            33.11Granted
            
            
            —
            
            
            
            —Vested
            
            
            8
            
            
            
            32.79Forfeited
            
            
            —
            
            
            
            —Nonvested
      at November 30, 2008
            
            
            1
            
            
            $
            35.37











61


(4)           PATENT, TRADEMARKS AND OTHER
PURCHASED PRODUCT RIGHTS




During
fiscal 2008, 2007 and 2006, we performed impairment testing of our intangible
assets as prescribed by SFAS 142.  The valuations indicated no
impairment.  The carrying value of trademarks, which are not subject
to amortization under the provisions of SFAS 142, was $613,328 as of November
30, 2008 and 2007, respectively.




The gross
carrying amount of intangible assets subject to amortization at November 30,
2008 and 2007, which consist primarily of non-compete agreements and shelf
presence, was $7,028 and $6,053, respectively.  The related
accumulated amortization of these intangible assets at November 30, 2008 and
2007, was $3,687 and $2,797, respectively.  Amortization of our
intangible assets subject to amortization under the provisions of SFAS 142 was
$890, $824 and $238 for fiscal 2008, 2007 and 2006,
respectively.  Estimated annual amortization expense for these assets
for fiscal 2009, 2010, 2011, 2012 and 2013 is $945, $925, $925, $208 and $75,
respectively.  Royalty expense related to other purchased product
rights for fiscal 2008, 2007 and 2006 was $53, $62 and $78,
respectively.  Amortization and royalty expense are included in
advertising and promotion expense in the accompanying consolidated statements of
income.




(5)           LONG-TERM
DEBT




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




2008
            
            
            2007Revolving
      Credit Facility due 2010 at a variable rate of 6.07% and 6.19%
      as of November 30, 2008 and 2007, respectively
            
            $
            19,500
            
            
            $
            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 6.57% and  6.97% as of
      November 30, 2008 and 2007, respectively
            
            
            107,500
            
            
            
            145,5007.0%
      Senior Subordinated Notes due 2014
            
            
            107,500
            
            
            
            107,500


Total
      long-term debt
            
            
            459,500
            
            
            
            508,000Less:  current
      maturities
            
            
            3,000
            
            
            
            3,000Total
      long-term debt, net of current maturities
            
            $
            456,500
            
            
            $
            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
were able to increase the borrowing capacity under the Amended Revolving Credit
Facility by $50,000 to an aggregate of $150,000.  In November 2006, we
entered into an amendment to our Amended Revolving Credit Facility that, among
other things, permitted the sale of the 2.0% Convertible Senior Notes due 2013
(the “2.0% Convertible Notes”).  In January 2007, we completed an
amendment to the Amended Revolving Credit Facility providing for up to a
$100,000 revolving credit facility and a $300,000 term loan (the “Credit
Facility”).  The proceeds from the term loan under the Credit Facility
were used to finance in part the acquisition of the five consumer and OTC brands
from Johnson & Johnson.  The Credit Facility includes “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 0.50% or the prime rate (the “Base
Rate”).  The






62


applicable
percentages are calculated based on our leverage ratio.  As of
November 30, 2008 and 2007, respectively we had $19,500 and $30,000 of
borrowings outstanding under the revolving credit facility portion of our Credit
Facility.  As of January 22, 2009, we had no borrowings outstanding
under the revolving credit facility portion of our Credit Facility and our
borrowing capacity was $100,000.





The term
loan under the Credit Facility bears interest at either LIBOR plus 1.75% or the
Base Rate plus 0.75%.  The term loan borrowings are to be repaid in
increments of $750 each calendar quarter, with the first principal payment paid
June 2007.  The principal outstanding after scheduled repayment and
any unscheduled prepayments matures and is payable January 2013.  In
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 2008, 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.  As of November 30, 2008, we were in compliance with all
covenants in our Credit Facility.





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





Interest
payments on the 7.0% Subordinated Notes are due semi-annually in 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 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 fiscal quarter (the “prescribed
measurement period”).  The evaluation of the classification of the
2.0% Convertible Notes occurs each fiscal quarter.





63


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.  During the second quarter and fourth quarter of fiscal
2008, we retired a portion of the swap for approximately $270 and $26,
respectively, which was recorded as additional interest expense in the
accompanying consolidated statement of income.  As of November 30,
2008, we had $125,322 of LIBOR based borrowings hedged under the provisions of
the swap.  During fiscal 2008, the decrease in fair value of the swap
of $52, net of tax, was recorded to other comprehensive income.  The
current portion of the fair value of the swap of $2,602 is included in
accrued liabilities, and the long-term portion of $321 is included in other
noncurrent liabilities.  As of November 30, 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 expires 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.  The cap agreement expired 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 occurs each fiscal quarter.





Upon
conversion, a holder will receive, in lieu of common stock, an amount of cash
equal to the lesser of (i) the principal amount of the 1.625% Convertible
Notes, or (ii) the conversion value, determined in the manner set forth in
the indenture governing the 1.625%  Convertible Notes, of a number of
shares equal to the conversion rate. If the conversion value exceeds the
principal amount of the 1.625% Convertible Note on the conversion date, we will
also deliver, at our election, cash or common stock or a combination of cash and
common stock with respect to the conversion value upon conversion. If conversion
occurs in connection with a change of control, we may be required to deliver
additional shares of our common stock






64


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.





Subsequent
to November 30, 2008, we issued an aggregate of 487 shares of our common stock
in exchange for $28,700 in aggregate principal amount of our outstanding 2.0%
Convertible Notes.  Upon completion of the transaction, the balance of
the remaining 2.0% Convertible Notes was reduced to $96,300
outstanding.




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 have not been accounted for
as separate derivatives. Additionally, pursuant to EITF 00-19 and EITF 01-6, the
note hedges and warrants are accounted for as equity transactions, and
therefore, the payments associated with the issuance of the note hedges and the
proceeds received from the issuance of the warrants were recorded as a charge
and an increase, respectively, in common shares in shareholders’ equity as
separate equity transactions.





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





The
future maturities of long-term debt outstanding as of November 30, 2008 are as
follows:




2009
            
            $
            3,0002010
            
            
            22,5002011
            
            
            3,0002012
            
            
            3,0002013
            
            
            220,500Thereafter
            
            
            207,500$
            459,500




Cash
interest payments during fiscal 2008, 2007 and 2006 were $22,247, $26,671 and
$10,831, respectively.




65


(6)           FAIR VALUE OF FINANCIAL
INSTRUMENT




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




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




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





The
following table summarizes the interest rate swap measured at fair value in the
accompanying consolidated balance sheet as of November 30, 2008:





Fair
      Value Measurements as of
              November 30, 2008Level 1
            
            
            Level 2
            
            
            Level 3
            
            
            TotalLiabilitiesInterest
      rate swap (1)
            
            $
            —
            
            
            $
            2,923
            
            
            $
            —
            
            
            $
            2,923




(1)
            The
      total fair value of the interest rate swap is partially classified as a
      current and a noncurrent liability as of November 30, 2008 and matures in
      January 2010.  We value this instrument using the “Income
      Approach” valuation technique. This method uses valuation techniques to
      convert future amounts to a single present value amount. The measurement
      is based on the value indicated by current market expectations about those
      future amounts.





SFAS 157 requires separate disclosure
of assets and liabilities measured at fair value on a recurring basis, as
documented above, from those measured at fair value on a nonrecurring
basis.  As of November 30, 2008, no assets or liabilities are measured
at fair value on a nonrecurring basis.




At
November 30, 2008 and 2007, the carrying value of the 7.0% Subordinated Notes
approximated fair value based on market prices and market volume for same
or similar issues. At November 30, 2008 and 2007, the fair value of the 2.0%
Convertible Notes was determined to be $153,965 and $150,444, respectively,
based upon consideration of our closing stock price of $72.57 and $70.91,
respectively, and determination of conversion value as defined in the
indenture under which the 2.0% Convertible Notes were issued. At November 30,
2008 and 2007, the fair value of the 1.625% Convertible Notes was determined to
be $99,143 and $96,875, respectively, based upon consideration of our closing
stock price and determination of conversion value as defined in the
indenture under which the 1.625% Convertible Notes were
issued.


(7)           INCOME
TAXES




The
provision for income taxes includes the following components for fiscal 2008,
2007 and 2006:




2008
            
            
            2007
            
            
            2006Current:Federal
            
            $
            13,428
            
            
            $
            16,850
            
            
            $
            23,009State
            
            
            1,191
            
            
            
            1,674
            
            
            
            1,058Deferred
            
            
            19,010
            
            
            
            12,865
            
            
            
            111$
            33,629
            
            
            $
            31,389
            
            
            $
            24,178




As of
November 30, 2008, we had a foreign tax credit of $1,988 which will expire over
nine years beginning in fiscal 2011 through 2018, and state net operating loss
carry forwards of $4,054, which will begin to expire in 2019 through 2020 if
unused.  In fiscal 2008, 2007 and 2006 income tax benefits of $8,902,
$8,291 and $1,627, respectively, attributable to employee stock option
transactions were allocated to shareholders’ equity.




66


Deferred
income tax assets and liabilities reflect the impact of temporary differences
between the amounts of assets and liabilities for financial reporting and income
tax reporting purposes.  Temporary differences and carryforwards,
which give rise to deferred tax assets and liabilities at November 30, 2008 and
2007, are as follows:




2008
            
            
            2007Deferred
      tax assets:Allowances
      and accruals
            
            $
            1,511
            
            
            $
            1,671Inventory
      reserve
            
            
            484
            
            
            
            1,830Stock-based
      compensation expense
            
            
            3,822
            
            
            
            2,578Allowance
      for product returns
            
            
            1,194
            
            
            
            2,622Net
      operating loss carryforwards
            
            
            1,844
            
            
            
            1,412Accrued
      postretirement health care benefits
            
            
            491
            
            
            
            382Note
      hedge call option
            
            
            18,315
            
            
            
            21,179Foreign
      tax credit
            
            
            1,988
            
            
            
            1,385Other
            
            
            3,641
            
            
            
            2,228Gross
      deferred tax assets
            
            
            33,290
            
            
            
            35,287Valuation
      allowance
            
            
            —
            
            
            
            —Net
      deferred tax assets
            
            
            33,290
            
            
            
            35,287Deferred
      tax liabilities:Depreciation
      and amortization
            
            
            63,976
            
            
            
            48,335Prepaid
      advertising
            
            
            637
            
            
            
            289Inventory
            
            
            —
            
            
            
            177Other
            
            
            121
            
            
            
            792Gross
      deferred tax liabilities
            
            
            64,734
            
            
            
            49,593Net deferred liability
            
            $
            31,444
            
            
            $
            14,306




The
deferred provision for income taxes excludes the tax effect of the note hedge
call option of $0 and $11,092, the interest rate hedge adjustment of $42 and
$647, and unrealized actuarial gains and losses related to the pension and post
retirement health benefit plans of $946 and $0 for fiscal 2008 and 2007,
respectively, which are included in the consolidated statements of shareholders’
equity.  The deferred provision for income taxes also excludes the
impact of adopting FIN48 in fiscal 2008 of $884.




The
difference between the provision for income taxes and the amount computed by
multiplying income before income taxes by the United States statutory rate for
fiscal 2008, 2007 and 2006 is summarized as follows:




2008
            
            
            2007
            
            
            2006Expected
      federal tax provision
            
            $
            34,970
            
            
            $
            31,878
            
            
            $
            24,252State
      income taxes, net of federal income tax benefit
            
            
            2,077
            
            
            
            1,922
            
            
            
            1,022Permanent
      Items
            
            
            (2,928
            )
            
            
            (1,083
            )
            
            
            (1,231
            )Other,
      net
            
            
            (490
            )
            
            
            (1,328
            )
            
            
            135Provision
      for income taxes
            
            $
            33,629
            
            
            $
            31,389
            
            
            $
            24,178







Income
taxes paid in fiscal 2008, 2007 and 2006 were $11,181, $7,977 and $21,665,
respectively.  We received income tax refunds of $135, $34 and $376
during fiscal 2008, 2007 and 2006, respectively.




We have
undistributed earnings of Chattem Canada, our Canadian subsidiary, of
approximately $3,900 at November 30, 2008, for which deferred taxes have not
been provided.  Such earnings are considered indefinitely invested in
the foreign subsidiaries.  If such earnings were repatriated,
additional tax expense may result, although the calculation of such additional
taxes is not practicable.




We
adopted FIN 48, as amended by FSP FIN 48-1, 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 had a total unrecognized tax benefit of $2,180 as of
December 1, 2007.





67


A
reconciliation of the beginning and ending amount of unrecognized tax benefits
is as follows:





Unrecognized
      tax benefit upon adoption of FIN 48
            
            $
            2,180Increase
      for current year positions
            
            
            6,392Increase
      for prior period positions
            
            
            210Decrease
      due to settlements and payments
            
            
            (1,109
            )Unrecognized
      tax benefit at November 30, 2008
            
            $
            7,673





The total
amount of net unrecognized tax benefit that, if recognized, would affect the
effective tax rate is $890 as of November 30, 2008.  We recognize
interest and penalties related to income tax matters as a component of the
provision for income taxes.  Included in the liability for
unrecognized tax benefits we have $191 accrued for penalties and interest, net
of tax benefits.





It is
reasonably possible that the amount of unrecognized tax benefit could increase
by approximately $1,000 during the next twelve months if certain elements of
compensation are deducted in our 2008 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 2000,
state income taxes for fiscal years before 1997 or non-U.S. income taxes for
fiscal years before 1999.






(8)           SUPPLEMENTAL FINANCIAL
INFORMATION




Inventories
consisted of the following at November 30, 2008 and 2007:




2008
            
            
            2007Raw
      materials and work in process
            
            $
            16,753
            
            
            $
            17,892Finished
      goods
            
            
            24,180
            
            
            
            25,373Total
      inventories
            
            $
            40,933
            
            
            $
            43,265




International
inventories included above were $3,328 and $3,803 at November 30, 2008 and 2007,
respectively.






Property,
plant and equipment consisted of the following at November 30, 2008 and
2007:




2008
            
            
            2007Land
            
            $
            1,123
            
            
            $
            1,123Buildings
      and improvements
            
            
            11,228
            
            
            
            10,876Machinery
      and equipment
            
            
            60,269
            
            
            
            60,127Package
      design and tooling
            
            
            8,241
            
            
            
            7,629Construction
      in progress
            
            
            4,824
            
            
            
            3,474Total
      property, plant and equipment
            
            
            85,685
            
            
            
            83,229Less
      – accumulated depreciation
            
            
            (53,442
            )
            
            
            (50,880
            )Property,
      plant and equipment, net
            
            $
            32,243
            
            
            $
            32,349






68


Accrued
liabilities consisted of the following at November 30, 2008 and
2007:




2008
            
            
            2007Interest
            
            $
            3,216
            
            
            $
            3,510Salaries,
      wages and commissions
            
            
            5,333
            
            
            
            6,209Product
      advertising and promotion
            
            
            2,611
            
            
            
            3,051Litigation
      settlements and legal fees
            
            
            799
            
            
            
            2,084Income
      taxes payable
            
            
            4,636
            
            
            
            3,643Interest
      rate swap
            
            
            2,602
            
            
            
            1,274Other
            
            
            2,096
            
            
            
            1,766Total
      accrued liabilities
            
            $
            21,293
            
            
            $
            21,537






(9)           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 issuance of
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 included $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, $11,653; and
Balmex,
$8,742.  Certain of the products are manufactured and supplied under
assumed agreements with third party manufacturers.  During fiscal 2007
and 2008, 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 fiscal 2007, we incurred $2,057, of expenses related
to these transition services, which are recorded as acquisition expenses in the
accompanying consolidated statements of income.




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




PRO FORMA
CONSOLIDATED RESULTS OF OPERATIONS (Unaudited)




Year
      Ended November 30,2007
            
            
            2006Total
      revenue
            
            $
            432,559
            
            
            $
            418,944Net
      income
            
            
            60,472
            
            
            
            56,285Earnings
      per share – basic:
            
            
            3.20
            
            
            
            2.96Earnings
      per share – diluted:
            
            
            3.13
            
            
            
            2.92




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 market
ACT in Western Europe
from Johnson & Johnson (“ACT Acquisition”) for $4,100
in cash plus certain assumed liabilities.  The ACT Acquisition was funded
with existing cash.




69


(10)        POSTRETIREMENT BENEFIT
PLANS




We
maintain two defined benefit postretirement plans that cover certain employees
who have met specific age and service requirements.  The plans include
a noncontributory defined benefit pension plan (the “Pension Plan”) and a
postretirement health care benefits plan (the “Retiree Health
Plan”).  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, Pension
Plan benefits and participation were frozen.  The Retiree Health Plan
provides benefits to 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 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”).  Contributions to the Retiree Health Plan are limited to $2
per participant per year and are paid monthly on a fully insured
basis.  Retiree Health Plan participants are required to pay any
insurance premium amount in excess of the employer contribution.  Plan
assets and benefit obligations are measured as of November 30 for both
plans.




In
addition to the previously described plans, we also sponsor a defined
contribution plan that covers substantially all employees.  Eligible
employees are allowed to contribute their eligible compensation up to the
applicable annual elective deferral and salary reduction limits as set forth by
the IRS.  We make matching contributions of 25% on the first 6% of
contributed compensation.  Our expense for the matching contribution
totaled $293 in fiscal 2008, $286 in fiscal 2007, and $249 in fiscal
2006.  In addition to matching contributions, safeharbor contributions
equaling 3% of eligible annual compensation are made on behalf of eligible
participants.  Safeharbor contributions totaled $879 in fiscal 2008,
$775 in fiscal 2007 and $758 in fiscal 2006.  Our contributions to
this plan are expensed as incurred.




The
frozen status of the Pension Plan prevents any future salary increase of
participants from affecting the plan’s accumulated benefit
obligation.  Therefore, the Pension Plan’s projected benefit
obligation continually equals the accumulated benefit
obligation.   In fiscal 2008 the Pension Plan did not recognize
any previously unrecognized actuarial (gains) losses as a component of net
periodic (benefit) cost.  As a result of the actual return on plan
assets in fiscal 2008, amortization of the cumulative loss in the amount of $185
is expected to be recognized as a component of net periodic pension (benefit)
cost in fiscal 2009.




The
Retiree Health Plan recognized a previously unrecognized actuarial gain in the
amount of $136 in fiscal 2008 as a result of a decrease in plan
participants.  No actuarial gain or loss for the Retiree Health Plan
is expected in fiscal 2009.




Net periodic (benefit) cost for fiscal
2008, 2007 and 2006 was comprised of the following components:




Pension
      Plan
              
              
              Retiree
      Health Plan2008
              
              
              2007
              
              
              2006
              
              
              2008
              
              
              2007
              
              
              2006Service
      cost
              
              $
              —
              
              
              $
              —
              
              
              $
              —
              
              
              $
              7
              
              
              $
              21
              
              
              $
              57Interest
      cost
              
              
              576
              
              
              
              609
              
              
              
              610
              
              
              
              55
              
              
              
              56
              
              
              
              73Amortization
      of prior service cost
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              15Expected
      return on plan assets
              
              
              (921
              )
              
              
              (937
              )
              
              
              (882
              )
              
              
              —
              
              
              
              —
              
              
              
              —Recognized
      net actuarial   (gain)/loss
              
              
              —
              
              
              
              —
              
              
              
              5
              
              
              
              (136
              )
              
              
              (96
              )
              
              
              (16
              )Settlement/Curtailment
      loss
              
              
              —
              
              
              
              89
              
              
              
              54
              
              
              
              —
              
              
              
              —
              
              
              
              —Net
      periodic (benefit) cost
              
              $
              (345
              )
              
              $
              (239
              )
              
              $
              (213
              )
              
              $
              (74
              )
              
              $
              (19
              )
              
              $
              129





70


For each plan, the changes in the
benefit obligations are as follows for fiscal 2008 and 2007:




Pension
      Plan
            
            
            Retiree
      Health Plan2008
            
            
            2007
            
            
            2008
            
            
            2007Benefit
      obligation, beginning of year
            
            $
            10,165
            
            
            $
            10,733
            
            
            $
            1,003
            
            
            $
            1,094Service
      cost
            
            
            —
            
            
            
            —
            
            
            
            7
            
            
            
            21Interest
      cost
            
            
            576
            
            
            
            609
            
            
            
            55
            
            
            
            56Plan
      participants’ contributions
            
            
            —
            
            
            
            —
            
            
            
            19
            
            
            
            7Actuarial
      (gain)/loss
            
            
            (825
            )
            
            
            185
            
            
            
            (71
            )
            
            
            (104
            )Benefits
      paid
            
            
            (690
            )
            
            
            ( 1,362
            )
            
            
            (77
            )
            
            
            (71
            )Benefit
      obligation, end of year
            
            $
            9,226
            
            
            $
            10,165
            
            
            $
            936
            
            
            $
            1,003








For each
plan the changes in plan assets are as follows for fiscal 2008 and
2007:





Pension
    Plan
            
            
            Retiree Health
      Plan2008
            
            
            2007
            
            
            2008
            
            
            2007Plan
      assets at fair value, beginning of year
            
            $
            11,883
            
            
            $
            12,040
            
            
            $
            —
            
            
            $
            —Actual
      return on plan assets
            
            
            (2,320
            )
            
            
            1,205
            
            
            
            —
            
            
            
            —Employer
      contribution
            
            
            —
            
            
            
            —
            
            
            
            58
            
            
            
            64Plan
      participants’ contributions
            
            
            —
            
            
            
            —
            
            
            
            19
            
            
            
            7Benefits
      paid
            
            
            (690
            )
            
            
            (1,362
            )
            
            
            (77
            )
            
            
            (71
            )Plan
      assets at fair value, end of year
            
            $
            8,873
            
            
            $
            11,883
            
            
            $
            —
            
            
            $
            —






The
following table sets forth the funded status of each plan as of November 30,
2008 and 2007:




Pension
    Plan
            
            
            Retiree Health
      Plan2008
            
            
            2007
            
            
            2008
            
            
            2007Plan
      assets at fair value
            
            $
            8,873
            
            
            $
            11,883
            
            
            $
            —
            
            
            $
            —Benefit
      obligation
            
            
            9,226
            
            
            
            10,165
            
            
            
            936
            
            
            
            1,003Funded
      status prepaid (deficiency)
            
            
            (353
            )
            
            
            1,718
            
            
            
            (936
            )
            
            
            (1,003
            )Unrecognized
      actuarial net (gain)/loss
            
            
            2,771
            
            
            
            355
            
            
            
            (277
            )
            
            
            (342
            )Total
      recognized in the consolidated balance sheet
            
            $
            2,418
            
            
            $
            2,073
            
            
            $
            (1,213
            )
            
            $
            (1,345
            )







Amounts
recognized in the Company’s consolidated balance sheet as of November 30, 2008
and 2007 consist of the following:




Pension
      Plan
            
            
            Retiree Health
      Plan2008
            
            
            2007
            
            
            2008
            
            
            2007Deferred
      income tax assets (liabilities)
            
            $
            1,057
            
            
            $
            134
            
            
            $
            (106
            )
            
            $
            (129
            )Other
      noncurrent assets (liabilities)
            
            
            (353
            )
            
            
            1,718
            
            
            
            (936
            )
            
            
            (1,003
            )Shareholder
      equity:Accumulated
      other comprehensive income
            
            
            1,714
            
            
            
            221
            
            
            
            (171
            )
            
            
            (213
            )Net
      asset (liability) recognized in the consolidated balance
    sheet
            
            $
            2,418
            
            
            $
            2,073
            
            
            $
            (1,213
            )
            
            $
            (1,345
            )








71


The
discount rate used in determining the actuarial present value of the projected
benefit obligation for the Pension Plan and the Retiree Health Plan was 6.5% and
5.75% in fiscal 2008 and 2007, respectively.  The expected long-term
rate of return on the Pension Plan assets was 8% in fiscal 2008 and
2007.  The long-term return percentage on assets is based on the
weighted-average of the Pension Plan’s invested allocation as of the measurement
date and the available historical returns for those asset categories as
published by Ibbotson Associates, a leading provider of historical financial
market data.




Our
existing investment policy of the Pension Plan recognizes that the most
significant decision to affect the ability to meet the investment objectives is
the asset allocation decision.  Therefore, based on the investment
objectives and our risk tolerances, the investment policy defines the following
asset mix range:




Asset
    Class
            
            RangeCorporate
      & Government Bonds
            
            30.0
      – 70.0%Equities
            
            30.0
      – 70.0%






In
addition, the existing investment policy requires a performance review
annually.  The weighted-average asset allocations at November 30, 2008
and 2007 by asset class are as follows:




Pension
      Plan Assets at
              November
      30,Asset
    Class
            
            2008
            
            
            2007Mutual
      funds
            
            
            84%
            
            
            
            88%Equity
      securities
            
            
            16
            
            
            
            12Total
            
            
            100%
            
            
            
            100%






As of
November 30, 2008, we had 20 shares of our common stock in the Pension Plan with
a fair value of $1,451.






The
following benefit payments, are expected to be paid:




Year Ending November
      30,
            
            Estimated
      Benefit PaymentsPension
    Plan
            
            
            Retiree Health
      Plan2009
            
            $
            690
            
            
            $
            952010
            
            
            695
            
            
            
            922011
            
            
            700
            
            
            
            922012
            
            
            705
            
            
            
            942013
            
            
            710
            
            
            
            972014-2018
            
            
            2,200
            
            
            
            494







In fiscal
2009, no employer contributions are expected for the Pension
Plan.  Employer contributions for the Retiree Health Plan are expected
to be paid upon receipt of the monthly insurance premium.






(11)        PRODUCT AND GEOGRAPHICAL
SEGMENT INFORMATION




We
currently operate in only one primary segment – OTC health care.  This
segment includes medicated skin care, topical pain care, oral care, internal
OTC, medicated dandruff shampoo, dietary supplement and other OTC and toiletry
products.




72


Geographical
segment information is as follows for fiscal 2008, 2007 and 2006:




2008
            
            
            2007
            
            
            2006Revenues:Domestic
            
            $
            423,088
            
            
            $
            393,493
            
            
            $
            276,397International
      (1)
            
            
            31,791
            
            
            
            29,885
            
            
            
            24,151Total
            
            $
            454,879
            
            
            $
            423,378
            
            
            $
            300,548Long-Lived
      Assets (2)Domestic
            
            $
            646,676
            
            
            $
            646,926
            
            
            $
            235,909International
            
            
            2,237
            
            
            
            2,233
            
            
            
            593Total
            
            $
            648,913
            
            
            $
            649,159
            
            
            $
            236,502




(1)International
sales include export sales from United States operations and royalties from
international sales of Selsun.  These
royalties were $90, $93 and $228 for fiscal 2008, 2007 and 2006,
respectively.




(2)Consists
of book value of property, plant, equipment, patents, trademarks and other
purchased product rights.




Net sales
of our domestic product categories within our single healthcare business segment
are as follows for fiscal 2008, 2007 and 2006:




2008
            
            
            2007
            
            
            2006Medicated
      skin care
            
            $
            141,942
            
            
            $
            123,456
            
            
            $
            67,238Topical
      pain care
            
            
            96,779
            
            
            
            95,858
            
            
            
            101,396Oral
      care
            
            
            62,872
            
            
            
            48,863
            
            
            
            6,773Internal
      OTC
            
            
            48,006
            
            
            
            45,043
            
            
            
            11,958Medicated
      dandruff shampoos
            
            
            35,737
            
            
            
            36,934
            
            
            
            37,742Dietary
      supplements
            
            
            19,491
            
            
            
            26,121
            
            
            
            35,081Other
      OTC and toiletry products
            
            
            18,261
            
            
            
            17,218
            
            
            
            16,209Total
            
            $
            423,088
            
            
            $
            393,493
            
            
            $
            276,397






(12)         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.




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




73


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 was included in our consolidated statements of income, net
of legal expenses, as litigation settlement for 2006.  The payment to
us by the DELACO settlement trust of $8,750 has conclusively compromised and
settled our indemnity claim filed in the DELACO bankruptcy. The confirmation of
the DELACO bankruptcy plan effectively released us from liability for all PPA
products liability cases with injury dates prior to December 21,
1998.




On
December 30, 2003, the United States Food and Drug Administration ("FDA") issued
a consumer alert on the safety of dietary supplements containing ephedrine
alkaloids and on February 6, 2004 published a final rule with respect to these
products.  The final rule prohibits the sale of dietary supplements
containing ephedrine alkaloids because such supplements present an unreasonable
risk of illness or injury.  The final rule became effective on April
11, 2004.  We discontinued the manufacturing and shipment of Dexatrim containing ephedrine
in September 2002. During April to June 2008, we received notification from an
attorney of 26 individual claims alleging the development of pulmonary arterial
hypertension as a result of ingesting Dexatrim containing ephedrine
and/or PPA in 1998 through 2003.  In September 2008, we resolved all
of these claims for $13,250, of which approximately $2,545 was funded from the
proceeds of the Dexatrim settlement
trust.  We are not currently aware of any additional product liability
claims relating to Dexatrim.





We were
named as a defendant in a putative class action lawsuit filed by California
consumer Robert O. Wilkinson in the United States District Court for the
Southern District of California relating to the labeling, advertising, promotion
and sale of our Garliqueproduct.  We were served with this lawsuit on July 5,
2007.  The plaintiff has voluntarily dismissed his claim for class
certification but still seeks injunctive relief and attorney fees.  A
different California consumer using the same counsel filed a lawsuit in the
Eastern District of California seeking injunctive relief, actual and punitive
damages and class certification based on the same set of facts that Mr.Wilkinson
alleged.  We were served with this lawsuit on December 18,
2008.  We are vigorously defending both Garlique cases.





On
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 resolved
this lawsuit through a settlement agreement executed on November 25,
2008.  This confidential agreement provides a license that permits us
to continue manufacturing and selling Bullfrog Mosquito Coast
without further litigation.





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, and are
no longer marketing these products.  We conducted the recall to the
consumer level.  We recalled these products because we received some
consumer reports of first, second and third degree burns, as well as skin
irritation resulting from consumer use or possible misuse of the
products.  As of January 22, 2009, there were approximately 170
consumers with pending claims against us and four products liability lawsuits
pending against us alleging burns and skin irritation from the use of the Icy HotHeat Therapy
products.  We may receive additional claims and/or lawsuits in the
future alleging burns and/or skin irritation from use of our Heat Therapy
products.  The outcome of any such potential litigation cannot be
predicted.





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





74


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





We
maintain insurance coverage for product liability claims relating to our
products under claims-made policies which are subject to annual
renewal.  For the current annual policy period beginning September 1,
2008, we maintain product liability insurance coverage in the amount of $30,000
through our captive insurance subsidiary, of which approximately $2,803 has been
funded as of January 22, 2009.  We also have $25,000 of excess
coverage through a third party reinsurance policy.








REGULATORY




We were
notified in October 2000 that the FDA denied a citizen petition submitted by
Thompson Medical Company, Inc., the previous owner of Sportscreme and Aspercreme.  The
petition sought a determination that 10% trolamine salicylate, the active
ingredient in Sportscreme and Aspercreme, was clinically
proven to be an effective active ingredient in external analgesic OTC drug
products and should be included in the FDA's yet-to-be finalized monograph for
external analgesics. We are working to develop alternate formulations for Sportscreme and Aspercreme in the event that
the FDA does not consider the available clinical data to conclusively
demonstrate the efficacy of trolamine salicylate when the OTC external analgesic
monograph is finalized. If 10% trolamine salicylate is not included in the final
monograph, we would likely be required to discontinue these products as
currently formulated after expiration of an anticipated grace period. If this
occurred, we believe we could still market these products as homeopathic
products or reformulate them using other ingredients included in the FDA
monograph.  We believe that the monograph is unlikely to become final
and take effect before mid-2009.





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




We have responded to certain questions
with respect to efficacy received from the FDA in connection with clinical
studies for pyrilamine maleate, one of the active ingredients used in certain of
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 believe
that any adverse finding by the FDA would likewise affect our principal
competitors in the menstrual product category and that finalization of the
menstrual products monograph is not imminent.  Moreover, we have
formulated alternative Pamprin products that fully
comply with both the internal analgesic and menstrual product
monographs.





We are
aware of the FDA's concern about the potential toxicity due to concomitant use
of OTC and prescription products that contain the analgesic ingredient
acetaminophen, an ingredient found in Pamprin and Prēmsyn
PMS.  We are participating in an industry-wide effort to
reassure the FDA that the current recommended dosing regimen is safe and
effective and that proper labeling and public education by both OTC and
prescription drug companies are the best policies to abate the






75


FDA's
concern.  The FDA will address both issues in its effort to finalize
the monograph on internal analgesic products.  We believe the FDA may
issue revised labeling requirements within the next year, perhaps prior to
monograph closure that will cause the industry to relabel its analgesic
products.





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





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





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








LEASES
AND ENDORSEMENTS




The
minimum rental commitments under all noncancelable operating leases, primarily
real estate, in effect at November 30, 2008 are as follows:




2009
            
            $
            5472010
            
            
            1662011
            
            
            1012012
            
            
            262013
            
            
            23Thereafter
            
            
            24$
            887




Rental
expense was $2,648, $2,395 and $2,060 for fiscal 2008, 2007 and 2006,
respectively.






76


The
minimum commitments under noncancelable endorsement contracts related to our
advertising in effect at November 30, 2008 are as follows:




2009
            
            $
            1,8502010
            
            
            2,2502011
            
            
            900$
            5,000









(13)        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 November 30, 2008 arose in conjunction with Chattem’s Credit
Facility and Chattem’s issuance of the 7.0% Subordinated Notes (See Note
5).  The maximum amount of future payments the guarantors would be
required to make under the guarantees as of November 30, 2008 is
$234,500.




























































77


Note
13




CHATTEM,
INC. AND SUBSIDIARIES


CONSOLIDATING
BALANCE SHEETS




NOVEMBER
30, 2008


(In
thousands)




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







78


Note
13




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,
      net
            
            
            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
      overdrafts
            
            
            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 and outstanding
      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
            )
            
            
            165,655202,455
            
            
            
            458,377
            
            
            
            39,234
            
            
            
            (497,611
            )
            
            
            202,455Accumulated
      other comprehensive income (loss), 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






79


Note
13




CHATTEM,
INC. AND SUBSIDIARIES


CONSOLIDATING
STATEMENTS OF INCOME




FOR
THE YEAR ENDED NOVEMBER 30, 2008


(In
thousands)




CHATTEM
            
            
            GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            NON-GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            ELIMINATIONS
            
            
            CONSOLIDATEDTOTAL
      REVENUES
            
            $
            413,450
            
            
            $
            89,033
            
            
            $
            24,624
            
            
            $
            (72,228
            )
            
            $
            454,879COSTS
      AND EXPENSES:Cost
      of sales
            
            
            118,000
            
            
            
            5,370
            
            
            
            11,194
            
            
            
            (2,944
            )
            
            
            131,620Advertising
      and promotion
            
            
            105,873
            
            
            
            6,193
            
            
            
            6,027
            
            
            
            —
            
            
            
            118,093Selling,
      general and administrative
            
            
            58,185
            
            
            
            697
            
            
            
            3,708
            
            
            
            —
            
            
            
            62,590Product
      recall expenses
            
            
            5,479
            
            
            
            —
            
            
            
            790
            
            
            
            —
            
            
            
            6,269Litigation
      settlement
            
            
            567
            
            
            
            —
            
            
            
            10,704
            
            
            
            —
            
            
            
            11,271Equity
      in subsidiary income
            
            
            (42,411
            )
            
            
            —
            
            
            
            —
            
            
            
            42,411
            
            
            
            —Total
      costs and expenses
            
            
            245,693
            
            
            
            12,260
            
            
            
            32,423
            
            
            
            39,467
            
            
            
            329,843INCOME
      FROM OPERATIONS
            
            
            167,757
            
            
            
            76,773
            
            
            
            (7,799
            )
            
            
            (111,695
            )
            
            
            125,036OTHER
      INCOME (EXPENSE):Interest
      expense
            
            
            (25,134
            )
            
            
            —
            
            
            
            (4,236
            )
            
            
            4,060
            
            
            
            (25,310
            )Investment
      and other income, net
            
            
            189
            
            
            
            4,074
            
            
            
            3,012
            
            
            
            (6,560
            )
            
            
            715Loss
      on early extinguishment of debt
            
            
            (526
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (526
            )Royalties
            
            
            (66,145
            )
            
            
            (3,141
            )
            
            
            —
            
            
            
            69,286
            
            
            
            —Corporate
      allocations
            
            
            1,973
            
            
            
            (1,812
            )
            
            
            (161
            )
            
            
            —
            
            
            
            —Total
      other income (expense)
            
            
            (89,643
            )
            
            
            (879
            )
            
            
            (1,385
            )
            
            
            66,786
            
            
            
            (25,121
            )INCOME
      (LOSS) BEFORE INCOME TAXES
            
            
            78,114
            
            
            
            75,894
            
            
            
            (9,184
            )
            
            
            (44,909
            )
            
            
            99,915PROVISION
      FOR INCOME TAXES
            
            
            11,828
            
            
            
            25,139
            
            
            
            (3,338
            )
            
            
            —
            
            
            
            33,629NET
      INCOME (LOSS)
            
            $
            66,286
            
            
            $
            50,755
            
            
            $
            (5,846
            )
            
            $
            (44,909
            )
            
            $
            66,286


















80


Note
13




CHATTEM,
INC. AND SUBSIDIARIES


CONSOLIDATING
STATEMENTS OF INCOME




FOR
THE YEAR ENDED NOVEMBER 30, 2007


(In
thousands)




CHATTEM
            
            
            GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            NON-GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            ELIMINATIONS
            
            
            CONSOLIDATEDTOTAL
      REVENUES
            
            $
            378,225
            
            
            $
            92,089
            
            
            $
            22,875
            
            
            $
            (69,811
            )
            
            $
            423,378COSTS
      AND EXPENSES:Cost
      of sales
            
            
            115,001
            
            
            
            7,125
            
            
            
            10,932
            
            
            
            (4,003
            )
            
            
            129,055Advertising
      and promotion
            
            
            96,471
            
            
            
            9,844
            
            
            
            6,004
            
            
            
            (113
            )
            
            
            112,206Selling,
      general and administrative
            
            
            55,120
            
            
            
            320
            
            
            
            2,438
            
            
            
            —
            
            
            
            57,878Acquisition
      expenses
            
            
            2,057
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,057Equity
      in subsidiary income
            
            
            (46,302
            )
            
            
            —
            
            
            
            —
            
            
            
            46,302
            
            
            
            —Total
      costs and expenses
            
            
            222,347
            
            
            
            17,289
            
            
            
            19,374
            
            
            
            42,186
            
            
            
            301,196INCOME
      FROM OPERATIONS
            
            
            155,878
            
            
            
            74,800
            
            
            
            3,501
            
            
            
            (111,997
            )
            
            
            122,182OTHER
      INCOME (EXPENSE):Interest
      expense
            
            
            (30,142
            )
            
            
            —
            
            
            
            (2,645
            )
            
            
            2,857
            
            
            
            (29,930
            )Investment
      and other income, net
            
            
            801
            
            
            
            2,589
            
            
            
            3,428
            
            
            
            (5,358
            )
            
            
            1,460Loss
      on early extinguishment of debt
            
            
            (2,633
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (2,633
            )Royalties
            
            
            (61,517
            )
            
            
            (4,178
            )
            
            
            —
            
            
            
            65,695
            
            
            
            —Corporate
      allocations
            
            
            2,424
            
            
            
            (2,362
            )
            
            
            (62
            )
            
            
            —
            
            
            
            —Total
      other income (expense)
            
            
            (91,067
            )
            
            
            (3,951
            )
            
            
            721
            
            
            
            63,194
            
            
            
            (31,103
            )INCOME
      (LOSS) BEFORE INCOME TAXES
            
            
            64,811
            
            
            
            70,849
            
            
            
            4,222
            
            
            
            (48,803
            )
            
            
            91,079PROVISION
      FOR INCOME TAXES
            
            
            5,121
            
            
            
            24,797
            
            
            
            1,471
            
            
            
            —
            
            
            
            31,389NET
      INCOME (LOSS)
            
            $
            59,690
            
            
            $
            46,052
            
            
            $
            2,751
            
            
            $
            (48,803
            )
            
            $
            59,690






















81


Note
13




CHATTEM,
INC. AND SUBSIDIARIES


CONSOLIDATING
STATEMENTS OF INCOME




FOR
THE YEAR ENDED NOVEMBER 30, 2006


(In
thousands)




CHATTEM
            
            
            GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            NON-GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            ELIMINATIONS
            
            
            CONSOLIDATEDTOTAL
      REVENUES
            
            $
            248,219
            
            
            $
            79,722
            
            
            $
            19,686
            
            
            $
            (47,079
            )
            
            $
            300,548COSTS
      AND EXPENSES:Cost
      of sales
            
            
            78,044
            
            
            
            9,661
            
            
            
            8,784
            
            
            
            (2,453
            )
            
            
            94,036Advertising
      and promotion
            
            
            80,316
            
            
            
            10,713
            
            
            
            5,042
            
            
            
            —
            
            
            
            96,071Selling,
      general and administrative
            
            
            47,059
            
            
            
            (93
            )
            
            
            23
            
            
            
            —
            
            
            
            46,989Litigation
      settlement
            
            
            (19,292
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (19,292
            )Equity
      in subsidiary income
            
            
            (36,764
            )
            
            
            —
            
            
            
            —
            
            
            
            36,764
            
            
            
            —Total
      costs and expenses
            
            
            149,363
            
            
            
            20,281
            
            
            
            13,849
            
            
            
            34,311
            
            
            
            217,804INCOME
      FROM OPERATIONS
            
            
            98,856
            
            
            
            59,441
            
            
            
            5,837
            
            
            
            (81,390
            )
            
            
            82,744OTHER
      INCOME (EXPENSE):Interest
      expense
            
            
            (11,582
            )
            
            
            —
            
            
            
            (2,618
            )
            
            
            2,475
            
            
            
            (11,725
            )Investment
      and other income, net
            
            
            483
            
            
            
            2,535
            
            
            
            3,033
            
            
            
            (4,975
            )
            
            
            1,076Loss
      on early extinguishment of debt
            
            
            (2,805
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (2,805
            )Royalties
            
            
            (39,017
            )
            
            
            (5,610
            )
            
            
            —
            
            
            
            44,627
            
            
            
            —Corporate
      allocations
            
            
            3,324
            
            
            
            (3,260
            )
            
            
            (64
            )
            
            
            —
            
            
            
            —Total
      other income (expense)
            
            
            (49,597
            )
            
            
            (6,335
            )
            
            
            351
            
            
            
            42,127
            
            
            
            (13,454
            )INCOME
      (LOSS) BEFORE INCOME TAXES
            
            
            49,259
            
            
            
            53,106
            
            
            
            6,188
            
            
            
            (39,263
            )
            
            
            69,290PROVISION
      FOR INCOME TAXES
            
            
            4,147
            
            
            
            17,940
            
            
            
            2,091
            
            
            
            —
            
            
            
            24,178NET
      INCOME (LOSS)
            
            $
            45,112
            
            
            $
            35,166
            
            
            $
            4,097
            
            
            $
            (39,263
            )
            
            $
            45,112
























82


Note
13




CHATTEM,
INC. AND SUBSIDIARIES


CONSOLIDATING
STATEMENTS OF CASH FLOWS




FOR
THE YEAR ENDED NOVEMBER 30, 2008


(In
thousands)




CHATTEM
            
            
            GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            NON-GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            ELIMINATIONS
            
            
            CONSOLIDATEDOPERATING
      ACTIVITIES:Net
      income (loss)
            
            $
            66,286
            
            
            $
            50,755
            
            
            $
            (5,846
            )
            
            $
            (44,909
            )
            
            $
            66,286Adjustments
      to reconcile net income (loss) to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
            
            
            8,134
            
            
            
            —
            
            
            
            252
            
            
            
            —
            
            
            
            8,386Deferred
      income taxes
            
            
            3,643
            
            
            
            15,734
            
            
            
            (1,238
            )
            
            
            —
            
            
            
            18,139Stock-based
      compensation expense
            
            
            5,970
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            5,970Loss
      on early extinguishment of debt
            
            
            526
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            526Tax
      benefit realized from stock options exercised
            
            
            (3,709
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (3,709
            )Other,
      net
            
            
            (1,417
            )
            
            
            —
            
            
            
            (46
            )
            
            
            —
            
            
            
            (1,463
            )Equity
      in subsidiary income
            
            
            (44,909
            )
            
            
            —
            
            
            
            —
            
            
            
            44,909
            
            
            
            —Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            (6,683
            )
            
            
            467
            
            
            
            1,019
            
            
            
            (467
            )
            
            
            (5,664
            )Interest
      receivable
            
            
            (8
            )
            
            
            (15
            )
            
            
            8
            
            
            
            15
            
            
            
            —Inventories
            
            
            425
            
            
            
            1,431
            
            
            
            475
            
            
            
            —
            
            
            
            2,331Prepaid
      expenses and other current assets
            
            
            (2,115
            )
            
            
            —
            
            
            
            (31
            )
            
            
            1,755
            
            
            
            (391
            )Accounts
      payable and accrued liabilities
            
            
            3,171
            
            
            
            5
            
            
            
            (126
            )
            
            
            (1,303
            )
            
            
            1,747Net
      cash provided by (used in) operating activities
            
            
            29,314
            
            
            
            68,377
            
            
            
            (5,533
            )
            
            
            —
            
            
            
            92,158INVESTING
      ACTIVITIES:Purchase
      of property, plant and equipment
            
            
            (4,251
            )
            
            
            —
            
            
            
            (370
            )
            
            
            —
            
            
            
            (4,621
            )(Increase)
      decrease in other assets, net
            
            
            (237
            )
            
            
            1,694
            
            
            
            (2,991
            )
            
            
            —
            
            
            
            (1,534
            )Net
      cash (used in) provided by investing activities
            
            
            (4,488
            )
            
            
            1,694
            
            
            
            (3,361
            )
            
            
            —
            
            
            
            (6,155
            )FINANCING
      ACTIVITIES:Repayment
      of long-term debt
            
            
            (38,000
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (38,000
            )Proceeds
      from borrowings under revolving credit facility
            
            
            151,500
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            151,500Repayments
      of revolving credit facility
            
            
            (162,000
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (162,000
            )Bank
      overdraft
            
            
            (6,400
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (6,400
            )Repurchase
      of common shares
            
            
            (26,327
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (26,327
            )Proceeds
      from exercise of stock options
            
            
            8,372
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            8,372Tax
      benefit realized from stock options exercised
            
            
            3,709
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            3,709Changes
      in intercompany accounts
            
            
            (5,438
            )
            
            
            537
            
            
            
            4,901
            
            
            
            —
            
            
            
            —Dividends
      paid
            
            
            67,128
            
            
            
            (69,628
            )
            
            
            2,500
            
            
            
            —
            
            
            
            —Net
      cash provided by (used in) financing activities
            
            
            (7,456
            )
            
            
            (69,091
            )
            
            
            7,401
            
            
            
            —
            
            
            
            (69,146
            )EFFECT
      OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
            
            
            —
            
            
            
            —
            
            
            
            46
            
            
            
            —
            
            
            
            46CASH
      AND CASH EQUIVALENTSIncrease
      (decrease) for the year
            
            
            17,370
            
            
            
            980
            
            
            
            (1,447
            )
            
            
            —
            
            
            
            16,903At
      beginning of year
            
            
            4,685
            
            
            
            590
            
            
            
            10,132
            
            
            
            —
            
            
            
            15,407At
      end of year
            
            $
            22,055
            
            
            $
            1,570
            
            
            $
            8,685
            
            
            $
            —
            
            
            $
            32,310









83


Note
13




CHATTEM,
INC. AND SUBSIDIARIES


CONSOLIDATING
STATEMENTS OF CASH FLOWS




FOR
THE YEAR ENDED NOVEMBER 30, 2007


(In
thousands)




CHATTEM
            
            
            GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            NON-GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            ELIMINATIONS
            
            
            CONSOLIDATEDOPERATING
      ACTIVITIES:Net
      income (loss)
            
            $
            59,690
            
            
            $
            46,052
            
            
            $
            2,751
            
            
            $
            (48,803
            )
            
            $
            59,690Adjustments
      to reconcile net income (loss)to net cash provided by operating
      activities:Depreciation
      and amortization
            
            
            8,480
            
            
            
            —
            
            
            
            363
            
            
            
            —
            
            
            
            8,843Deferred
      income taxes
            
            
            1,875
            
            
            
            10,847
            
            
            
            (4
            )
            
            
            —
            
            
            
            12,718Stock-based
      compensation expense
            
            
            5,622
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            5,622Loss
      on early extinguishment of debt
            
            
            2,633
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,633Tax
      benefit realized from stock options exercised
            
            
            (8,291
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (8,291
            )Other,
      net
            
            
            154
            
            
            
            —
            
            
            
            (343
            )
            
            
            —
            
            
            
            (189
            )Equity
      in subsidiary income
            
            
            (48,803
            )
            
            
            —
            
            
            
            —
            
            
            
            48,803
            
            
            
            —Changes
      in operating assets and liabilities, net of acquisitions:Accounts
      receivable
            
            
            (12,289
            )
            
            
            (7,286
            )
            
            
            (1,612
            )
            
            
            7,286
            
            
            
            (13,901
            )Interest
      receivable
            
            
            (83
            )
            
            
            —
            
            
            
            83
            
            
            
            —
            
            
            
            —Inventories
            
            
            (5,721
            )
            
            
            918
            
            
            
            (1,017
            )
            
            
            —
            
            
            
            (5,820
            )Prepaid
      expenses and other current assets
            
            
            1,243
            
            
            
            —
            
            
            
            (144
            )
            
            
            150
            
            
            
            1,249Accounts
      payable and accrued liabilities
            
            
            27,814
            
            
            
            (441
            )
            
            
            4,243
            
            
            
            (7,436
            )
            
            
            24,180Net
      cash provided by operating activities
            
            
            32,324
            
            
            
            50,090
            
            
            
            4,320
            
            
            
            —
            
            
            
            86,734INVESTING
      ACTIVITIES:Purchase
      of property, plant and equipment
            
            
            (5,854
            )
            
            
            —
            
            
            
            (441
            )
            
            
            —
            
            
            
            (6,295
            )Acquisition
      of brands
            
            
            (8,420
            )
            
            
            (405,784
            )
            
            
            (1,561
            )
            
            
            —
            
            
            
            (415,765
            )Decrease
      in other assets, net
            
            
            (1,342
            )
            
            
            468
            
            
            
            2,784
            
            
            
            —
            
            
            
            1,910Net
      cash (used in) provided by investing activities
            
            
            (15,616
            )
            
            
            (405,316
            )
            
            
            782
            
            
            
            —
            
            
            
            (420,150
            )FINANCING
      ACTIVITIES:Repayment
      of long-term debt
            
            
            (154,500
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (154,500
            )Proceeds
      from long-term debt
            
            
            400,000
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            400,000Proceeds
      from borrowings under revolving credit facility
            
            
            159,000
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            159,000Repayments
      of revolving credit facility
            
            
            (129,000
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (129,000
            )Bank
      overdraft
            
            
            1,760
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,760Repurchase
      of common shares
            
            
            (23,601
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (23,601
            )Proceeds
      from exercise of stock options
            
            
            16,661
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            16,661Purchase
      of note hedge
            
            
            (29,500
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (29,500
            )Proceeds
      from issuance of warrant
            
            
            17,430
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            17,430Increase
      in debt issuance costs
            
            
            (9,383
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (9,383
            )Premium
      paid on interest rate cap agreement
            
            
            (114
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (114
            )Proceeds
      from sale of interest rate cap
            
            
            909
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            909Tax
      benefit realized from stock options exercised
            
            
            8,291
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            8,291Changes
      in intercompany accounts
            
            
            (374,120
            )
            
            
            373,095
            
            
            
            1,025
            
            
            
            —
            
            
            
            —Dividends
      paid
            
            
            17,546
            
            
            
            (18,046
            )
            
            
            500
            
            
            
            —
            
            
            
            —Intercompany
      debt proceeds (payments)
            
            
            6,400
            
            
            
            (1,200
            )
            
            
            (5,200
            )
            
            
            —
            
            
            
            —Net
      cash provided by (used in) financing activities
            
            
            (92,221
            )
            
            
            353,849
            
            
            
            (3,675
            )
            
            
            —
            
            
            
            257,953EFFECT
      OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
            
            
            —
            
            
            
            —
            
            
            
            343
            
            
            
            —
            
            
            
            343CASH
      AND CASH EQUIVALENTSIncrease
      for the year
            
            
            (75,513
            )
            
            
            (1,377
            )
            
            
            1,770
            
            
            
            —
            
            
            
            (75,120
            )At
      beginning of year
            
            
            80,198
            
            
            
            1,967
            
            
            
            8,362
            
            
            
            —
            
            
            
            90,527At
      end of year
            
            $
            4,685
            
            
            $
            590
            
            
            $
            10,132
            
            
            $
            —
            
            
            $
            15,407







84


Note
13




CHATTEM,
INC. AND SUBSIDIARIES


CONSOLIDATING
STATEMENTS OF CASH FLOWS




FOR
THE YEAR ENDED NOVEMBER 30, 2006


(In
thousands)




CHATTEM
            
            
            GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            NON-GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            ELIMINATIONS
            
            
            CONSOLIDATEDOPERATING
      ACTIVITIES:Net
      income (loss)
            
            $
            45,112
            
            
            $
            35,166
            
            
            $
            4,097
            
            
            $
            (39,263
            )
            
            $
            45,112Adjustments
      to reconcile net income (loss)  to net cash provided by (used
      in) operating activities:Depreciation
      and amortization
            
            
            5,655
            
            
            
            —
            
            
            
            180
            
            
            
            —
            
            
            
            5,835Deferred
      income taxes
            
            
            (5,204
            )
            
            
            5,653
            
            
            
            (36
            )
            
            
            —
            
            
            
            413Stock-based
      compensation expense
            
            
            4,745
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            4,745Loss
      on early extinguishment of debt
            
            
            2,805
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,805Tax
      benefit realized from stock options exercised
            
            
            (1,627
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,627
            )Other,
      net
            
            
            127
            
            
            
            —
            
            
            
            257
            
            
            
            —
            
            
            
            384Equity
      in subsidiary income
            
            
            (39,263
            )
            
            
            —
            
            
            
            —
            
            
            
            39,263
            
            
            
            —Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            12,538
            
            
            
            1,774
            
            
            
            (197
            )
            
            
            (1,774
            )
            
            
            12,341Inventories
            
            
            (6,115
            )
            
            
            (1,730
            )
            
            
            224
            
            
            
            —
            
            
            
            (7,621
            )Refundable
      income taxes
            
            
            2,834
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,834Prepaid
      expenses and other current assets
            
            
            574
            
            
            
            —
            
            
            
            425
            
            
            
            (420
            )
            
            
            579Accounts
      payable and accrued liabilities
            
            
            (7,497
            )
            
            
            163
            
            
            
            (6,238
            )
            
            
            2,194
            
            
            
            (11,378
            )Net
      cash provided by (used in) operating activities
            
            
            14,684
            
            
            
            41,026
            
            
            
            (1,288
            )
            
            
            —
            
            
            
            54,422INVESTING
      ACTIVITIES:Purchase
      of property, plant and equipment
            
            
            (4,473
            )
            
            
            —
            
            
            
            (232
            )
            
            
            —
            
            
            
            (4,705
            )Increase
      in other assets, net
            
            
            (487
            )
            
            
            (468
            )
            
            
            (1,156
            )
            
            
            —
            
            
            
            (2,111
            )Net
      cash (used in) provided by investing activities
            
            
            (4,960
            )
            
            
            (468
            )
            
            
            (1,388
            )
            
            
            —
            
            
            
            (6,816
            )FINANCING
      ACTIVITIES:Repayment
      of long-term debt
            
            
            (75,000
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (75,000
            )Proceeds
      from long-term debt
            
            
            125,000
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            125,000Proceeds
      from borrowings under revolving credit facility
            
            
            75,500
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            75,500Repayments
      of revolving credit facility
            
            
            (75,500
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (75,500
            )Bank
      overdraft
            
            
            5,824
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            5,824Repurchase
      of common shares
            
            
            (39,332
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (39,332
            )Proceeds
      from exercise of stock options
            
            
            2,480
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,480Purchase
      of note hedge
            
            
            (32,042
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (32,042
            )Proceeds
      from issuance of warrant
            
            
            18,581
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            18,581Increase
      in debt issuance costs
            
            
            (9,099
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (9,099
            )Debt
      retirement costs
            
            
            (1,501
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,501
            )Premium
      paid on interest rate cap agreement
            
            
            (687
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (687
            )Tax
      benefit realized from stock options exercised
            
            
            1,627
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,627Changes
      in intercompany accounts
            
            
            37,976
            
            
            
            (38,073
            )
            
            
            97
            
            
            
            —
            
            
            
            —Dividends
      paid
            
            
            —
            
            
            
            (2,500
            )
            
            
            2,500
            
            
            
            —
            
            
            
            —Net
      cash provided by (used in) financing activities
            
            
            33,827
            
            
            
            (40,573
            )
            
            
            2,597
            
            
            
            —
            
            
            
            (4,149
            )EFFECT
      OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
            
            
            —
            
            
            
            —
            
            
            
            (257
            )
            
            
            —
            
            
            
            (257
            )CASH
      AND CASH EQUIVALENTSIncrease
      (decrease) for the year
            
            
            43,551
            
            
            
            (15
            )
            
            
            (336
            )
            
            
            —
            
            
            
            43,200At
      beginning of year
            
            
            36,647
            
            
            
            1,982
            
            
            
            8,698
            
            
            
            —
            
            
            
            47,327At
      end of year
            
            $
            80,198
            
            
            $
            1,967
            
            
            $
            8,362
            
            
            $
            —
            
            
            $
            90,527







85


(14)       
 QUARTERLY
INFORMATION (Unaudited and in thousands, except per share
amounts)




Quarter EndedTotal
            
            
            February 29
            
            
            May 31
            
            
            August 31
            
            
            November 30FISCAL
      2008:Total
      revenues
            
            $
            454,879
            
            
            
            120,773
            
            
            
            116,716
            
            
            
            111,929
            
            
            
            105,461Gross
      profit
            
            $
            323,259
            
            
            
            86,040
            
            
            
            84,075
            
            
            
            80,176
            
            
            
            72,968Net
      income
            
            $
            66,286
            
            
            
            14,873
            
            
            
            20,732
            
            
            
            13,966
            
            
            
            16,715Net
      income per share:Basic  (1)
            
            $
            3.49
            
            
            
            .78
            
            
            
            1.08
            
            
            
            .74
            
            
            
            .88Diluted
      (1)
            
            $
            3.42
            
            
            
            .75
            
            
            
            1.06
            
            
            
            .73
            
            
            
            .86FISCAL
      2007:Total
      revenues
            
            $
            423,378
            
            
            
            100,831
            
            
            
            112,964
            
            
            
            108,965
            
            
            
            100,618Gross
      profit
            
            $
            294,323
            
            
            
            69,851
            
            
            
            77,869
            
            
            
            76,172
            
            
            
            70,431Net
      income
            
            $
            59,690
            
            
            
            13,650
            
            
            
            14,908
            
            
            
            16,312
            
            
            
            14,820Net
      income per share:Basic
      (1)
            
            $
            3.15
            
            
            
            .73
            
            
            
            .78
            
            
            
            .86
            
            
            
            .78Diluted
      (1)
            
            $
            3.08
            
            
            
            .71
            
            
            
            .77
            
            
            
            .84
            
            
            
            .76




(1)The sum
of the quarterly earnings per share amounts may differ from annual earnings per
share because of the differences in the weighted average number of common shares
and dilutive potential shares used in the quarterly and annual
computations.













































86


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Board of Directors and Shareholders of


Chattem,
Inc.:





We have
audited Chattem, Inc. (a Tennessee corporation) and subsidiaries’ (the Company)
internal control over financial reporting as of November 30, 2008, based on
criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission
(COSO).  The Company’s management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting, included in the
accompanying Management’s Report on Internal Control Over Financial
Reporting.  Our responsibility is to express an opinion on Chattem,
Inc. and subsidiaries’ internal control over financial reporting based on our
audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects.  Our audit included obtaining an understanding of
internal control over financial reporting, assessing the risk that a material
weakness exists, testing and evaluating the design and operating effectiveness
of internal control based on the assessed risk, and performing such other
procedures as we considered necessary in the circumstances.  We
believe our audit provides a reasonable basis for our opinion.





A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles.  A company’s internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.





In our
opinion, Chattem, Inc. and subsidiaries maintained, in all material respects,
effective internal control over financial reporting as of November 30, 2008,
based on criteria established in Internal Control—Integrated Framework issued by
COSO.





We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Chattem,
Inc. and subsidiaries as of November 30, 2008 and 2007, and the related
consolidated statements of income, shareholders’ equity, and cash flows for each
of the three years in the period ended November 30, 2008, and our report dated
January 29, 2009, expressed an unqualified opinion on those consolidated
financial statements.





/s/ GRANT
THORNTON LLP







Charlotte,
North Carolina


January
29, 2009




87


Item
9.    Changes in and Disagreements
with Accountants on Accounting and Financial Disclosure




On
January 27, 2009, the exhibit to Chattem, Inc. Annual Cash Incentive Plan (the
“Plan”) was corrected to conform one of the components affecting the range of
potential incentive awards payable thereunder with the original understanding
and intent of our board of directors and compensation committee at the time the
Plan was adopted.  The exhibit to the Plan sets forth percentages of
base salaries used in determining the annual incentive awards payable to
participants based on specified participant groupings and corporate performance
levels achieved during the applicable performance period.  At the time
of the Plan’s adoption, our board of directors and compensation committee
understood that all percentages set forth in the exhibit to the Plan were equal
to those percentages previously approved and in effect under the terms of our
previous short-term incentive plan, which remained in effect until the Plan’s
adoption.  The percentage of base salary used in determining the
annual incentive award payable to our chairman and chief executive officer upon
achievement of corporate performance level 3 under the previous short-term
incentive plan had been set at 100% by our board of directors and compensation
committee in January 2004.  The exhibit to the Plan, however,
erroneously reflects that such percentage is 75%.  Accordingly, our
compensation committee, pursuant to authority granted to it under the Plan,
authorized and approved the correction of the Plan and the exhibit, effective as
of the date on which the Plan first became effective, to reflect and fully
effectuate the original understanding and intent of our board of directors and
compensation committee.




A copy of
the Plan with the corrected exhibit thereto is attached hereto as Exhibit 10.47
and is incorporated herein by reference thereto.  The foregoing
description of the terms and conditions of the Plan, as so corrected, is
qualified in its entirety by reference to the full text of the correct Plan
attached hereto.






Item 9A. Controls and
Procedures




Disclosure
Controls and Procedures




Under the
supervision and with the participation of our management, including our chief
executive officer and chief 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 November 30, 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 filings
under the Exchange Act.




Management’s
Report on Internal Control Over Financial Reporting




Management
of the Company is responsible for establishing and maintaining adequate internal
control over financial reporting.  Internal control over financial
reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the
Exchange Act as a process designed by, or under the supervision of, the
Company’s principal executive and principal financial officers and effected by
the Company’s board of directors, management and other personnel, to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles and includes those policies and
procedures that:




•
            Pertain
      to the maintenance of records that in reasonable detail accurately and
      fairly reflect the transactions and dispositions of the assets of the
      Company;




•
            Provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the Company
      are being made only in accordance with authorizations of management and
      directors of the Company; and




•
            Provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of the Company’s assets that
      could have a material effect on the financial
  statements.






88


Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.




The
Company’s management assessed the effectiveness of the Company’s internal
control over financial reporting as of November 30, 2008 using the criteria set
forth by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO) in Internal Control-Integrated Framework.  Management’s
assessment included an evaluation of the design of our internal control over
financial reporting and testing the operational effectiveness of our internal
control over financial reporting.  Management reviewed the results of
the assessment with the Audit Committee of the Board of
Directors.  Based on our assessment, management determined that, at
November 30, 2008, we maintained effective internal control over financial
reporting.




The
Company’s independent registered public accounting firm has issued an
attestation report on our internal control over financial reporting, which is
included herein.




Changes
in Internal Control Over Financial Reporting




There
have been no changes during the quarter ended November 30, 2008 in the Company’s
internal control over financial reporting that have materially affected, or are
reasonably likely to materially affect, the Company’s internal control over
financial reporting.






Item
9B.  Other
Information




None






PART
III




Item 10. 
 Directors, Executive
Officers and Corporate Governance




(a)           Directors




The
information found in our 2009 Proxy Statement under the heading “Information
about Nominees and Continuing Directors” is hereby incorporated by
reference.




(b)           Executive
Officers




The
following table lists the names of the executive officers and other key
employees of the Company as of January 22, 2009, their ages and their positions
and offices with the Company:




NAME
            
            AGE
            
            POSITION WITH
      REGISTRANTZan
      Guerry*
            
            60
            
            Chairman
      of the Board andChief
      Executive Officer; DirectorRobert
      E. Bosworth*
            
            61
            
            President
      and Chief Operating Officer;DirectorAndrea
      M. Crouch
            
            50
            
            Vice
      President – Brand ManagementRon
      Galante
            
            65
            
            Vice
      President – New Business DevelopmentRobert
      B. Long*
            
            37
            
            Vice
      President and Chief Financial OfficerB.
      Derrill Pitts
            
            66
            
            Vice
      President – Operations






89




J.
      Blair Ramey
            
            42
            
            Vice
      President – MarketingJohn
      L. Stroud
            
            48
            
            Vice
      President – MarketingCharles
      M. Stafford
            
            58
            
            Vice
      President – SalesJoseph
      J. Czerwinski
            
            59
            
            Vice
      President – Product DevelopmentTheodore
      K. Whitfield, Jr.*
            
            43
            
            Vice
      President, General Counsel and Secretary*Executive
      Officer






Zan Guerry.  Mr.
Guerry became our chairman of the board and chief executive officer in June
1990.  Previously, he served as our vice president and chief financial
officer from 1980 until 1983, as executive vice president from 1983 to 1990, as
president of Chattem Consumer Products from 1989 to 1994, as chief operating
officer from 1989 to 1990 and as president from 1990 to 1998.  Mr.
Guerry became one of our directors in 1981.  He is also a director of
SunTrust Bank, Chattanooga, N.A.




Robert E.
Bosworth.  Mr. Bosworth became our president and chief
operating officer in September 2005.  From 2001 to September 2005, Mr.
Bosworth served as Vice President-Corporate Finance of Livingston Company, a
merchant banking firm.




Andrea M.
Crouch.  Ms. Crouch became our vice president-brand management
in 1995.  Ms. Crouch joined us in 1985 as an assistant brand
manager.  Prior to joining us, she served as product planner for Hayes
Microcomputer Products, a manufacturer of modems and communication equipment,
and previously was a systems consultant with Arthur Andersen LLP, an accounting
firm.




Ron Galante.  Mr.
Galante became our vice president-new business development in June
1996.  Previously, he was director - new business
development.  Prior to that, Mr. Galante served as general manager of
Chattem Canada, our Canadian subsidiary, from June 1990 to May 1993 and as
director of marketing for many of our domestic brands from 1980 until
1990.




Robert B.
Long.  Mr. Long became our vice president and chief financial
officer in July 2008.  Previously, he served as our vice
president-finance since July 2007 and as our chief accounting officer from April
2006 to July 2007.  Prior to joining us, Mr. Long was Chief Financial
Officer of Charleston Hosiery, Inc. and served as a senior audit manager with
Ernst & Young LLP from 2003 to 2005.




B. Derrill
Pitts.  Mr. Pitts joined us in 1961 and since that time has
served us in all manufacturing operation disciplines.  He was promoted
to vice president-operations in 1984.




J. Blair
Ramey.  Mr. Ramey became our vice president-marketing in
November 2007.  Mr. Ramey joined us in 1998 and previously served as a
marketing manager, a marketing director, and since April 2006 as our vice
president-brand management and media.  Prior to joining the Company,
he held marketing positions at Nabisco, Inc. and Bryan Foods.




John L.
Stroud.  Mr. Stroud became our vice president-marketing in
November 2007.  Previously, he served as our vice president-brand
management and category manager since joining the Company in August
2005.  Prior to joining us, he served in various capacities, including
Vice President, Marketing, R&D and Quality, at Brach’s Confections, Inc., a
manufacturer of confections and fruit snacks.




Charles M.
Stafford.  Mr. Stafford became our vice president-sales in June
1994.  Previously, he served as our director of field sales and zone
sales manager.  Prior to joining us in 1983, Mr. Stafford held sales
management positions with Johnson & Johnson, a pharmaceutical company, and
Schering Corporation (now Schering–Plough Corporation), a research-based
pharmaceutical company.




Joseph J.
Czerwinski.  Mr. Czerwinski became our vice president-product
development in July 2007.  Since joining the company in 2002, he has
served as the Company’s Director of Product Development.




90


Theodore K. Whitfield,
Jr.  Mr. Whitfield became our vice president, general counsel
and secretary in June 2004.  Prior to joining us, Mr. Whitfield was a
member with the law firm of Miller & Martin PLLC, from 1999 to
2004.




(c)           Compliance with Section
16(a) of the Exchange Act




The
information found in our 2009 Proxy Statement under the heading “Section 16(a)
Beneficial Ownership Reporting Compliance” is hereby incorporated by
reference.




(d)           Audit Committee; Audit
Committee Financial Expert




The
information found in our 2009 Proxy Statement regarding the identity of the
audit committee members and the audit committee financial expert under the
heading “Audit Committee Report – Identification of Members and Functions of
Committee” is hereby incorporated by reference.




(e)           Code of
Ethics




We have
adopted a code of business conduct and ethics that applies to our directors,
officers and employees, including our principal executive officer, principal
financial officer, principal accounting officer, controller or persons
performing similar functions.  A copy of this code of business conduct
and ethics is posted on the Company’s website at www.chattem.com.  In
the event waivers are granted under the code of business conduct and ethics,
such waivers will be posted on our website for one year from the date the waiver
is granted.






Item
11.  Executive
Compensation




The
information found in our 2009 Proxy Statement under the headings “Corporate
Governance – Compensation
Committee –
Compensation Committee Interlocks and Insider Participation” and “Executive
Compensation and Other Information” is hereby incorporated by
reference.






Item
12.  Security Ownership of
Certain Beneficial Owners and Management and Related Shareholder
Matters




The
information found in our 2009 Proxy Statement under the headings “Executive
Compensation and Other Information – Equity Compensation Plan Information” and
“Ownership of Common Stock” is hereby incorporated by reference.






Item
13.  Certain Relationships,
Related Transactions and Director Independence




The
information found in our 2009 Proxy Statement under the headings “Corporate
Governance – Policies and
Procedures for the Approval of Related Person Transactions” and “Executive
Compensation and Other Information – Certain Relationships,
Related Transactions and Director Independence” is hereby incorporated by
reference.






Item
14.  Principal Accountant Fees
and Services




The
information found in our 2009 Proxy Statement under the headings “Corporate
Governance - Audit Committee Pre-Approval of Services by the Independent
Auditor” and “Corporate Governance - Audit and Non-Audit Fees” is hereby
incorporated by reference.








91


PART
IV




Item
15.  Exhibits and Financial
Statement Schedules




(a)           1.           Consolidated
Financial Statements




The
following consolidated financial statements of Chattem, Inc. and Subsidiaries
are set forth in Item 8 hereof:




Report of
Independent Registered Public Accounting Firm


Consolidated
Balance Sheets as of November 30, 2008 and 2007


Consolidated
Statements of Income for the Years Ended November 30, 2008, 2007 and
2006


Consolidated
Statements of Shareholders’ Equity for the Years Ended November 30, 2008, 2007
and 2006


Consolidated
Statements of Cash Flows for the Years Ended November 30, 2008, 2007 and
2006


Notes to
Consolidated Financial Statements


Report of
Independent Registered Public Accounting Firm on Internal Control over Financial
Reporting




2.           The
following financial statement schedule is filed as Exhibit 99.1 to this
report:




Schedule
II - Valuation and Qualifying Accounts




All other
schedules for which provision is made in the applicable accounting regulation of
the Securities and Exchange Commission are not required under the related
instructions or are inapplicable and therefore have been omitted.




3.           The
following documents are filed or incorporated by reference as exhibits to this
report:




Exhibit
              Number
            
            Description of
      Exhibit
            
            References3.1
            
            Restated
      Charter of Chattem, Inc., as amended
            
            (4),
      (5), (10), and (16)3.2
            
            Amended
      and Restated By-Laws of Chattem, Inc.
            
            (1),
      (6), (20) and (30)4.1
            
            Rights
      Agreement dated January 27, 2000 between Chattem, Inc. and SunTrust
      Bank,  Atlanta, N.A.
            
            (2)4.2
            
            Indenture
      dated as of February 26, 2004 among Chattem, Inc., its domestic
      subsidiaries and  SouthTrust Bank, as trustee, relating to the 7%
      Senior Subordinated Notes due 2014
            
            (3)4.3
            
            First
      Amendment to and Supplemental Indenture dated July 25, 2006 among
      Chattem, Inc., its domestic subsidiaries and U.S. Bank, National
      Association, as successor trustee, relating to the 7% Senior Subordinated
      Notes due 2014
            
            (22)4.4
            
            Indenture
      dated as of November 22, 2006 between Chattem, Inc. and U.S. Bank,
      National Association, as trustee, relating to 2% Convertible Senior Notes
      due 2013
            
            (25)4.5
            
            Registration
      Rights Agreement dated November 22, 2006 among Chattem, Inc. and the
      purchasers of the 2% Convertible Senior Notes due 2013
            
            (25)4.6
            
            Indenture
      dated as of April 11, 2007 between Chattem, Inc., and U.S. Bank, National
      Association, as trustee, relating to 1.625% Convertible Senior Notes due
      2014
            
            (29)








92


Exhibit
                Number
              
              Description of
      Exhibit
              
              References


4.7
            
            Registration
      Rights Agreement dated April 11, 2007 between Chattem, Inc., and Merrill
      Lynch, Pierce, Fenner & Smith Incorporated
            
            (29)10.1
            
            Lease
      Agreements as amended, dated  February 1, 1996 between
      Tammy  Development Company and Chattem,  Inc. for
      warehouse space at 3100  Williams Street, Chattanooga,
      Tennessee
            
            (6)
      and (7)10.2
            
            First
      Amended and Restated Master Trademark License Agreement between Signal
      Investment & Management Co.  and Chattem, Inc., effective
      June 30, 1992
            
            (8)10.3
            
            Commercial
      Lease dated April 1, 1998 between Chattem, Inc., lessee, and Kenco Group,
      Inc., lessor, for warehouse space  located at 4309 Distribution
      Avenue, Chattanooga, Tennessee
            
            (9)10.4*
            
            Chattem,
      Inc. Non-Statutory Stock Option Plan –  1998
            
            (8)10.5*
            
            1999
      Stock Plan for Non-Employee Directors
            
            (21)10.6*
            
            Chattem,
      Inc. Non-Statutory Stock Option Plan –  2000
            
            (10)10.7*
            
            Chattem,
      Inc. Stock Incentive Plan – 2003
            
            (12)10.8*
            
            Chattem,
      Inc. Stock Incentive Plan – 2005
            
            (17)10.9*
            
            Form
      of Stock Option Grant Agreement under Chattem, Inc. Stock Incentive Plan –
      2005
            
            (17)10.10*
            
            Form
      of Restricted Stock Agreement under Chattem, Inc. Stock Incentive Plan –
      2005
            
            (17)10.11*
            
            Form
      of Amendment to Grant Agreement under 2005 Stock Incentive Plan pertaining
      only to officers
            
            (19)10.12*
            
            Form
      of Amendment to Grant Agreement under 2005 Stock Incentive Plan
      pertaining to all optionees other than officers
            
            (19)10.13*
            
            Amended
      and Restated Employment Agreement dated July 8, 2008 by and between
      Chattem, Inc. and Zan Guerry
            
            (31)10.14*
            
            Second
      Amended and Restated Severance Agreement dated July 8, 2008 by and between
      Chattem, Inc. and Zan Guerry
            
            (31)10.15*
            
            Form
      of Amended and Restated Non-Competition and Severance Agreement- Robert E.
      Bosworth, Andrea M. Crouch, Ron Galante, B. Derrill Pitts, Charles M.
      Stafford, Theodore K. Whitfield, Jr.
            
            (31)10.16*
            
            Form
      of Non-Competition and Severance Agreement - Joseph J. Czwerwinski, Robert
      B. Long and John L. Stroud
            
            (31)10.17*
            
            Form
      of Restricted Stock Agreements – Zan Guerry
            
            (11)




93
 
 Exhibit
                  Number
                
                Description of
      Exhibit
                
                References


10.18
            
            Asset
      Purchase Agreement dated as of October 5, 2006, among Johnson &
      Johnson, Pfizer, Inc. and Chattem, Inc.
            
            (23)10.19
            
            Letter
      Agreement dated November 16, 2006 among Chattem, Inc., Merrill Lynch
      International and Merrill Lynch, Pierce, Ferner & Smith Incorporated
      regarding confirmation of OTC Convertible Note Hedge
            
            (25)10.20
            
            Letter
      Agreement dated November 16, 2006 among Chattem, Inc., Merrill Lynch
      International and Merrill Lynch, Pierce, Ferner & Smith Incorporated
      regarding confirmation of OTC Warrant Transaction
            
            (25)10.21
            
            Securities
      Purchase Agreement dated November 16, 2006 among Chattem, Inc. and the
      purchasers of the 2% Convertible Senior Notes due 2013
            
            (24)10.22
            
            Purchase
      Agreement dated April 4, 2007 among Chattem, Inc., and the initial
      purchasers of the 1.625% Convertible Senior Notes due 2014
            
            (28)10.23
            
            Letter
      Agreement dated April 10, 2007 among Chattem, Inc., Merrill Lynch
      International and Merrill Lynch, Pierce, Fenner & Smith Incorporated
      regarding confirmation of OTC Convertible Note Hedge
            
            (29)10.24
            
            Letter
      Agreement dated April 10, 2007 among Chattem, Inc., Merrill Lynch
      Incorporated and Merrill Lynch, Pierce, Fenner & Smith Incorporated
      regarding confirmation of the OTC Warrant Transactions
            
            (29)10.25
            
            Credit
      Agreement dated as of February 26, 2004 among Chattem, Inc., its domestic
      subsidiaries, identified lenders and Bank of America, N.A., as
      agent
            
            (3)10.26
            
            New
      Commitment Agreement dated March 9, 2004 between Chattem, Inc. and Bank of
      America, N.A., as administrative agent
            
            (14)10.27
            
            First
      Amendment to Credit Agreement dated as of December 22, 2004 among Chattem,
      Inc., its domestic subsidiaries, identified lenders and  Bank of
      America, N.A., as agent
            
            (18)10.28
            
            Waiver
      and Second Amendment to Credit Agreement dated as of February 25, 2005
      among Chattem, Inc., its domestic subsidiaries,  identified lenders
      and  Bank of America, N.A., as  agent
            
            (18)10.29
            
            Third
      Amendment to Credit Agreement dated as of November 29, 2005 among Chattem,
      Inc.,  its domestic subsidiaries, identified lenders and Bank of
      America, N.A., as agent
            
            (19)10.30
            
            Fourth
      Amendment to Credit Agreement dated as of November 16, 2006 among Chattem,
      Inc., its domestic subsidiaries, identified lenders and Bank of America,
      N.A., as agent
            
            (24)10.31
            
            Fifth
      Amendment to Credit Agreement dated December 22, 2006 among Chattem, Inc.,
      its domestic subsidiaries, identified lenders and Bank of America, N.A.,
      as agent
            
            (26)




94


Exhibit
                Number
              
              Description of
      Exhibit
              
              References


10.32
            
            Sixth
      Amendment to Credit Agreement dated April 3, 2007 among Chattem, Inc., its
      domestic subsidiaries, identified lenders and Bank of America, N.A., as
      agent
            
            (27)10.33
            
            Rate
      Cap Transaction Agreement dated March 8, 2004 between Chattem, Inc. and JP
      Morgan Chase Bank
            
            (14)10.34
            
            First
      Amendment to the Second Amended and Restated Master Trademark
      License Agreement between Signal Investment &  Management
      Co. and Chattem, Inc. effective May 31, 2003
            
            (13)10.35
            
            First
      Amendment to Master Trademark License Agreement between Signal Investment
      & Management Co. and SunDex, LLC, effective May 31,
    2003
            
            (13)10.36
            
            Memorandum
      of Understanding dated December 19, 2003 with Plaintiffs’ Steering
      Committee in In re: Phenylpropanalomine (PPA) Products Liability
      Litigation, MDL 1407, pending  before the United States District
      Court for the  Western District of Washington
            
            (12)10.37
            
            Class
      Action Settlement Agreement dated as of April 13, 2004 between Chattem,
      Inc. and Class Counsel on behalf of Class Representatives In re:
      Phenylpropanolamine (PPA) Products  Liability
    Litigation
            
            (14)10.38
            
            Initial
      Settlement Trust Agreement dated April 12, 2004 between Chattem, Inc. and
      Amsouth Bank
            
            (14)10.39
            
            Final
      Settlement Trust Agreement between Chattem, Inc. and AmSouth Bank
      dated March 16, 2005
            
            (18)10.40
            
            Settlement
      Agreement dated April 26, 2004 between Chattem, Inc. and General Star
      Indemnity Company
            
            (14)10.41
            
            Memorandum
      of Understanding dated December 13, 2003 between and among Chattem, Inc.
      and Kemper Indemnity Insurance  Company
            
            (14)10.42
            
            Settlement
      Agreement dated December 30, 2003 between Chattem, Inc. and
      Admiral Insurance Company
            
            (14)10.43
            
            Settlement
      Agreement dated July 14, 2004 between Chattem, Inc. and Sidmak
      Laboratories
            
            (15)10.44
            
            Dexatrim Case Scoring
      System and Matrix for the Chattem Dexatrim Class Action
      Settlement
            
            (15)10.45
            
            Settlement
      and Coverage-In-Place Agreement between Interstate Fire &
      Casualty Company and Chattem, Inc. effective March 18,
2005
            
            (18)10.46
            
            Settlement
      Agreement dated as of June 30, 2005 by and between Chattem, Inc. and The
      DELACO Company
            
            (17)10.47*
            
            Chattem,
      Inc. Annual Cash Incentive Compensation Plan




95
 Exhibit
                Number
              
              Description of
      Exhibit
              
              References


21
            
            Subsidiaries
      of the Company23.1
            
            Consent
      of Independent Registered Public Accounting Firm31.1
            
            Certification
      required by Rule 13a-14(a) under the Securities Exchange
    Act31.2
            
            Certification
      required by Rule 13a-14(a) under the Securities Exchange
      Act32
            
            Certification
      required by Rule 13a-14(b) under the Securities Exchange Act of 1934 and
      18 U.S.C. Section 135099.1
            
            Schedule
      II – Valuation and Qualifying Accounts




*This
item is a management contract or compensatory plan or arrangement required to be
filed as an exhibit to this Form 10-K pursuant to Item 15(b) of this
report.






References:




Previously
filed as an exhibit to and incorporated by reference from the indicated report
filed with the Securities and Exchange Commission:




(1)
            Form
      8-K filed February 1, 2000.




(2)
            Form
      8-A filed February 1, 2000.




(3)
            Form
      S-4 filed March 22, 2004.




(4)
            Form
      S-8 filed June 2, 1999.




(5)
            Form
      10-K for the year ended November 30,
1992.




(6)
            Form
      10-K for the year ended November 30,
1995.




(7)
            Form
      10-K for the year ended November 30,
1996.




(8)
            Form
      10-K for the year ended November 30,
1997.




(9)
            Form
      10-K for the year ended November 30,
1998.




(10)
            Form
      10-K for the year ended November 30,
1999.




(11)
            Form
      10-K for the year ended November 30,
2001.




(12)
            Form
      10-K for the year ended November 30,
2003.




(13)
            Form
      10-Q filed for the quarter ended May 31,
2003.




(14)
            Form
      10-Q filed for the quarter ended May 31,
2004.




(15)
            Form
      10-Q filed for the quarter ended August 31,
  2004.




96


(16)
            Schedule
      14A filed March 4, 2005.




(17)
            Form
      10-Q filed for the quarter ended May 31,
2005.




(18)
            Form
      10-Q filed for the quarter ended February 28,
  2005.




(19)
            Form
      8-K filed December 2, 2005.




(20)
            Form
      8-K/A filed August 31, 2005.




(21)
            Schedule
      14A filed March 8, 1999.




(22)
            Form
      8-K filed July 19, 2006, as supplemented by Form 8-K filed July 26,
      2006.




(23)
            Form
      8-K filed November 15, 2006.




(24)
            Form
      8-K filed November 22, 2006.




(25)
            Form
      8-K filed November 29, 2006.




(26)
            Form
      8-K filed December 28, 2006.




(27)
            Form
      8-K filed April 4, 2007.




(28)
            Form
      8-K filed April 11, 2007.




(29)
            Form
      8-K filed April 17, 2007.




(30)
            Form
      8-K filed November 13, 2007




(31)
            Form
      10-Q for the quarter ended May 31,
2008.

































97


SIGNATURES




Pursuant
to the requirements of Section 13 or 15 (d) 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.Dated:   January 29, 2009
              By:
              /s/ Zan
      GuerryZan
      GuerryChairman
      and Chief Executive Officer




By:
                /s/ Robert
      B. LongRobert
      B. LongVice
      President and Chief Financial Officer






Pursuant
to the requirements of the Securities Exchange Act of 1934, this Report has been
signed below by the following persons on behalf of the Registrant in the
capacities and on the dates indicated:




Signature
            
            Title
            
            Date/s/ Zan Guerry
            
            Chairman
      of the Board and Director
            
            1-29-09Zan
      Guerry
            
            (Chief
      Executive Officer)/s/ Robert E. Bosworth
            
            President
      and Director
            
            1-29-09Robert
      E. Bosworth
            
            (Chief
      Operating Officer)/s/ Robert B. Long
            
            Vice
      President and Chief Financial Officer
            
            1-29-09Robert
      B. Long/s/ Samuel E. Allen
            
            Director
            
            1-29-09Samuel
      E. Allen/s/ Ruth W.
      Brinkley
            
            Director
            
            1-29-09Ruth
      W. Brinkley/s/ Gary D. Chazen
            
            Director
            
            1-29-09Gary
      D. Chazen/s/ Bill W. Stacy
            
            Director
            
            1-29-09Bill
      W. Stacy/s/ Philip H.
      Sanford
            
            Director
            
            1-29-09Philip
      H. Sanford






98


CHATTEM, INC. AND
SUBSIDIARIES




EXHIBIT
INDEX








EXHIBIT
                NUMBER
              
              DESCRIPTION OF
      EXHIBIT10.47
              
              Chattem,
      Inc. Annual Cash Incentive Plan21
              
              Subsidiaries
      of the Company23.1
              
              Consent
      of Independent Registered Public Accounting Firm31.1
              
              Certification
      required by Rule 13a-14(a) under the Securities Exchange
    Act31.2
              
              Certification
      required by Rule 13a-14(a) under the Securities Exchange
    Act32
              
              Certification
      required by Rule 13a-14(b) under the Securities Exchange Act and 18 U.S.C.
      Section 135099.1
              
              Schedule
      II – Valuation and Qualifying
Accounts






















































99