**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, 2005**
 
 **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
                      Registered****None**
                  **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**x     **NO**o
 
 **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**o     **NO**x
  **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** x  **NO** o
 
 **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.**o
 
 **Indicate
            by check mark whether the registrant is a large accelerated filer, an
            accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2
            of the
            Act).**
 
 **Large
            accelerated filer**x**Accelerated
            filer**o**Non-accelerated
            filer**o
 
 **Indicate
            by check mark whether the registrant is a shell company (as defined in
            rule
            12b-2 of the Act).** **YES** o  **NO** x ****
  **As
              of May 31, 2005, the aggregate market value of voting shares held by
              non-affiliates was $791,923,275. 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 February 17, 2006, 19,529,396 shares of
              common stock were outstanding.
  **DOCUMENTS
            INCORPORATED BY REFERENCE:**
 **Portions
            of the registrant’s Proxy Statement for the registrant’s Annual Meeting of
            Shareholders to be held on April 12, 2006 (the “2006 Proxy Statement”) are
            incorporated by reference in Part III of this Form 10-K.**
 
 
 
 **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, 2003, November 30, 2004 and
              November
              30, 2005 are referred to as fiscal 2003, fiscal 2004 and fiscal 2005,
              respectively, and our fiscal year ending on November 30, 2006 is referred
              to as
              fiscal 2006. Brand names that are italicized in this Form 10-K refer
              to
              trademarks that we own or license.
 
 ***General***
 
 We
              are a
              leading marketer and manufacturer of a broad portfolio of branded
              over-the-counter (“OTC”) healthcare products, toiletries and dietary
              supplements, including such categories as topical analgesics, medicated
              skin
              care products, medicated dandruff shampoos and conditioner, dietary
              supplements
              and other OTC and toiletry products. Our portfolio of products includes
              well-recognized brands such as:
 
 •
                    Topical
                        analgesics such as*Icy
                        Hot*and*Aspercreme*;
 
 •
                    Medicated
                        skin care products such as*Gold
                        Bond*medicated skin care powder, cream, lotion, first aid and
                        foot care
                        products
 
 •
                    *Selsun
                        Blue*medicated dandruff shampoos and
                        conditioner;
 
 •
                    Dietary
                        supplements including*Dexatrim,
                        Garlique*and*New
                        Phase*;
                        and
 
 •
                    Other
                        OTC and toiletry products such as*Pamprin,*a
                        menstrual analgesic;*Herpecin-L,*a
                        lip care product;*Benzodent,*a
                        dental analgesic cream; and toiletries such as*Bullfrog,*a
                        line of sunblocks;*UltraSwim,*a
                        chlorine-removing shampoo; and*Sun-In*,
                        a
                        hair lightener.
 
 Our
              products target niche markets that are often outside the core product
              areas of
              larger companies where we believe we can achieve and sustain significant
              market
              penetration through innovation and strong advertising and promotion
              support.
              Many of our products are among the U.S. market leaders in their respective
              categories. For example, our portfolio of topical analgesic brands
              and our *Gold
              Bond* medicated
              body powders have the leading U.S. market share in these categories.
              We support
              our brands through extensive and cost-effective advertising and promotion,
              the
              expenditures for which represented approximately 28% of our total revenues
              in
              fiscal 2005. We sell our products nationally through mass merchandiser,
              drug and
              food channels, principally utilizing our own sales force.
 
 Our
              experienced management team has grown our business by developing product
              line
              extensions, increasing market penetration of our existing products
              and acquiring
              brands. Recent product line extensions include *Gold
              Bond Ultimate* Healing
              Skin Therapy Lotion and the *Icy
              Hot* Medicated
              Sleeve. In March 2002, we acquired the *Selsun
              Blue* line of
              medicated dandruff shampoos, expanding our brand portfolio into another
              attractive niche category. We will continue to seek opportunities to
              acquire
              attractive brands in niche markets such as *Selsun
              Blue* .
              We
              intend to drive growth through strong marketing and promotional programs,
              new
              product development and acquisitions of new brands.
 
 ***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 22 brands in a variety
              of
              different product categories, including topical analgesics, medicated
              dandruff
              shampoos and conditioner, medicated skin care products, toiletries
              and dietary
              supplements. Our products are marketed under well-recognized brand
              names, such
              as our portfolio of topical analgesic brands *lcy
              Hot, Aspercreme, Flexall* , *Sportscreme* , *Capzasin* and *Arthritis
              Hot* ,
              as well
              as *Gold
              Bond* , *Selsun
              Blue, Dexatrim* and *Garlique* .
              Our
              presence in diverse product categories allows us to reduce 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 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 niche markets
              that are
              frequently outside the core product areas of larger consumer products
              and
  2
 pharmaceutical
              companies. Our focus on niche markets provides us with the opportunity
              to
              develop strong brand equity, identify and respond to consumer trends
              in these
              markets and leverage our strong selling and distribution
              capabilities.
 
 ***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 weather temporary
              fluctuations in our product markets that could otherwise more adversely
              affect
              our business.
 
 ***Proven
              advertising and promotion strategy.*** We
              aggressively seek to build brand awareness and usage of our larger
              brands
              through extensive and cost-effective advertising strategies that emphasize
              the
              competitive strengths of our products. We rely principally on television
              and
              radio advertising and, to a lesser extent, 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 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
              28% of
              our total revenues in fiscal 2005. 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.,
              Walgreen
              Co. and The Kroger Co. In fiscal 2005, sales to our top ten customers
              constituted approximately 70% of our total sales, which allows us to
              target our
              selling efforts to our key customers and tailor specific programs to
              meet their
              needs. Our fiscal 2005 sales to Wal-Mart Stores, Inc. accounted for
              approximately 36% of our total revenues. Through targeted sales and
              by utilizing
              our established network, including our approximately 45 person sales
              force, we
              believe we can effectively sell and distribute 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 base brands while obtaining an increased
              market
              presence through product line extensions. In fiscal 2005, our product
              development expenditures were $3.6 million. During the past several
              years, we
              have expanded our product development staff and completed a new 10,000
              square
              foot research and development facility. 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. Recent examples of
              successful
              product line extensions include *Gold
              Bond Ultimate* Healing
              Skin Therapy Lotion and the *Icy
              Hot* Medicated
              Sleeve. In fiscal 2005, we introduced seven new product line extensions
              and have
              six new product launches scheduled for fiscal 2006.
 
 ***Enhanced
              financial position.*** We have
              strengthened our balance sheet as a significant portion of our cash
              flows have
              been used to reduce our debt. For example, since the acquisition of *Selsun
              Blue* in
              March
              2002, we have reduced outstanding debt by approximately $67.2 million
              as of
              November 30, 2005. In addition, we completed a debt refinancing transaction
              in
              February 2004 that generated a reduction of annual interest expense
              of
              approximately $5.5 million in fiscal 2004. Our total debt outstanding
              as of
              November 30, 2005 was $182.5 million. On November 29, 2005, we amended
              our
              Senior Secured Revolving Credit Facility (the “Amended Revolving Credit
              Facility”) with a syndicate of commercial banks led by Bank of America, N.A.,
              as
              agent, that, among other things, increased our borrowing capacity under
              the
              facility from $50.0 million to $100.0 million, increased our flexibility
              to
              repurchase shares of our stock and improved our borrowing rate under
              the
              facility. On November 30, 2005, we called our $75.0 million of Floating
              Rate
              Senior Notes for full redemption on December 30, 2005. The $75.0 million
              of
              Floating Rate Senior Notes were fully redeemed on December 30, 2005
              at a
              purchase price of 102% of the principal amount of the notes plus accrued
              interest. We utilized borrowings of $38.0 million under our Amended
              Revolving
              Credit Facility and $38.9 million of our cash on hand to fund the redemption
              of
              the Floating Rate Senior Notes. Our total debt outstanding as of February
              17,
              2006 was $145.5 million.
 
 ***Business
              Strategy***
 
 Our
              strategy to achieve future growth is to generate new sales through
              strong
              marketing and promotional programs, new product development and acquisitions
              of
              new brands.
 
 ***Brand
              management and growth*** .
              We will
              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
  3
 growth.
              We
              also intend to increase our new product line extension activities as
              evidenced
              by our increased research and development spending, the expansion of
              our product
              development staff and our research and product development facility
              constructed
              in 2003. 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.
              For example, in fiscal 2000, we sold the Ban ® (a
              registered trademark of Kao Corporation) product line of antiperspirants
              and
              deodorants in response to major shifts in the competitive environment
              in this
              product category and the resulting prospect of declining sales, and
              in fiscal
              2005, we sold the pHisoderm line of skin care products, a brand that
              was no
              longer consistent with our brand strategy.
 
 ***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 highly 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. We will continue to seek opportunities
              to
              acquire attractive brands in niche markets.
 
 ***Developments
              During Fiscal 2005***
 
 Fiscal
              2005 was highlighted by the development and marketing of new product
              line
              extensions; the refinancing of our indebtedness; the class action settlement
              of
              claims relating to *Dexatrim* containing phenylpropanolamine (“PPA”); and our sale of the pHisoderm line of
              skin care products.
 
 In
              the
              first quarter of fiscal 2005, we introduced the following product line
              extensions: *Aspercreme* Odor-Free
              Therapy Back and Body Patch, *Gold
              Bond* Ultimate
              Comfort Powder, *New
              Phase* Extra
              Strength, *Dexatrim* Max and *Bullfrog* Kids UV
              Defender. *Selsun
              Salon* was
              introduced in the fourth quarter of fiscal 2005.
 
 During
              the
              second quarter of fiscal 2005, we repurchased $17.5 million of our
              7.0% Senior
              Subordinated Notes due March 1, 2014 (“7.0% Subordinated Notes”) in the open
              market at an average premium of 1.6% over the principal amount of the
              notes. The
              repurchases resulted in a loss on early extinguishment of debt of $0.7
              million
              in the second quarter of fiscal 2005. The outstanding balance of the
              remaining
              7.0% Subordinated Notes was reduced to $107.5 million.
 
 On
              November 29, 2005, we entered into the Amended Revolving Credit Facility
              that,
              among other things, increased our borrowing capacity under the facility
              from
              $50.0 million to $100.0 million, increased our flexibility to repurchase
              shares
              of our common stock and improved our borrowing rate under the
              facility.
 
 On
              November 30, 2005, we called our $75.0 million of Floating Rate Senior
              Notes for
              full redemption on December 30, 2005. The terms of the indenture for
              the
              Floating Rate Senior Notes required the payment of a price of 102%
              of the
              principal amount of the notes plus accrued interest. The $75.0 million
              of
              Floating Rate Senior Notes were fully redeemed on December 30, 2005.
              We utilized
              borrowings of $38.0 million under our Amended Revolving Credit Facility
              and
              $38.9 million of our cash on hand to fund the redemption of the Floating
              Rate
              Senior Notes. As a result of the redemption, a loss on early extinguishment
              of
              debt of $2.9 million will be recorded in the first quarter of fiscal
              2006.
 
 During
              fiscal 2005, we resolved substantially all of the claims submitted
              in the *Dexatrim* PPA
              settlement and now estimate that the total cost of the *Dexatrim* settlement will be approximately $56.0 million. A total of $70.9 million
              has
              been funded into a settlement trust by our insurers and the product
              manufacturer
              and is available to pay claims in the settlement. Any funds remaining
              in the
              settlement trust after all claims and expenses of the trust have been
              paid will
              be distributed as approved by the court in accordance with the class
              action
              settlement agreement and our settlement agreements with each of Kemper
              Indemnity
              Insurance Company and the product manufacturer. We currently expect
              that after
              all claims and expenses of the settlement trust have been paid, we
              could recover
              up to approximately $8.5 million from the settlement trust. If realized,
              this
              potential recovery is estimated to occur in the first half of fiscal
              2006. We
              currently do not expect to record any additional charges relative to
              the
              settlement of the PPA litigation, except for legal expenses that will
              be
              recorded in the period incurred. During the fourth quarter of fiscal
              2005, we
              incurred and recorded $0.3 million of legal expenses related to the *Dexatrim* litigation.
  During
              the
              third quarter of fiscal 2005, we entered into a settlement agreement
              with the
              DELACO Company (“DELACO”), successor by merger to the Thompson Medical Company,
              Inc., which owned the *Dexatrim* brand
              prior to December 21, 1998 (the “DELACO Agreement”). Pursuant to the DELACO
              Agreement, we will assume responsibility for all claims against DELACO
              and its
              predecessor, Thompson Medical Company, Inc., or us relating to *Dexatrim* products
              involving an injury date after December 21, 1998 and will hold the
              DELACO
              bankruptcy estate harmless from any such claims. In exchange, a settlement
              trust
              to be established under DELACO’s bankruptcy plan will pay us $8.75 million and
              will assume responsibility for all claims
  4
 related
              to
*Dexatrim* products alleging injury dates on or before December 21,
              1998.
              The DELACO Agreement was approved by the bankruptcy court in the DELACO
              bankruptcy on July 28, 2005. The DELACO Agreement and our receipt of
              $8.75
              million from the DELACO settlement trust is conditioned upon final
              confirmation
              and approval of the DELACO bankruptcy plan and funding of the DELACO
              settlement
              trust by the insurance companies and other parties obligated to fund
              the
              trust.  At the confirmation hearing on February 15, 2006, the bankruptcy
              court indicated that it would enter an order confirming the DELACO
              bankruptcy
              plan. Absent any appeals being filed, the order confirming the plan
              would become
              final ten days after the bankruptcy court enters the order. Substantial
              funding
              of the DELACO settlement trust is due to occur on or before March 13,
              2006.
              Counsel for DELACO announced at the confirmation hearing that the effective
              date
              of the plan is anticipated to be March 13, 2006. On the effective date,
              we will
              be released from all liability from holders of Dexatrim claims with
              injury dates
              prior to December 21, 1998, and if the settlement trust is funded as
              anticipated, we expect to receive a payment of $8.75 million before
              the end of
              March 2006.
  In
              the
              first quarter of fiscal 2005, we sold our *Selsun* business
              in certain countries in Africa and Asia to The Mentholatum Co., Inc.
              We maintain
              our rights to *Selsun* elsewhere
              in the world (except India). The divested territory was not compatible
              with our
              strategic goals for the remainder of our international *Selsun* operations and contributed only $1.3 million in net sales in fiscal
              2004.
 
 On
              November 30, 2005, we sold the pHisoderm line of skin care products
              to The
              Mentholatum Co., Inc. for a purchase price of $8.5 million plus inventories
              of
              approximately $1.1 million. Of the $2.9 million initially held in escrow
              subject
              to certain post-closing conditions, only $0.3 million remained in escrow
              as of
              February 17, 2006. The transaction allowed us to divest a brand that
              was no
              longer consistent with our brand strategy and enables us to focus our
              financial
              and management resources on our leading brands. pHisoderm generated
              a total of
              $10.5 million of net sales in fiscal 2005. As a result of this transaction,
              we
              recorded a loss on product divestures of $8.7 million in the fourth
              quarter of
              fiscal 2005.
 
 ***Products***
 
 We
              currently market a diverse and broad portfolio of branded OTC healthcare
              products, toiletries and dietary supplements in such categories as
              topical
              analgesics, medicated skin care products, medicated dandruff shampoos,
              dietary
              supplements and other OTC and toiletry products. Our branded products
              by
              category consist of:
 
 
 **Category
                        and Brands**
                    **Product
                        Description*****Topical
                        Analgesics****Icy
                        Hot*
                    Dual
                        action muscular and arthritis pain reliever*Aspercreme*
                    Odor-free
                        arthritis pain reliever*Flexall*
                    Aloe-vera
                        based pain reliever*Capzasin*
                    Deep
                        penetrating, odor-free arthritis pain reliever*Sportscreme*
                    Odor-free
                        muscular pain reliever*Arthritis
                        Hot*
                    Value-priced
                        arthritis pain reliever***Medicated
                        Skin Care Products****Gold
                        Bond*
                    Medicated
                        powder, cream, lotion, first aid and foot care products***Medicated
                        Dandruff Shampoos****Selsun
                        Blue*
                    Medicated
                        dandruff shampoos and conditioner*Selsun
                        Salon*
                    Medicated
                        dandruff shampoos with enhanced moisturizers and nutrients***Dietary
                        Supplements****Dexatrim*
                    Diet
                        pills*Garlique*
                    Cholesterol
                        health supplement*Melatonex*
                    Sleep
                        aid*New
                        Phase*
                    Menopausal
                        supplement*Omnigest
                        EZ*
                    Digestive
                        aid***Other
                        OTC and Toiletry Products******Internal
                        Analgesics****Pamprin*
                    Menstrual
                        pain reliever*Prēmsyn**PMS*
                    Premenstrual
                        pain reliever***Seasonal****Bullfrog*
                    Waterproof
                        sunblocks
  5
  *Sun-In*
                    Spray-on
                        hair lightener*UltraSwim*
                    Chlorine-removing
                        shampoo and conditioner***Oral
                        Care****Herpecin-L*
                    Cold
                        sore lip treatment*Benzodent*
                    Denture
                        pain relief cream***Other****Mudd*
                    Facial
                        Masque
 
 ***Topical
              Analgesics***
 
 Our
              topical analgesic 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 the
              first
              quarter of fiscal 2006, we will extend the *Icy
              Hot* brand
              into the elastics support category with *Icy
              Hot Pro-Therapy* ,
              a new
              product line which combines strong knee or back support with therapeutic
              pain
              relieving inserts. *Icy
              Hot Pro-Therapy* began
              shipping to the retail trade in late January, 2006. The new product
              line will be
              supported with advertising featuring Shaquille O'Neal and Olympic Gold
              Medalist
              and World Cup soccer champion Mia Hamm.
 
 *Aspercreme* provides
              odor-free pain relief for sufferers of arthritis and other joint and
              muscle
              pain. *Capzasin* is an
              arthritis pain reliever that contains capsaicin, the active ingredient
              that
              doctors and pharmacists recommend most for arthritis sufferers. In
              the first
              quarter of 2006, we will launch a new back and body patch under our *Capzasin* brand. *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 chronic back pain or muscle strain. *Arthritis
              Hot* rounds
              out the portfolio and is positioned against private label products
              at a value
              price.
 
 We
              support
              our topical analgesic brands with extensive national television and
              radio
              advertising as well as targeted consumer promotions.
 
 
 ***Medicated
              Skin Care Products***
 
 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 during the first quarter of fiscal 2005. *Gold
              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 2005, we continued efforts to expand our presence
              in the
              foot care category through advertising and promotional support of our
              foot
              powder, foot spray and foot cream business.
 
 The *Gold
              Bond* product
              line is heavily supported by national television, print and radio advertising
              throughout most of the year as well as with consumer promotions such
              as sampling
              and coupons to further drive awareness and trial. We believe *Gold
              Bond* continues
              to represent a solid opportunity for growth both through our existing
              medicated
              product lines and the introduction of line extensions under the *Ultimate* line.
 
 ***Medicated
              Dandruff Shampoos***
 
 Domestic
              net sales of our medicated dandruff shampoos have continued to grow
              significantly following our acquisition of the *Selsun
              Blue* brand in
              2002. We attribute the resurgence and continuing strength of this 50+
              year old
              medicated shampoo brand to the development and implementation of an
              effective
              advertising campaign, expansion of the brand’s appeal to a broader consumer
              base, increased media and promotional support and expanded distribution.
              Virtually all aspects of the brand image have been enhanced since 2002,
              including the product, packaging, advertising, media and retail distribution.
 
 *Selsun
              Blue* offers
              four domestic shampoo formulations: medicated, with a unique cooling
              clean feel;
              moisturizing, with aloe and moisturizers; 2-in-1, with a patented conditioning
              system; and pH balanced for color treated hair. Each formula blends
  6
 the
              active
              medication (selenium sulfide) with extra hair care properties to provide
              alternative formulas for individuals who need a medicated dandruff
              shampoo.
 
 In
              the
              fourth quarter of fiscal 2005, we began shipping *Selsun
              Salon* ,
              a
              maximum dandruff control shampoo with enhanced moisturizers and nutrients.
              All *Selsun*  *Salon* products
              are formulated with a unique blend of salon quality moisturizers, vitamins
              and
              nutrients to provide great looking hair and the proven dandruff ingredient
              pyrithione zinc 1% for effective dandruff control. *Selsun
              Salon* is
              available in four formulas to accommodate varying hair types of the
              dandruff
              shampoo consumer: Classic - for normal hair; 2-in-1 - for dry or damaged
              hair;
              Volumizing - for thinning or fine hair; and Moisturizing - for hair
              that needs
              extra conditioning.
 
 We
              believe
              that growth opportunities remain for both *Selsun
              Blue* and new *Selsun*  *Salon* and we
              will continue to support both segments of our business with extensive
              national
              television and radio advertising as well as targeted consumer
              promotions.
 
 ***Dietary
              Supplements***
 
 *Dexatrim* is a
              leading brand in the diet pill category. *Dexatrim* diet
              pills are available in two forms: *Dexatrim* Natural,
              and, new to the brand in 2005, *Dexatrim* MAX. *Dexatrim* Natural,
              a drug-free, all-natural dietary supplement, is available in green
              tea,
              caffeine-free and extra energy versions. The newly launched *Dexatrim* Max has
              been a strong positive addition to the line and contains Vitamin B
              Complex,
              Ginseng, Chromium and EGCG from Green Tea *.*  *Dexatrim*  *Max* was
              introduced to consumers through television advertising and Sunday newspaper
              coupons. The initial success of *Dexatrim*  *Max* has
              provided a platform for a unique new diet product, *Dexatrim* Max 2 O,
              which
              we plan to launch in the second quarter of fiscal 2006.
 
 We
              compete
              in the dietary supplements category with our *Sunsource* line of
              products. We focus the marketing of our *Sunsource* dietary
              supplements in two key areas: cardiovascular and menopausal health.
              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 will help maintain cholesterol levels within a healthy
              range. In
              fiscal 2006, we intend to introduce a new cardiovascular health supplement
              called *Garlique*  *CardioAssist.*  *Garlique
              CardioAssist* is a
              clinically tested, odor-free dietary supplement containing an ingredient
              clinically proven to help lower total and LDL cholesterol. The proprietary
              formula also helps support normal levels of HDL cholesterol, triglycerides
              and
              homosysteines for more complete heart health. *New
              Phase* is a
              menopausal supplement that helps relieve the common discomforts of
              menopause, as
              well as providing support for strong bones and a healthy heart. All *Sunsource* products
              are specially formulated to provide consumers with an all-natural,
              drug-free way
              to support their specific health care goals.
 
 ***Other
              OTC and Toiletry Products***
 
 *Internal
              Analgesics*
 
 We
              compete
              in the menstrual analgesic category with two brands, *Pamprin* and *Prēmsyn* *PMS* . *Pamprin* ,
              featuring three 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.
              The
              target consumers for our menstrual analgesic business are women aged
              18 to 49,
              and secondarily teen girls as they first enter the category. *Pamprin* is
              available in three formulas: Multi-Symptom, Cramp and All Day. In fiscal
              2006,
              we plan to add *Pamprin*  *Max* to the
              line. *Pamprin*  *Max* is
              formulated with three active ingredients to provide maximum relief
              from
              menstrual symptoms. Awareness of the *Pamprin* brand is
              driven by network, cable and spot television advertising.
 
 *Seasonal*
 
 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. In fiscal 2005, *Bullfrog* enhanced
              its product offering for children with the introduction of *Bullfrog* Kids UV
              Defender which is available in three product forms: Fastblast Spray
              Gel, Lotion
              Spray and Surfer Gel. All three Kids UV Defender formulas remain true
              to *Bullfrog’s* waterproof and high SPF heritage. This launch was supported with print
              and radio
              advertising targeted towards mothers of children age 4 to 12. The base *Bullfrog* business
              was supported with local and national radio advertising as well as
              through event
              sponsorships and targeted sampling programs. In the first quarter of
              fiscal
              2006, we will launch *Bullfrog*  *Mosquito
              Coast* .
              This new
              product combines SPF 30 sunblock with a DEET-free insect repellent
              in a
              convenient spray form. *Bullfrog*  *Mosquito
              Coast* provides
              sun protection and mosquito repellency for up to 8 hours. We will seek
              to
              establish awareness of *Bullfrog
              Mosquito Coast* among
              active adults through a comprehensive advertising campaign including
              magazines,
              television, radio and the internet.
 
 7
 *Sun-In* ,
              a hair
              lightener, is available in two varieties of spray-on and a highlighting
              gel. *Sun-In* is
              supported by print advertising in teen magazines, an interactive web
              site and
              promotional prepacks. *UltraSwim* is our
              niche line of swimmers’ shampoos and conditioner. In addition to promotional
              prepacks, we support this brand through print advertising targeted
              at
              competitive and fitness swimmers to communicate that *UltraSwim* removes
              more chlorine from hair than ordinary shampoos.
  *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. We support *Herpecin-L* with
              national television advertising.
 
 *Other*
 
 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 10% of our
              total
              revenues in fiscal 2005, has been concentrated in Canada, an export
              market
              driven from our operations in Ireland and the U.K. and in international
              countries in which *Selsun* and
              certain of our other products are sold.
  ***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 a
              distributor 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., in which
              we engage
              national brokers.
 
 ***Europe***
 
 Our
              European business is conducted through Chattem Global Consumer Products
              Limited
              (“Chattem Global”), our Irish subsidiary, located in Limerick, Ireland, and
              Chattem (U.K.) Limited (“Chattem (U.K.)”), a wholly-owned subsidiary located in
              Basingstoke, Hampshire, England. This unit also services distributors
              in various
              other worldwide locations. 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* , *Sun-In* , *Mudd* and *UltraSwim* .
              Cornsilk ® is sold
              by Chattem (U.K.) under a licensing arrangement with the owner of its
              registered
              trademark, Del Laboratories, 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.
 
 ***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.*
 
 ***United
              States Export***
 
 Our
              United
              States export division services various distributors primarily located
              in the
              Caribbean and Latin America. We distribute *Selsun,
              Gold Bond, Dexatrim* and
              certain of our topical analgesic products into these markets.
 
 8
 ***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 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 28% of total revenues in fiscal 2005.
 
 We
              will
              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 and radio advertising and to a lesser extent
              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 new
              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.
 
 ***Customers***
 
 Our
              customers consist of mass merchandisers such as Wal-Mart Stores, Inc.,
              drug
              retailers such as Walgreens Co. and CVS Corp. and food retailers such
              as The
              Kroger Co. In fiscal 2005, our ten largest customers represented approximately
              70% of total revenues, and our 20 largest customers represented approximately
              81% of total revenues, which allows us to target our selling efforts
              to our key
              customers and customize programs to meet their needs. Our fiscal 2005
              sales to
              Wal-Mart Stores, Inc. accounted for approximately 36% of total revenues.
              No
              other customer accounts for more than 10% of our total revenues. Shoppers
              Drug
              Mart, a Canadian retailer, accounted for more than 10% of our international
              revenues in fiscal 2005. 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 sales 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
              newly acquired brands and product line extensions while maintaining
              tight
              controls over our selling expenses. Our experienced sales force of
              approximately
              45 people serves all direct buying accounts on an individual basis.
              Our internal
              sales force accounts for more than 95% of domestic sales. 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 90%
              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
              currently shipped from a leased warehouse 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
              outside carriers to transport our products. We do
  9
 not
              generally experience wide variances in the amount of inventory we maintain.
              At
              present, we have no significant backlog of customer orders and are
              promptly
              meeting customer requirements.
 
 ***Manufacturing
              and Quality Control***
 
 We
              currently manufacture approximately 60% of the sales volume of our products
              at our two Chattanooga, Tennessee, facilities. The balance of our products
              are
              manufactured by third party contract manufacturers including our *Gold
              Bond* medicated
              powders and first aid wipes, *Icy
              Hot* patches
              and sleeves, *Herpecin-L,* and
              our
              dietary supplements, including *Dexatrim* products.
              Newly acquired products that are similar to our currently manufactured
              products
              generally can be manufactured by us with the adaptation of existing
              equipment
              and facilities or the addition of new equipment at relatively small
              cost. 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 many 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.
 
 We
              currently are manufacturing all of our North American *Selsun
              Blue* products
              at our Chattanooga, Tennessee, facilities. We have entered into third
              party
              manufacturing agreements to source the international markets in which *Selsun* is
              sold.
 
 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 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. Sales of our *Pamprin* and *Prēmsyn* *PMS* products
              represented approximately 3% of our consolidated total revenues in
              fiscal 2005.
              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 for selenium
              metal, a major component in the manufacture of selenium sulfide, prices
              have
              been and are expected to be volatile. We believe that our current and
              potential
              alternative sources of supply will be adequate to meet future product
              demands.
 
 ***Product
              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
              increased emphasis on new product development as evidenced by our increased
              research and development spending, the expansion of our product development
              staff and our completion of a new 10,000 square foot research and product
              development facility in fiscal 2003. We currently employ approximately
              24
              persons 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 $3.6 million in fiscal 2005, $3.1
              million in fiscal 2004 and $2.7 million in fiscal 2003.
 
 ***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 Pfizer,
              Inc. and
              Johnson & Johnson, consumer products companies such as Procter & Gamble
              Co. and dietary supplements companies such as Nature’s Bounty, Inc. and
              Pharmaton Natural Health Products, many of which have considerably
              greater
              financial and other resources and are not as highly leveraged. 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.
 
 10
 ***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 2005, 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* and *Aspercreme* .
 
 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
              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”).
  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 dietary
              supplements including vitamins, minerals and herbs, as well as food
              additives,
              OTC and prescription drugs, medical devices and cosmetics. In addition,
              the FTC
              has primary jurisdiction to regulate the advertising of OTC drugs,
              medical
              devices, dietary supplements, functional toiletries and skin care
              products.
  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”, that 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
  11
 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.
  All
              of our
              OTC drug products are regulated pursuant to the FDA monograph system
              with the
              exception of *Pamprin* All Day,
              the subject of an abbreviated NDA held by The Perrigo Company. 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 safety or efficacy
              issue
              with respect to one of our products or finalize these monographs with
              revised
              conditions as to which of our products do not comply. If any of our
              products
              were found not to be in compliance with the final monograph, we may
              be forced to
              reformulate or relabel such products, if possible, or submit an abbreviated
              NDA
              or an abbreviated NDA to continue to market our existing formulation.
              The
              submission of a marketing application may require the preparation and
              submission
              of clinical tests, which would be time consuming and expensive. We
              may not
              receive FDA approval of any application 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 levels or labeling claims,
              unless
              we obtain pre-marketing approval from the FDA. In 2004, we launched *Pamprin* All Day
              containing the menstrual pain reliever naproxen sodium. The Perrigo
              Company
              manufactures this product for us under its existing abbreviated NDA.
              Failure to
              comply with the conditions in a final monograph or NDA, where applicable,
              could
              result in an FDA enforcement action.
  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  have
              been
              actively monitoring the process and do not believe that either *Pamprin* Menstrual
              Pain Relief or *Prēmsyn* *PMS* will be
              materially adversely affected by the FDA review. We believe that any
              adverse
              finding by the FDA would likewise affect our principal competitors
              in the
              menstrual product category and that finalization of the menstrual products
              monograph is not imminent. Moreover, the company has formulated alternative *Pamprin* products
              that fully comply with both the internal analgesic and menstrual product
              monographs. Sales of our *Pamprin* Menstrual
              Pain Relief and *Prēmsyn* *PMS* products
              represented approximately 3% of our consolidated total revenues in
              fiscal 2005.
  In
              early
              2005, infrequent, but serious, adverse cardiovascular events were reported
              to
              the FDA associated with patients who were prescribed a subclass of
              COX-2
              inhibitor non-steroidal anti-inflammatory drugs (“NSAID’s”) for long periods to
              relieve pain of chronic diseases such as arthritis. These products
              include
              Vioxx®, Bextra® and Celebrex®. In February 2005, the FDA held a joint advisory
              committee meeting to seek external counsel on the extent to which manufacturers
              might further warn patients of these cardiovascular risks on prescription
              product labeling, or prohibit sale of these prescription products.
              As part of
              its response on this issue, the FDA has recommended labeling changes
              for both
              the prescription and OTC NSAID’s. Well-known OTC NSAID’s such as ibuprofen and
              naproxen, which have been sold in vast quantities since the 1970s were
              affected
              by this regulatory action. Manufacturers of OTC NSAID’s were asked to revise
              their labeling to provide more specific information about the potential
              cardiovascular and gastrointestinal risks recognizing the limited dose
              and
              duration of treatment of these products. Our *Pamprin
              All Day* product,
              which contains naproxen sodium, is subject to these new labeling requirements. *Pamprin
              All Day* is
              manufactured for us by The Perrigo Company (“Perrigo”), holder of an abbreviated
              NDA for naproxen sodium. As holder of the abbreviated NDA, Perrigo
              has made the
              mandated labeling changes within the time frame required by the FDA.
              Product
              with revised labeling compliant with new FDA regulations is being shipped
              in
              February, 2006.
 
 We
              are
              also aware of the FDA's concern about the potential toxicity due to
              concomitant
              use of OTC and prescription products that contain the analgesic ingredient
              acetaminophen, an ingredient also found in *Pamprin* and *Prēmsyn
              PMS* .
              We are
              participating in an industry-wide effort to reassure the FDA that the
              current
              recommended dosing regimen is safe and effective and that proper labeling
              and
              public education by both OTC and prescription drug companies are the
              best
              policies to abate the FDA's concern. The FDA will address this issue
              in its
              effort to finalize the monograph on internal analgesic products. We
              believe the
              FDA may issue revised labeling requirements within the next year, perhaps
              prior
              to monograph closure, that will cause the industry to relabel its analgesic
              products to better inform consumers of concomitant use.
  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
  12
 OTC
              drug
              products and should be included in the FDA’s yet-to-be finalized monograph for
              external analgesics. We have met with the FDA and submitted a proposed
              protocol
              study to evaluate the efficacy of 10% trolamine salicylate as an active
              ingredient in OTC external analgesic drug products. We are working
              to develop
              alternate formulations for *Sportscreme* and *Aspercreme* in the
              event that the FDA does not consider the available clinical data to
              conclusively
              demonstrate the efficacy of trolamine salicylate when the OTC external
              analgesic
              monograph is finalized. If 10% trolamine salicylate is not included
              in the final
              monograph, we would likely be required to discontinue these products
              as
              currently formulated and remove them from the market after expiration
              of an
              anticipated grace period. If this occurred, we believe we could market
              related
              products as homeopathic products and could also reformulate them using
              ingredients included in the FDA monograph. We are uncertain as to when
              the
              monograph is likely to become final. Sales of our *Sportscreme* and *Aspercreme* products
              represented approximately 7% of our consolidated total revenues in
              fiscal
              2005.
  Certain
              of
              our topical analgesic products are currently marketed under an FDA
              tentative
              final monograph. The FDA has recently proposed that the final monograph
              exclude
              external analgesic products in patch, plaster or poultice form, unless
              the FDA
              receives additional data supporting the safety and efficacy of these
              products.
              On October 14, 2003, we submitted to the FDA information regarding
              the safety of
              our *Icy
              Hot* patches
              and arguments to support our product’s inclusion in the final monograph. We have
              also participated in an industry-wide effort coordinated by Consumer
              Healthcare
              Products Association (“CHPA”) to establish with the FDA a protocol of additional
              research that will allow the patches to be marketed under the final
              monograph
              even if the final monograph does not explicitly allow them. The CHPA
              submission
              to the FDA was made on October 15, 2003. Thereafter, in April 2004,
              we launched
              the *Icy
              Hot* Sleeve, a
              flexible, non-occlusive fabric patch with 16% menthol. In February,
              2006 we
              launched the *Icy
              Hot Pro-Therapy* Medicated
              Foam Pad with Knee Wrap containing 5% menthol, and the *Capzasin* Back
&
              Body Patch containing 0.025% capsaicin. All of these drug products
              contain
              levels of active ingredients consistent with the levels permitted in
              the OTC
              monograph. If additional research is required either as a preliminary
              to final
              FDA monograph approval and/or as a requirement of future individual
              product
              sale, we may need to invest in a considerable amount of expensive testing
              and
              data analysis. Any preliminary cost may be shared with other patch
              manufacturers. Because the submissions made into the FDA docket have
              been
              forwarded from its OTC Division to its Dermatological Division within
              the Center
              for Drug Evaluation and Research (“CDER”), we believe that the monograph is
              unlikely to become final and take effect before mid-2007 and perhaps
              thereafter.
              If neither action described above is successful and the final monograph
              summarily excludes such products, we will have to file an NDA in order
              to
              continue to market the *Icy
              Hot* and *Aspercreme* patches, *Icy
              Hot* Sleeve,
              Icy *Hot
              Pro-Therapy* Medicated
              Pad with Knee Wrap, *Capzasin* Back
& Body Patch, and/or similar delivery systems under our other topical
              analgesic brands. In such case, we would have to remove the existing
              products
              from the market likely 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 18 months and would be expensive. It typically
              takes the
              FDA at least 12 months to rule on an NDA once it is submitted. Sales
              of our *Icy
              Hot* and *Aspercreme* patches
              and *Icy
              Hot* Sleeve
              products represented approximately 13% of our consolidated total revenues
              in
              fiscal 2005.
  During
              the
              finalization of the monograph on sunscreen products the FDA chose to
              hold in
              abeyance specific requirements relating to the characterization of
              a product’s
              ability to reduce UVA radiation. A final ruling on this matter would
              be expected
              to result in new UVA testing requirements and subsequent labeling changes
              related to sun protection factor, or SPF, ratings, and other labeling
              claims. We
              expect that the FDA may take action on this matter within the next
              six months.
              If implemented, the final rules would likely result in new testing
              requirements
              and revised labeling of our *Bullfrog* product
              line, and all of our competitors’ products in the suncare category, within one
              year after issuance of the final rules.
  The
              FDA
              also regulates the research, testing, manufacturing, safety, labeling,
              storage,
              recordkeeping, pre-market clearance or approval, promotion, distribution
              and
              production of medical devices in the United States to ensure that medical
              products distributed domestically are safe and effective for their
              intended
              uses. Under the FDC Act, medical devices are classified into one of
              three
              classes (Class I, Class II or Class III) depending on the degree of
              risk
              associated with each medical device and the extent of control needed
              to ensure
              safety and effectiveness. Our *Icy
              Hot Pro-Therapy* Knee and
              Back Brace and the *Icy
              Hot Pro-Therapy* Disposable Cold and Hot Packs are Class I devices.
  Class
              I
              devices are subject to the lowest level of regulatory scrutiny because
              they are
              considered low risk devices. FDA requires Class I devices to comply
              with its
              General Controls, which include compliance with the applicable portions
              of the
              FDA’s Quality System Regulation, or QSR, facility registration and product
              listing, reporting of adverse medical events, and use of appropriate
              truthful
              and non-misleading labeling, advertising, and promotional materials.
              Most Class
              I devices are not required to submit 510(k) pre-market notifications
              (so-called
“Class I Exempt”), but all are subject to FDA’s general misbranding and
              adulteration prohibitions. Both the *Icy
              Hot Pro-Therapy* Back and
              Knee Brace and the *Icy
              Hot Pro-Therapy* Disposable Cold and Hot Packs are subject to regulations which exempt
              them from
              the 510(k) pre-market notification requirements.
  13
 The
              FDA
              may disagree with our conclusion that clearances or approvals for such
              devices
              were not required or may require clearance or approval for future modifications
              of these or other devices. Such submissions may be time consuming and
              costly and
              may not ultimately be cleared or approved by FDA. If the FDA determines
              that we
              have failed to comply with applicable regulatory requirements, it can
              impose a
              variety of enforcement actions which could include public warning letters,
              fines, injunctions, consent decrees, civil penalties, suspension or
              delayed
              issuance of approvals or seizure or recall of our products. The FDA
              could also
              require us to repair, replace, or refund the cost of devices that we
              manufactured or distributed.
  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.
 
 Dietary
              supplement products may include truthful, non-misleading and substantiated
              statements of nutritional support.  Examples of such claims are
              statements describing general well-being resulting from consumption
              of a dietary
              ingredient or the role of a nutrient or dietary ingredient in affecting
              or
              maintaining a structure or function of the body.  These claims
              are also known as "structure/function" claims.  FDA requires companies
              which include structure/function claims on their labeling to notify the
              agency of the claim within 30 days of first marketing the dietary
              supplement with the identified claims.  FDA does not typically respond to
              these notifications, but could issue a "courtesy letter" should the
              agency
              question some aspect of the submission.  A dietary supplement that includes
              a structure/function claim on its labeling is also required to include
              a
              disclaimer stating that the FDA has not evaluated the claim.  FDA
              distinguishes between structure/function claims which do not require
              FDA
              pre-approval and disease-related health claims which require FDA prior
              approval
              or the issuance of an authorizing regulation.
  A
              product
              marketed as a dietary supplement and subsequently approved for use
              as a drug or
              biologic may continue to be sold and regulated as a dietary supplement
              unless
              the FDA specifically finds that it is unsafe for use as a dietary supplement.
              A
              substance that has not been marketed as a dietary supplement prior
              to its
              approval as a drug or biologic, or prior to initiation of substantial
              clinical
              investigations for such uses, may be sold as a dietary supplement only
              pursuant
              to an FDA regulation authorizing its use as a dietary supplement.
  The
              FDA
              may take enforcement action against a dietary supplement if the FDA
              believes the
              supplement presents a significant or unreasonable risk of illness or
              injury
              under conditions of use suggested in the labeling or under ordinary
              conditions
              of use. Under DSHEA, the FDA bears the burden of proof to show that
              a dietary
              supplement presents a significant or unreasonable risk of illness or
              injury. The
              FDA may also take enforcement action for unlawful promotion of a dietary
              supplement.
  The
              FDA
              has finalized some of its regulations to implement DSHEA including
              those
              relating to nutritional labeling requirements and nutritional support
              claims.
              The FDA also has under development additional regulations and guidelines
              to
              implement DSHEA. Newly adopted and future regulations may require expanded
              or
              different labeling for our dietary supplements. We cannot determine
              what effect
              these regulations, when fully implemented, will have on our business
              in the
              future. These regulations could require the reformulation or discontinuance
              of
              certain products, additional recordkeeping, warnings, notification
              procedures
              and expanded documentation of the properties of certain products and
              scientific
              substantiation regarding ingredients, product claims and safety. Failure
              to
              comply with applicable FDA requirements can result in sanctions being
              imposed on
              us or the manufacture of our products including, but not limited to,
              warning
              letters, product recalls and seizures, injunctions or criminal
              prosecution.
  The
              FDA
              has promulgated regulations relating to the manufacturing process for
              drugs,
              which are known as current GMP’s. We anticipate that the FDA will promulgate
              GMP’s, which are specific to dietary supplements and require at least some
              of
              the quality control provisions contained in the GMP’s for drugs, which are more
              rigorous than the GMP’s for foods. We source all of our dietary supplement
              products from outside suppliers, including *Dexatrim,
              New Phase, Garlique, Melatonex, CardioAssist,* 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 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
  14
 orders
              or 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
              1994,
              the Nonprescription Drug Manufacturers Association (now CHPA) initiated
              a large
              scale study in conjunction with the Yale University School of Medicine
              to
              investigate a possible association, if any, of stroke in women aged
              18 to 49
              using PPA, formerly the active ingredient in certain of our *Dexatrim* products
              (the “Yale Study”). PPA is also used in other OTC medications, which were also
              part of the study. In May 2000, the results of the Yale Study were
              filed with
              the FDA. The investigators concluded that the results of the Yale Study
              suggest
              that PPA increases the risk of hemorrhagic stroke. The FDA indicated
              at that
              time that no immediate action was required and scheduled an FDA advisory
              panel
              to meet in October 2000 to discuss the results of this study.
  In
              October
              2000, a Nonprescription Drugs Advisory Committee commissioned by the
              FDA to
              review the safety of PPA, determined that there is an association between
              PPA
              and hemorrhagic stroke and recommended that PPA not be considered generally
              recognized as safe for OTC use as a nasal decongestant or for weight
              control. In
              response to a request from the FDA to voluntarily cease marketing *Dexatrim* with PPA,
              we announced on November 7, 2000 our decision to immediately cease
              shipping *Dexatrim* with PPA
              and to accept product returns from any retailers who decide to discontinue
              marketing *Dexatrim* with PPA.
              We have been subject to a number of lawsuits arising from our *Dexatrim* with PPA
              product most of which are being resolved through the class action settlement
              of
              all *Dexatrim* PPA
              claims
              described below. See “Legal Proceedings”.
  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. Although we discontinued the manufacturing
              and
              shipment of *Dexatrim* containing ephedrine in September 2002, the FDA’s final rule may result in
              lawsuits in addition to those we currently have being filed against
              us alleging
              damages related to the use or purchase of *Dexatrim* containing ephedrine. See “Legal Proceedings”. In April 2005, a Utah federal
              court called into question the 2004 final rule. The court decision
              is being
              appealed and may have an effect on FDA’s enforcement of the ephedrine alkaloid
              final rule.
  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 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 US Territories). *Bullfrog*  *Mosquito
              Coast* received
              approval from all states and the EPA prior to launch. Further, the
              FDA has
              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 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
  15
 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. Sales of our *Bullfrog* Superblock products represented approximately 1% of our consolidated
              total
              revenues in fiscal 2005.
  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 the
              company registered as a medical device manufacturer with FDA. It might
              be
              expected that we could be audited as a new device manufacturer under
              medical
              device GMP’s. Working 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 the
              future, manufacturers of dietary supplements may be mandated by the
              FDA to
              comply with more rigorous GMPs as well as post-marketing responsibilities
              similar to those applied to OTC drugs or medical devices. Such regulations
              may
              include mandatory adverse event reporting requirements as part of new
              GMP’s
              regulations.
  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 handling, disposal,
              and
              environmental exposure of the insect repellent, IR-3535, is strictly
              regulated
              by EPA under the Clean Waters Act. We intend to make a capital investment
              in
              waste treatment of IR-3535 in July, 2006, while in the interim carefully
              controlling and monitoring effluent levels. Any failure to comply with
              the
              regulations with respect to the use of IR-3535 might result in EPA
              action
              against us, including fines or injunctive action.
 
 ***Legal
              Proceedings***
 
 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 Jacobs 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.
  16
 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. After the final judgment was entered, two parties who had
              objected
              to the settlement filed appeals challenging and seeking to set aside
              the final
              judgment. Both of these appeals have now been dismissed.
  The *Dexatrim* PPA
              settlement includes claims against us involving alleged injuries by *Dexatrim* products
              containing PPA in which the alleged injury occurred after December
              21, 1998, the
              date we acquired the *Dexatrim* brand. In
              accordance with the terms of the class action settlement agreement,
              we
              previously published notice of the settlement and details as to the
              manner in
              which claims could be submitted. The deadline for submission of claims
              was July
              7, 2004. A total of 391 claims were certified by the court as timely
              submitted.
              Of these 391 claims, 173 alleged stroke as an injury and 218 alleged
              other
              non-stroke injuries. Of the 391 total claims, only 371 claimants actually
              had
              alleged injuries that occurred after December 21, 1998 and continued
              to pursue
              their claims in the settlement. The remaining claimants have either
              withdrawn
              their claims or cannot be located. 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 nine of the opt out claims.
              The five
              remaining opt out claimants may pursue claims for damages against us
              in separate
              lawsuits. As of February 17, 2006, two of the five remaining opt out
              claimants
              have filed lawsuits against us that we are continuing to defend.
  We
              previously reached an agreement with Kemper Indemnity Insurance Company
              ("Kemper") to settle its lawsuit that sought to rescind our policy
              for $50.0
              million of excess coverage for product liability claims. After giving
              effect to
              the settlement with Kemper, we have available for the claims against
              us related
              to the PPA litigation, through our first three layers of insurance
              coverage,
              approximately $60.9 million of the $77.0 million of product liability
              coverage
              provided by these insurance policies. The $60.9 million of available
              coverage
              consists of $37.5 million of insurance under the Kemper policy and
              approximately
              $23.4 million under policies with two other insurance companies. In
              accordance
              with the terms of the class action settlement agreement, this $60.9
              million of
              coverage has been funded into a settlement trust. In addition, on July
              14, 2004,
              we entered into a settlement agreement with Sidmak Laboratories, Inc.
              (“Sidmak”), the manufacturer of *Dexatrim* products
              containing PPA, pursuant to which Sidmak has contributed $10.0 million
              into the
              settlement trust. We have also entered into a settlement agreement
              with
              Interstate Fire & Casualty Company (“Interstate”) with regard to its $25.0
              million of coverage in excess of the insurance funds available in the
              settlement
              trust.
  During
              fiscal 2005, we resolved substantially all of the claims submitted
              in the *Dexatrim* PPA
              settlement and now estimate that the total cost of the *Dexatrim* settlement will be approximately $56.0 million. As indicated above,
              a total of
              $70.9 million has been funded into a settlement trust by our insurers
              and Sidmak
              and is available to pay claims in the settlement. Any funds remaining
              in the
              settlement trust after all claims and expenses of the trust have been
              paid will
              be distributed as approved by the court in accordance with the class
              action
              settlement agreement and our settlement agreements with each of Kemper
              and
              Sidmak. We currently expect that after all claims and expenses of the
              settlement
              trust have been paid, we could recover up to approximately $8.5 million
              from the
              settlement trust. If realized, this potential recovery is estimated
              to occur in
              the first half of fiscal 2006. We currently do not expect to record
              any
              additional charges relative to the settlement of the PPA litigation,
              except for
              legal expenses that will be recorded in the period incurred. During
              the fourth
              quarter of fiscal 2005, we incurred and recorded $0.3 million of legal
              expenses
              related to the *Dexatrim* litigation.
  We
              are
              also named as a defendant in approximately 206 lawsuits relating to *Dexatrim* containing PPA which involve alleged injuries by *Dexatrim* products
              containing PPA manufactured and sold prior to our acquisition of *Dexatrim* on
              December 21, 1998. In these lawsuits, we are being defended on the
              basis of
              indemnification obligations assumed by The DELACO Company (“DELACO”), successor
              by merger to the Thompson Medical Company, Inc., which owned the brand
              prior to
              December 21, 1998. On February 12, 2004, DELACO filed a Chapter 11
              bankruptcy
              petition in the United States Bankruptcy Court for the Southern District
              of New
              York. Accordingly, it is uncertain whether DELACO will be able to indemnify
              us
              for claims arising from products manufactured and sold prior to our
              acquisition
              of *Dexatrim* on
              December 21, 1998. However, DELACO is seeking to resolve all *Dexatrim* cases
              with injury dates prior to December 21, 1998 as part of a liquidating
              Chapter 11
              bankruptcy plan. We understand that DELACO’s product liability insurance
              carriers and other sources are expected to fund this plan. We have
              filed a claim
              in DELACO’s bankruptcy case in order to preserve our claims for indemnification
              against DELACO.
  In
              order
              to resolve DELACO’s indemnity obligations to us, we have entered into a
              settlement agreement with DELACO dated June 30, 2005 (“the DELACO Agreement”).
              Pursuant to the DELACO Agreement, we will assume responsibility for
              all claims
              against DELACO and its predecessor, Thompson Medical Company, Inc.,
              or us
              relating to *Dexatrim* products
              involving an injury date after December 21, 1998, and will hold the
              DELACO
              bankruptcy estate harmless from any such claims. In exchange, a settlement
              trust
              to be established under DELACO’s bankruptcy plan will pay us $8.75 million and
              will assume responsibility for
  17
 all
              claims
              related to *Dexatrim* products alleging injury dates on or before
              December 21, 1998. Upon the effective date of the bankruptcy plan,
              we expect
              that the plan will release us from all liability from holders of
*Dexatrim* claims with injury dates prior to December 21, 1998, whether
              brought by an injured party or a co-defendant to a *Dexatrim* products
              liability case. We expect all claims with injury dates prior to December
              21,
              1998 to be channeled to the DELACO settlement trust, which we expect
              to come
              into existence and be funded prior to the effective date of the DELACO
              bankruptcy plan. This payment and the channeling injunction and release
              described above will conclusively compromise and settle our previously
              filed
              claim in the DELACO bankruptcy case. The DELACO Agreement was approved
              by the
              bankruptcy court in the DELACO bankruptcy on July 28, 2005. The DELACO
              Agreement
              and our receipt of $8.75 million from the DELACO settlement trust is
              conditioned
              upon final confirmation and approval of the DELACO bankruptcy plan,
              and funding
              of the DELACO settlement trust by the insurance companies and other
              parties
              obligated to fund the trust.  At the confirmation hearing on February 15,
              2006, the bankruptcy court indicated that it would enter an order confirming
              the
              DELACO bankruptcy plan. Absent any appeals being filed, the order confirming
              the
              plan would become final ten days after the bankruptcy court enters
              the order.
              Substantial funding of the DELACO settlement trust is due to occur
              on or before
              March 13, 2006. Counsel for DELACO announced at the confirmation hearing
              that
              the effective date of the plan is anticipated to be March 13, 2006.
              On the
              effective date, we will be released from all liability from holders
              of Dexatrim
              claims with injury dates prior to December 21, 1998, and if the settlement
              trust
              is funded as anticipated, we expect to receive a payment of $8.75 million
              before
              the end of March 2006.
  Our
              product liability insurance, as described above, would not apply to
              claims
              arising from products manufactured and sold prior to our acquisition
              of *Dexatrim* .
              If the
              DELACO bankruptcy plan does not resolve these cases as we expect, we
              will also
              seek to defend ourselves in these lawsuits on the basis that we did
              not
              manufacture and sell products containing PPA prior to December 21,
              1998. In the
              approximately 206 cases that have been filed against us for products
              manufactured and sold prior to December 21, 1998, approximately half
              of the
              plaintiffs are in cases filed in states that we believe do not under
              current law
              impose liability upon a successor. The remaining plaintiffs are in
              cases filed
              in states that may in some circumstances permit liability against a
              successor.
              Even in these cases, although there can be no assurances, we do not
              believe that
              successor liability would be imposed against us. The reasons for our
              belief,
              among others, are that we did not purchase all of DELACO’s assets and DELACO
              continued to operate its remaining business after December 21, 1998;
              we did not
              cause DELACO’s bankruptcy; and many plaintiffs included in cases filed in states
              that in some circumstances impose successor liability are actually
              residents of
              other states. If the DELACO bankruptcy plan is confirmed with the terms
              required
              by the DELACO Agreement, we will be released from potential liability
              in these
              cases.
  We
              maintain a significantly lower level of insurance coverage for all
              other
              potential product liability claims relating to our products, including *Dexatrim* products
              containing ephedrine. Our existing product liability insurance coverage
              for all
              of our other products, including *Dexatrim* products
              containing ephedrine, consists of $20.0 million of coverage through
              our captive
              insurance subsidiary, of which approximately $5.5 million is funded
              as of
              February 17, 2006, and a total of $30.0 million of excess coverage
              through third
              party insurers. We are currently defending two lawsuits related to *Dexatrim* containing ephedrine.
 
 On
              December 30, 2003, the United States Food and Drug Administration ("FDA")
              issued
              a consumer alert on the safety of dietary supplements containing ephedrine
              alkaloids and on February 6, 2004 published a final rule with respect
              to these
              products. The final rule prohibits the sale of dietary supplements
              containing
              ephedrine alkaloids because such supplements present an unreasonable
              risk of
              illness or injury. The final rule became effective on April 11, 2004.
              Although
              we discontinued the manufacturing and shipment of *Dexatrim* containing ephedrine in September 2002, the FDA's final rule may result
              in
              additional lawsuits being filed against us alleging damages related
              to the use
              or purchase of *Dexatrim* containing ephedrine.
  We
              have
              been named as a defendant in a putative class action suit filed in
              the Superior
              Court of the State of California for the County of Los Angeles on February
              11,
              2004. The lawsuit seeks certification of classes consisting of residents
              of the
              United States, or residents of the State of California, who have purchased
              our *Bullfrog* sun
              care
              products during the past four years. The lawsuit seeks injunctive relief
              and
              compensatory damages under the California Business and Professions
              Code against
              us arising out of alleged deceptive, untrue or misleading advertising,
              and
              breach of warranty, in connection with the manufacturing, labeling,
              advertising,
              promotion and sale of *Bullfrog* products.
              The plaintiff has stipulated that the amount in controversy with respect
              to
              plaintiff’s individual claim and each member of the proposed class does not
              exceed $75,000. We filed an answer on June 28, 2004 and are vigorously
              defending
              the lawsuit.
  We
              have
              been named as a defendant in a putative class action suit filed in
              the Superior
              Court of the State of California, County of Los Angeles, on January
              13, 2005.
              The lawsuit seeks injunctive relief, compensatory damages and attorney
              fees
              against us under the California Business and Professions Code, arising
              out of
              alleged deceptive, untrue or misleading advertising and breach of express
              warranty in connection with the manufacturing, labeling, advertising,
              promotion
              and sale of certain *Dexatrim* Natural
              products. The lawsuit seeks certification of a class consisting of
              all persons
              who purchased *Dexatrim* Natural
              in California during the four year period prior to the filing of the
              lawsuit up
              to the date of any judgment obtained. The
  18
 plaintiff
              has stipulated that the amount in controversy with respect to each
              individual
              claim and each member of the proposed class in the action does not
              exceed
              $75,000. We filed an answer on March 1, 2005 and are vigorously defending
              the
              lawsuit.
  Other
              claims, suits and complaints arise in the ordinary course of our business
              involving such matters as patents and trademarks, product liability,
              environmental matters, employment law issues and other alleged injuries
              or
              damage. The outcome of such litigation cannot be predicted, but, in
              the opinion
              of management, based in part upon assessments from counsel, all such
              other
              pending matters are without merit or are of such kind or involve such
              other
              amounts as would not have a material adverse effect on our financial
              position,
              results of operations or cash flows if disposed of unfavorably.
  ***Product
              Liability and Insurance***
 
 Our
              product liability insurance for claims asserted in the *Dexatrim* PPA
              litigation is provided by third party insurers. We previously reached
              an
              agreement with Kemper to settle Kemper’s lawsuit that sought to rescind our
              policy for $50.0 million of excess coverage for product liability claims.
              After
              giving effect to the settlement with Kemper, we have available through
              our first
              three layers of insurance coverage, approximately $60.9 million of
              the $77.0
              million of product liability coverage provided by these policies. These
              $60.9
              million of available funds consist of $37.5 million of insurance under
              the
              Kemper policy and approximately $23.4 million under policies with two
              other
              insurance companies. As noted above, this $60.9 million of coverage
              has been
              funded into a settlement trust in accordance with the terms of the
              class action
              settlement agreement. We have also entered into a settlement agreement
              with
              Interstate with regard to its $25.0 million of coverage in excess of
              the
              insurance funds available in the settlement trust.
 
 Currently,
              we maintain a significantly lower level of insurance coverage for all
              other
              potential product liability claims relating to our products, including *Dexatrim* products
              containing ephedrine, which consists of $20.0 million of coverage through
              our
              captive insurance subsidiary, of which approximately $5.5 million is
              funded as
              of February 17, 2006, and a total of $30.0 million of excess coverage
              through
              third party insurers.
 
 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
              provided by third parties will expire at the end of each annual policy
              period,
              currently in May 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.
 
 ***Employees***
 
 We
              employ
              approximately 414 persons on a full-time basis and 9 persons on a part-time
              basis in the United States. In addition, we employ approximately 26 persons
              at our foreign subsidiaries’ offices. Our employees are not represented by any
              organized labor union, and we consider our labor relations to be
              good.
 
 ***Financial
              Information on Products and Geographical Areas***
 
 For
              financial information on our product categories and geographical areas,
              see note
              12 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, 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.
 
 19
 **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
              may face additional lawsuits alleging injury from the use of** **Dexatrim** **products containing ephedrine, which we discontinued manufacturing
              and shipping
              in September 2002, or from other products that we currently produce
              or may
              produce in the future.**
 
 We
              are
              currently named as a defendant in two lawsuits alleging that the plaintiffs
              were
              injured as a result of the ingestion of *Dexatrim* containing
              ephedrine. On December 30, 2003, the FDA issued a consumer alert on
              the safety
              of dietary supplements containing ephedrine alkaloids and on February
              6, 2004
              published a final rule with respect to these products. The final rule
              prohibits
              the sale of dietary supplements containing ephedrine alkaloids because
              such
              supplements present an unreasonable risk of illness or injury. The
              final rule
              became effective on April 11, 2004. Although we discontinued the
              manufacturing and shipment of *Dexatrim* containing ephedrine in September 2002, the FDA’s final rule may result in
              additional lawsuits being filed against us alleging damages related
              to the use
              or purchase of *Dexatrim* containing ephedrine.
 
 Our
              available product liability coverage for the defense of lawsuits alleging
              injury
              from the use of *Dexatrim* products
              containing ephedrine, or from other products that we currently produce
              or may
              produce in the future, consists of $20.0 million of coverage through
              our captive
              insurance subsidiary, of which approximately $5.5 million is funded
              as of
              February 17, 2006, and an additional $30.0 million of excess coverage
              through
              third party insurers. In the future, if we face significant liabilities
              relating
              to the *Dexatrim* products
              which included ephedrine, our product liability insurance may be insufficient,
              and we may not have sufficient resources to satisfy these liabilities
              in excess
              of our insurance coverage.
 
 An
              inherent risk of our business is exposure to product liability claims
              by users
              of our products. We may also experience significant product liability
              exposure
              related to our other products in the future.
 
 **Our
              product liability insurance coverage may be insufficient to cover existing
              or
              future product liability claims.**
 
 Our
              business inherently makes us the potential target of product liability
              claims.
              We have product liability insurance through our captive insurance subsidiary
              and
              third party insurers that provides coverage for product liability claims.
              Our
              product liability insurance coverage for all of our products, including *Dexatrim* products
              containing ephedrine, consists of $20.0 million of coverage through
              our captive
              insurance subsidiary, of which approximately $5.5 million is funded
              as of
              February 17, 2006, and an additional $30.0 million of excess coverage
              through
              third party insurers.
 
 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
              provided by third parties will expire at the end of each annual policy
              period,
              currently in May 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
              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.
 
 20
 Any
              future
              acquisitions, or potential acquisitions, may result in substantial
              costs,
              disrupt our operations or materially adversely affect our operating
              results.
 
 **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 Pfizer, Inc. and Johnson
&
Johnson, consumer products companies such as Procter & Gamble Co. and
              dietary supplements companies such as Nature’s Bounty, Inc. and Pharmaton
              Natural Health Products, 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 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 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 demands.**
 
 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 meet consumer demands, 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.
 
 **We
              rely on a few large customers, particularly Wal-Mart Stores, Inc.,
              for a
              significant portion of our sales.**
 
 In
              fiscal
              2005, Wal-Mart Stores, Inc. represented approximately 36% of our total
              revenues,
              our ten largest customers represented approximately 70% of our total
              revenues
              and our 20 largest customers represented approximately 81% of our total
              revenues. 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.
 
 **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.**
 
 21
 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.
  **We
              rely on third party manufacturers for a portion of our product portfolio
              including products under our** ***Gold
              Bond, Icy Hot*** **,** ***Selsu*** **n
              and** ***Dexatrim*** **brands.**
 
 We
              use
              third party manufacturers to make products representing approximately
              40% of our
              fiscal 2005 sales volume, including our *Gold
              Bond* medicated
              powders and foot spray, the *Icy
              Hot* patches
              and sleeves, *Herpecin-L,* and our
              line of dietary supplements including *Dexatrim
              Max* and,
              internationally, our line of *Selsun* medicated
              dandruff shampoos. We will also rely on third party manufacturers to
              manufacture
              our *Icy
              Hot Pro-Therapy* line of
              products. In many cases, third party manufacturers are not obligated
              under
              contracts that fix the term of their commitments, and they may discontinue
              production upon 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.**
 
 Our
              trademarks are of material importance to our business and are among
              our most
              important assets. In fiscal 2005, 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* and *Aspercreme* .
              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
  22
 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
              may
              face litigation in the future, either to protect our intellectual property
              rights or to defend against claims that we have infringed the intellectual
              property rights of others. Intellectual property litigation can be
              extremely
              expensive, and such expense 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
              60% of our sales volume in fiscal 2005 was from products manufactured
              in 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. While we
              do not
              currently know of any facts or circumstances that would adversely affect
              the
              supply of pamabrom, pyrilamine maleate, compap, or selenium sulfide,
              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.**
 
 23
 In
              fiscal
              2005, approximately 10% of our total revenues were attributable to
              our
              international business. Our acquisition of *Selsun
              Blue* in
              2002
              has greatly expanded 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;
 
 •  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 as a result of the *Selsun
              Blue* acquisition, our exposure to fluctuations in foreign exchange rates
              has
              increased.
  **We
              have a significant amount of debt that could adversely affect our business
              and
              growth prospects.**
 
 As
              of
              November 30, 2005, our total long-term debt was $182.5 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.
 
 **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
              Amended Revolving Credit Facility impose operating and financial restrictions
              on
              us including restrictions on:
 
 •  incurrence
              of additional indebtedness;
 
 •  dividends
              and restricted payments;
 
 •  investments;
 
 •  loans
              and
              guarantees;
 
 24
 •  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 Amended Revolving 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.
 
 **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. Under these laws, 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 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 restated 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 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
              restated 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
 
 25
 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 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,
              including
              variations in our quarterly operating results, our leveraged financial
              position,
              potential sales of additional shares of our common stock, general trends
              in the
              consumer products industry, changes by securities analysts in their
              estimates or
              investment ratings, the relative illiquidity of our common stock, news
              regarding
              PPA-related product liability litigation and other potential product
              liability
              litigation and stock market conditions generally.
 
 **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
              repurchase our common stock and to repay our outstanding indebtedness
              and have
              no current intention of paying dividends to holders of our common
              stock.
 
 ***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.
 
 **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**
                      **Feet**Owned
                        Properties:Chattanooga,
                        Tennessee
                    12.0
                    
                    117,600
                    
                    Manufacturing
                      Office
                        & Administration
                    
                    77,000
                      40,600Chattanooga,
                        Tennessee
                    8.3
                    
                    78,500
                    
                    Manufacturing
                        & Warehousing
                      Office
                      Product
                        Development Center
                    
                    58,300
                      10,200
                      10,000Leased
                        Properties:Chattanooga,
                        Tennessee (1)
                    5.1
                    
                    139,000
                    
                    Warehousing
                      Warehousing
                        & Manufacturing
                    
                    103,800
                      35,200
  26
  Chattanooga,
                        Tennessee (2)
                    5.0
                    
                    50,000
                    
                    Warehousing
                      Office
                    
                    49,300
                      700Mississauga,
                        Ontario, Canada (3)
                    0.3
                    
                    15,069
                    
                    Warehousing
                      Office
                        & Administration
                      Packaging
                    
                    10,569
                      3,000
                      1,500Basingstoke,
                        Hampshire, England (4)
                    0.5
                    
                    12,332
                    
                    Warehousing
                      Office
                        & Administration
                    
                    9,332
                      3,000Limerick,
                        Ireland (5)
                    —
                    
                    2,100
                    
                    Office
                        & Administration
                    
                    2,100
 
 NOTES:
 
 (1)
                    Leased
                        on a month-to-month basis for a monthly rental of approximately
                        $38,000. A
                        twelve month termination notice is
                        required.
 (2)
                    Leased
                        on a month-to-month basis for a monthly rental of approximately
                        $13,000.
 (3)
                    Leased
                        on a month-to-month basis for a monthly rental of approximately
                        $9,400.
 (4)
                    Leased
                        under a lease ending in 2014 for a monthly rental of approximately
                        $14,000.
 (5)
                    Leased
                        under a lease ending in 2009 for a monthly rental of approximately
                        $3,000.
 
 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
“Legal
              Proceedings” in Item 1 of this Form 10-K and note 13 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
 
  27
 **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 quoted on the Nasdaq National 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 National Market for the periods indicated.
 
 Fiscal
                        2005:
                    
                    **High**
                    
                    **Low**First
                        Quarter
                    
                    $
                    38.08
                    
                    $
                    32.01Second
                        Quarter
                    
                    
                    45.65
                    
                    
                    36.30Third
                        Quarter
                    
                    
                    46.08
                    
                    
                    38.05Fourth
                        Quarter
                    
                    
                    39.68
                    
                    
                    31.77Fiscal
                        2004:First
                        Quarter
                    
                    $
                    23.33
                    
                    $
                    15.40Second
                        Quarter
                    
                    
                    28.65
                    
                    
                    23.71Third
                        Quarter
                    
                    
                    30.65
                    
                    
                    26.08Fourth
                        Quarter
                    
                    
                    36.22
                    
                    
                    30.31
 
 ***Holders***
 
 As
              of
              February 17, 2006, there were approximately 253 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
              Floating Rate Senior Notes were issued and by the terms of our Amended
              Revolving
              Credit Facility. (See note 5 of notes to consolidated financial statements
              in
              Item 8 “Financial Statements and Supplementary Data”.)
  ***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)9/1/05-9/30/05
                    
                    
                    
                    335,201
                    
                    $
                    37.05
                    
                    
                    335,201
                    
                    $
                    10,579,27710/1/05-10/31/05
                    
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    10,579,27711/1/05-11/30/05
                    
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    30,000,000Total
                        Fourth Quarter
                    
                    
                    
                    335,201
                    
                    $
                    37.05
                    
                    
                    355,201
                    
                    
                    30,000,000
  (1)
                    Average
                        price paid per share includes broker
                        commissions.
 
 (2)
                    In
                        January 2005, our board of directors increased the total
                        authorization to
                        repurchase our common stock under our stock buyback program
                        to $30.0
                        million. A total of $17.3 million remained available under
                        the stock
                        buyback authority prior to July 29, 2005, when our board
                        of directors
                        increased the total buyback authorization back to $30.0 million.
                        Subsequent to share purchases made in the fourth quarter
                        of fiscal 2005,
                        our board of directors again increased the total buyback
                        authorization
                        back to $30.0 million, effective November 29, 2005. There
                        is no expiration
                        date specified for our stock buyback
                        program.
  28
 **Item
              6.      Selected Financial
              Data**
 
 This
              selected financial data should be read in conjunction with 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. The following data for fiscal 2001 has
              been restated
              to give effect to the adoption of the provisions of Statement of Financial
              Accounting Standards (“SFAS”) No. 145, “Rescission of FASB Statements No. 4, 44,
              and 64, amendment of FASB Statement No. 13, and Technical Corrections” (“SFAS
              145”) on December 1, 2002 and Emerging Issues Task Force (“EITF”) Issue Nos.
              00-14 and 00-25 (codified by EITF Issue No. 01-9) on December 1,
              2001.
  **Year
                        Ended November 30,****2005**
                    
                    **2004**
                    
                    **2003**
                    
                    **2002**
                    
                    **2001**as
                        adjusted**(1)**
                    
                    as
                        adjusted**(1)**
                    
                    as
                        adjusted(**1)
                        (2)**
                    
                    as
                        adjusted**(1)
                        (2)****(dollars
                        in thousands, except per share amounts)**INCOME
                        STATEMENT DATA:Total
                        revenues
                    
                    $
                    279,318
                    
                    $
                    258,155
                    
                    $
                    233,749
                    
                    $
                    223,116
                    
                    $
                    181,166Operating
                        costs and expenses
                    
                    
                    212,830
                    
                    
                    228,292
                    
                    
                    177,849
                    
                    
                    171,540
                    
                    
                    147,937Income
                        from operations
                    
                    
                    66,488
                    
                    
                    29,863
                    
                    
                    55,900
                    
                    
                    51,576
                    
                    
                    33,229Other
                        expense, net
                    
                    
                    (13,478
                    )
                    
                    (27,709
                    )
                    
                    (20,307
                    )
                    
                    (21,406
                    )
                    
                    (8,221
                    )Income
                        before income taxes and change in accounting principle
                    
                    
                    53,010
                    
                    
                    2,154
                    
                    
                    35,593
                    
                    
                    30,170
                    
                    
                    25,008Provision
                        for (benefit from) income taxes
                    
                    
                    16,963
                    
                    
                    703
                    
                    
                    12,246
                    
                    
                    11,470
                    
                    
                    9,632Income
                        before change in accounting principle
                    
                    
                    36,047
                    
                    
                    1,451
                    
                    
                    23,347
                    
                    
                    18,700
                    
                    
                    15,376Cumulative
                        effect of change in accounting principle, net of income tax
                        benefit(3)
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    (8,877
                    )
                    
                    —Net
                        income
                    
                    $
                    36,047
                    
                    $
                    1,451
                    
                    $
                    23,347
                    
                    $
                    9,823
                    
                    $
                    15,376PER
                        SHARE DATA:Income
                        per diluted share before change in accounting principle
                    
                    $
                    1.77
                    
                    $
                    .07
                    
                    $
                    1.19
                    
                    $
                    .97
                    
                    $
                    .85Change
                        in accounting principle
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    (.46
                    )
                    
                    —Total
                        diluted
                    
                    $
                    1.77
                    
                    $
                    .07
                    
                    $
                    1.19
                    
                    $
                    .51
                    
                    $
                    .85BALANCE
                        SHEET DATA:
                      (At
                        end of year)Total
                        assets
                    
                    $
                    368,293
                    
                    $
                    372,642
                    
                    $
                    364,466
                    
                    $
                    354,574
                    
                    $
                    300,978Long-term
                        debt, less current maturities
                    
                    $
                    145,500
                    
                    $
                    200,000
                    
                    $
                    204,676
                    
                    $
                    217,458
                    
                    $
                    204,740
 
 (1)
                    The
                        selected financial data has been adjusted to reflect retroactively
                        the
                        change in method of valuing our domestic inventory from the
                        last-in,
                        first-out (“LIFO”) method to the first-in, first-out (“FIFO”) method
                        adopted in fiscal 2005.
 
 (2)
                    Share
                        amounts reflect the two-for-one split of our common stock
                        on November 29,
                        2002.
 
 (3)
                    Upon
                        adoption of SFAS 142, we obtained independent appraisals
                        to determine the
                        fair value of our indefinite lived intangible assets and
                        recorded a
                        write-down of $8.9 million in fiscal 2002, as a cumulative
                        effect of
                        change in accounting principle, net of income tax
                        benefit.
 
 **Item
              7.      Management’s Discussion and Analysis of
              Financial Condition and Results of Operations**
 
 This
              discussion and analysis contains forward-looking statements that involve
              risks,
              uncertainties and assumptions. The actual results may differ materially
              from
              those anticipated in these forward-looking statements as a result of
              a number of
              factors, including, but not limited to, those described in our filings
              with the
              Securities and Exchange Commission.
  ***Overview***
 
 We
              are a
              leading marketer and manufacturer of a broad portfolio of branded OTC
              healthcare
              products, toiletries and dietary supplements including such categories
              as
              topical analgesics, medicated skin care products, medicated dandruff
              shampoos
              and conditioner, dietary supplements, and other OTC and toiletry products.
              Our
              portfolio of products includes well-recognized brands such as:
 
 29
 •
                    Topical
                        analgesics such as*Icy
                        Hot*and*Aspercreme*;
 
 •
                    Medicated
                        skin care products such as*Gold
                        Bond*medicated skin care powder, cream, lotion, first aid, and
                        foot care
                        products;
 
 •
                    *Selsun
                        Blue*medicated dandruff shampoos and
                        conditioner;
 
 •
                    Dietary
                        supplements including*Dexatrim*,*Garlique*and*New
                        Phase*;
                        and
 
 •
                    Other
                        OTC and toiletry products such as*Pamprin*,
                        a
                        menstrual analgesic;*Herpecin-L*,
                        a
                        lip care product;*Benzodent*,
                        a
                        dental analgesic cream; and toiletries such as*Bullfrog*,
                        a
                        line of sunblocks;*UltraSwim*,
                        chlorine-removing shampoo; and*Sun-In*,
                        a
                        hair lightener.
 
 Our
              products typically target niche markets that are often outside the
              core product
              areas of larger companies where we believe we can achieve and sustain
              significant market penetration through innovation and strong advertising
              and
              promotion support. Many of our products are among the U.S. market leaders
              in
              their respective categories. For example, our portfolio of topical
              analgesic
              brands and our *Gold
              Bond* medicated
              body powders have the leading U.S. market share in these categories.
              We support
              our brands through extensive and cost-effective advertising and promotion,
              the
              expenditures for which represented approximately 28% of our total revenues
              in
              fiscal 2005. We sell our products nationally through mass merchandiser,
              drug and
              food channels principally utilizing our own sales force.
  ***Developments
              During Fiscal 2005***
 
 ***Products***
 
 In
              the
              first quarter of fiscal 2005, we introduced the following product line
              extensions: *Aspercreme* Odor-Free
              Therapy Back and Body Patch, *Gold
              Bond Ultimate* Comfort
              Powder, *New
              Phase* Extra
              Strength, *Dexatrim* Max and *Bullfrog* Kids UV
              Defender. *Selsun
              Salon* was
              introduced in the fourth quarter of fiscal 2005.
 
 ***Product
              Divestures***
 
 In
              the
              first quarter of fiscal 2005, we sold our *Selsun* business
              in certain countries in Africa and Asia to The Mentholatum Co., Inc.
              We maintain
              our rights to *Selsun* elsewhere
              in the world (except India). The divested territory was not compatible
              with our
              strategic goals for the remainder of our international *Selsun* operations and contributed only $1.3 million in net sales in fiscal
              2004.
 
 On
              November 30, 2005, we sold the pHisoderm line of skin care products
              to The
              Mentholatum Co., Inc. for a purchase price of $8.5 million plus inventories
              of
              approximately $1.1 million. Of the $2.9 million initially held in escrow
              subject
              to certain post-closing conditions, only $0.3 million remained in escrow
              as of
              February 17, 2006. The transaction allowed us to divest a brand that
              was no
              longer consistent with our brand strategy and enables us to focus our
              financial
              and management resources on our leading brands. pHisoderm generated
              a total of
              $10.5 million of net sales in fiscal 2005. As a result of this transaction,
              we
              recorded a loss on product divestures of $8.7 million in the fourth
              quarter of
              fiscal 2005.
 
 ***Debt***
 
 During
              the
              second quarter of fiscal 2005, we repurchased $17.5 million of our
              7.0% Senior
              Subordinated Notes due March 1, 2014 in the open market at an average
              premium of
              1.6% over the principal amount of the notes. The repurchases resulted
              in a loss
              on early extinguishment of debt of $0.7 million in the second quarter
              of fiscal
              2005. The outstanding balance of the remaining 7.0% Subordinated Notes
              was
              reduced to $107.5 million.
 
 On
              November 29, 2005, we entered into the Amended Revolving Credit Facility
              that,
              among other things, increased our borrowing capacity under the facility
              from
              $50.0 million to $100.0 million, increased our flexibility to repurchase
              shares
              of our stock and improved our borrowing rate under the facility.
 
 On
              November 30, 2005, we called our $75.0 million of Floating Rate Senior
              Notes for
              full redemption on December 30, 2005. The terms of the indenture for
              the
              Floating Rate Senior Notes required the payment of a price of 102%
              of the
              principal amount of the notes plus accrued interest. The $75.0 million
              of
              Floating Rate Senior Notes were fully redeemed on December 30, 2005.
              We utilized
              borrowings of $38.0 million under our Amended Revolving Credit Facility
              and
              $38.9 million of our cash on hand to fund the redemption of the Floating
              Rate
              Senior Notes. As a result of the redemption, a loss on early extinguishment
              of
              debt of $2.9 million will be recorded in the first quarter of fiscal
              2006.
 
 30
 ***Litigation***
 
 During
              fiscal 2005, we resolved substantially all of the claims submitted
              in the *Dexatrim* PPA
              settlement and now estimate that the total cost of the *Dexatrim* settlement will be approximately $56.0 million. A total of $70.9 million
              has
              been funded into a settlement trust by our insurers and the product
              manufacturer
              and is available to pay claims in the settlement. Any funds remaining
              in the
              settlement trust after all claims and expenses of the trust have been
              paid will
              be distributed as approved by the court in accordance with the class
              action
              settlement agreement and our settlement agreements with each of Kemper
              Indemnity
              Insurance Company and the product manufacturer. We currently expect
              that after
              all claims and expenses of the settlement trust have been paid, we
              could recover
              up to approximately $8.5 million from the settlement trust. If realized,
              this
              potential recovery is estimated to occur in the first half of fiscal
              2006. We
              currently do not expect to record any additional charges relative to
              the
              settlement of the PPA litigation, except for legal expenses that will
              be
              recorded in the period incurred. During the fourth quarter of fiscal
              2005, we
              incurred and recorded $0.3 million of legal expenses related to the *Dexatrim* litigation.
  During
              the
              third quarter of fiscal 2005, we entered into a settlement agreement
              with the
              DELACO Company (“DELACO”), successor by merger to the Thompson Medical Company,
              Inc., which owned the *Dexatrim* brand prior to December 21, 1998 (the
“DELACO Agreement”). Pursuant to the DELACO Agreement, we will assume
              responsibility for all claims against DELACO and its predecessor, Thompson
              Medical Company, Inc., or us relating to *Dexatrim* products involving an
              injury date after December 21, 1998 and will hold the DELACO bankruptcy
              estate
              harmless from any such claims. In exchange, a settlement trust to be
              established
              under DELACO’s bankruptcy plan will pay us $8.75 million and will assume
              responsibility for all claims related to *Dexatrim* products alleging
              injury dates on or before December 21, 1998. The DELACO Agreement was
              approved
              by the bankruptcy court on July 28, 2005. The DELACO Agreement and
              our receipt
              of $8.75 million from the DELACO settlement trust is conditioned upon
              final
              confirmation and approval of the DELACO bankruptcy plan and funding
              of the
              DELACO settlement trust by the insurance companies and other parties
              obligated
              to fund the trust.  At the confirmation hearing on February 15, 2006, the
              bankruptcy court indicated that it would enter an order confirming
              the DELACO
              bankruptcy plan. Absent any appeals being filed, the order confirming
              the plan
              would become final ten days after the bankruptcy court enters the order.
              Substantial funding of the DELACO settlement trust is due to occur
              on or before
              March 13, 2006. Counsel for DELACO announced at the confirmation hearing
              that
              the effective date of the plan is anticipated to be March 13, 2006.
              On the
              effective date, we will be released from all liability from holders
              of Dexatrim
              claims with injury dates prior to December 21, 1998, and if the settlement
              trust
              is funded as anticipated, we expect to receive a payment of $8.75 million
              before
              the end of March 2006.
  ***Management***
 
 During
              the
              third quarter of fiscal 2005, we entered into a separation agreement
              with our
              former president and chief operating officer. In connection with the
              separation
              agreement, we incurred a $2.3 million executive severance charge consisting
              of a
              $0.9 million lump-sum cash payment and a $1.4 million non-cash charge
              as a
              result of accelerating the vesting of restricted stock. Robert E. Bosworth
              was
              named our president and chief operating officer effective September
              19,
              2005.
 
 On
              November 16, 2005, Richard D. Moss resigned from his position as vice
              president
              and chief financial officer of Chattem. Robert E. Bosworth, our president
              and
              chief operating officer, who formerly served as our chief financial
              officer from
              1985 to 1998, will serve as our principal financial officer on an interim
              basis.
  31
 ***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,****2005**
                    
                    
                    **2004**
                    
                    
                    **2003**as
                        adjusted****(1)
                    
                    
                    as
                        adjusted**(1)**TOTAL
                        REVENUES
                    
                    
                    100.0
                    %
                    
                    100.0
                    %
                    
                    100.0
                    %COSTS
                        AND EXPENSES:Cost
                        of sales
                    
                    
                    28.6
                    
                    
                    28.4
                    
                    
                    28.4Advertising
                        and promotion
                    
                    
                    27.5
                    
                    
                    29.0
                    
                    
                    30.2Selling,
                        general and administrative
                    
                    
                    16.9
                    
                    
                    17.1
                    
                    
                    17.5Executive
                        severance charges
                    
                    
                    0.8
                    
                    
                    —
                    
                    
                    —Impairment
                        of indefinite-lived intangible assets
                    
                    
                    —
                    
                    
                    7.8
                    
                    
                    —Loss
                        on product divestures
                    
                    
                    3.1
                    
                    
                    —
                    
                    
                    —Litigation
                        settlement
                    
                    
                    (0.7
                    )
                    
                    6.1
                    
                    
                    —Total
                        costs and expenses
                    
                    
                    76.2
                    
                    
                    88.4
                    
                    
                    76.1INCOME
                        FROM OPERATIONS
                    
                    
                    23.8
                    
                    
                    11.6
                    
                    
                    23.9OTHER
                        INCOME (EXPENSE):Interest
                        expense
                    
                    
                    (4.9
                    )
                    
                    (5.9
                    )
                    
                    (8.8
                    )Investment
                        and other income (expense), net
                    
                    
                    0.4
                    
                    
                    0.1
                    
                    
                    0.1Loss
                        on early extinguishment of debt
                    
                    
                    (0.3
                    )
                    
                    (5.0
                    )
                    
                    —Total
                        other income (expense)
                    
                    
                    (4.8
                    )
                    
                    (10.8
                    )
                    
                    (8.7
                    )INCOME
                        BEFORE INCOME TAXES
                    
                    
                    19.0
                    
                    
                    0.8
                    
                    
                    15.2PROVISION
                        FOR INCOME TAXES
                    
                    
                    6.1
                    
                    
                    0.2
                    
                    
                    5.2NET
                        INCOME
                    
                    
                    12.9
                    %
                    
                    0.6
                    %
                    
                    10.0
                    %
 
 (1)
                    The
                        fiscal 2004 and 2003 consolidated statements of income have
                        been adjusted
                        to reflect retroactively the change in method of valuing
                        our domestic
                        inventory from the LIFO to the FIFO method adopted in fiscal
                        2005.
  32
 Our
              net
              income margin (net income/total revenues) was 12.9%, 0.6% and 10.0%
              for fiscal
              2005 and 2004, respectively. Our adjusted net income (excluding debt
              extinguishment, impairment, loss on product divestures, litigation
              settlement
              and executive severance charges) margin (adjusted net income/total
              revenues) was
              15.2% and 13.2% for fiscal 2005 and 2004, respectively. Adjusted net
              income (net
              income excluding debt extinguishment, impairment, loss on product divestures,
              litigation settlement and executive severance charges) margin is a
              non-GAAP
              financial measure. We believe that disclosure of adjusted net income
              margin
              provides investors with useful information regarding our financial
              performance
              and allows for easier comparison with net income margin without the
              effect of
              the charges in prior periods. We use this non-GAAP financial measure
              to analyze
              our performance compared to forecasted and prior period results. In
              addition,
              the fiscal 2004 consolidated statement of income has been adjusted
              to reflect
              retroactively the change in method of valuing our domestic inventory
              from the
              LIFO to the FIFO method adopted in fiscal 2005. A reconciliation of
              adjusted net
              income to net income for fiscal 2005 and 2004 is presented in the following
              table:
  **For
                        the Year**
                      **Ended**
                      **November
                        30,**
                    ********
                    ****
                    **(dollars
                        in thousands)****2005**
                    
                    2004as
                        adjustedNet
                        income
                    
                    $
                    36,047
                    
                    $
                    1,451Add:Loss
                        on early extinguishment of debt
                    
                    
                    750
                    
                    
                    12,958Impairment
                        of indefinite-lived assets
                    
                    
                    —
                    
                    
                    20,000Loss
                        on product divestures
                    
                    
                    8,678
                    
                    
                    —Litigation
                        settlement
                    
                    
                    (2,086
                    )
                    
                    15,836Executive
                        severance
                    
                    
                    2,269
                    
                    
                    —Provision
                        for income taxes
                    
                    
                    (3,076
                    )
                    
                    (16,102
                    )Net
                        income (excluding debt extinguishment, impairment, loss on product
                        divestures, litigation settlement and executive severance charges)
                    
                    $
                    42,582
                    
                    $
                    34,143Net
                        income (excluding debt extinguishment, impairment, loss on product
                        divestures, litigation settlement and executive severance charges)
                        per common share (diluted)
                    
                    $
                    2.09
                    
                    $
                    1.69Net
                        income (excluding debt extinguishment, impairment, loss on product
                        divestures, litigation settlement and executive severance charges)
                        margin
                    
                    
                    15.2
                    %
                    
                    13.2
                    %
 
 EBITDA,
              earnings before interest, taxes, depreciation and amortization, is
              a key
              non-GAAP financial measure used by us to measure operating performance
              but may
              not be comparable to similarly titled measures reported by other companies.
              The
              most directly comparable U.S. generally accepted accounting principles
              (“GAAP”)
              financial measure is net income. EBITDA and adjusted EBITDA (excluding
              impairment, loss on product divestures, litigation settlement charges
              and
              executive severance charges) are used by us to supplement net income
              as an
              indicator of operating performance and not as an alternative to measures
              defined
              and required by GAAP. We consider EBITDA and adjusted EBITDA as well
              as EBITDA
              margin and adjusted EBITDA margin as important indicators of our operational
              strength and performance, including our ability to pay interest, service
              debt
              and fund capital expenditures. We believe that presenting EBITDA and
              EBITDA
              margin, both adjusted to exclude litigation settlement and executive
              severance
              charges, provides investors with a useful measure of our ongoing operating
              performance. Further, EBITDA adjusted to exclude litigation settlement
              charges
              is one measure used in the calculation of certain ratios to determine
              our
              compliance with the terms of our Amended Revolving Credit Facility.
              Our
              presentation of EBITDA and EBITDA margin, as we have adjusted such
              measures,
              should not be construed as an inference that our future results will
              be
              unaffected by items similar to those excluded from the calculation
              of EBITDA and
              EBITDA margin, as we have adjusted such measures. EBITDA and adjusted
              EBITDA are
              not measurements of financial performance and liquidity under GAAP
              and should
              not be considered as alternatives to operating income, net income and
              other
              measures of financial performance reported in accordance with GAAP
              or as
              alternatives to cash flows provided by operating, investing or financing
              activities.
  33
 A
              reconciliation of EBITDA and EBITDA (excluding impairment, loss on
              product
              divestures, litigation settlement charges and executive severance charges)
              to
              net income is presented in the following table:
  **For
                        the Year Ended November 30,****Increase
                        (Decrease)****Amount**
                    
                    **Percentage****2005**
                    
                    **2004**
                    
                    **2003**
                    
                    **2005**
                        **vs.**
                        **2004**
                    
                    **2004**
                      **vs.**
                      **2003**
                    
                    **2005**
                      **vs.**
                      **2004**
                    
                    **2004**
                      **vs.**
                      **2003**as
                        adjusted**(2)**
                    
                    
                    as
                        adjusted**(2)**
                    
                    
                    
                    
                    
                    as
                        adjusted**(2)**
                    
                    
                    
                    
                    
                    as
                        adjusted**(2)****(dollars
                        in thousands)**Net
                        income
                    
                    $
                    36,047
                    
                    $
                    1,451
                    
                    $
                    23,347
                    
                    $
                    34,596
                    
                    $
                    (21,896
                    )
                    
                    2384.3
                    %
                    
                    (93.8
                    )%Add:Provision
                        for income taxes
                    
                    
                    16,963
                    
                    
                    703
                    
                    
                    12,246
                    
                    
                    16,260
                    
                    
                    (11,543
                    )
                    
                    2312.9
                    
                    
                    (94.3
                    )Interest
                        expense, net**(1)**
                    
                    
                    13,478
                    
                    
                    27,709
                    
                    
                    20,307
                    
                    
                    (14,231
                    )
                    
                    7,402
                    
                    
                    (51.4
                    )
                    
                    36.5Depreciation
                        and amortization less amounts included in interest
                    
                    
                    5,388
                    
                    
                    5,293
                    
                    
                    4,969
                    
                    
                    95
                    
                    
                    324
                    
                    
                    1.8
                    
                    
                    6.5EBITDA
                    
                    $
                    71,876
                    
                    $
                    35,156
                    
                    $
                    60,869
                    
                    $
                    36,720
                    
                    $
                    (25,713
                    )
                    
                    104.4
                    
                    
                    (42.2
                    )Impairment
                        of indefinite-lived intangibleassets
                    
                    
                    —
                    
                    
                    20,000
                    
                    
                    —
                    
                    
                    (20,000
                    )
                    
                    20,000
                    
                    
                    nm
                    
                    
                    nmLoss
                        on product divestures
                    
                    
                    8,678
                    
                    
                    —
                    
                    
                    —
                    
                    
                    8,678
                    
                    
                    —
                    
                    
                    nm
                    
                    
                    nmLitigation
                        settlement charges
                    
                    
                    (2,086
                    )
                    
                    15,836
                    
                    
                    —
                    
                    
                    (17,922
                    )
                    
                    15,836
                    
                    
                    (113.2
                    )
                    
                    nmExecutive
                        severance charges
                    
                    
                    2,269
                    
                    
                    —
                    
                    
                    —
                    
                    
                    2,269
                    
                    
                    —
                    
                    
                    nm
                    
                    
                    nmEBITDA
                        (excluding impairment and litigation settlement charges)
                    
                    $
                    80,737
                    
                    $
                    70,992
                    
                    $
                    60,869
                    
                    $
                    9,745
                    
                    $
                    10,123
                    
                    
                    13.7
                    
                    
                    16.6EBITDA
                        margin (EBITDA/total revenues)
                    
                    
                    25.7
                    %
                    
                    13.6
                    %
                    
                    26.0
                    %EBITDA
                        (excluding impairment loss on product divestures, litigation
                        settlement
                        and executive settlement charges) margin (EBITDA (excluding
                        impairment,
                        loss on product divestures, litigation settlement and executive
                        settlement
                        charges)/total revenues)
                    
                    
                    28.9
                    %
                    
                    27.5
                    %
                    
                    26.0
                    %
 
 (1)
                    Fiscal
                        2005 and 2004 results include losses on early extinguishment
                        of debt of
                        $0.8 million and $13.0 million,
                        respectively.
 
 (2)
                    The
                        fiscal 2004 and 2003 consolidated statements of income have
                        been adjusted
                        to reflect retroactively the change in method of valuing
                        our domestic
                        inventory from the LIFO to the FIFO method adopted in fiscal
                        2005.
 
 ***Critical
              Accounting Policies***
 
 The
              preparation of financial statements in accordance with U.S. generally
              accepted
              accounting principles requires management to use estimates. Several
              different
              estimates or methods can be used by management that might yield different
              results. The following are the significant estimates used by management
              in the
              preparation of the November 30, 2005 consolidated financial
              statements:
 
 ***Allowance
              for Doubtful Accounts***
 
 As
              of
              November 30, 2005, 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, 2005, we performed a detailed assessment
              of
              the collectibility of trade accounts receivable and reduced our estimate
              of
              allowance for doubtful accounts by approximately $0.5 million, which
              resulted in a decrease to
  34
 selling,
              general and administrative expense in our consolidated financial
              statements .
              The
              balance of allowance for doubtful accounts was $0.3 million and $0.8
              million at
              November 30, 2005 and 2004, respectively.
 
 ***Revenue
              Recognition***
 
 Revenue
              is
              recognized when our products are shipped to our customers. It is generally
              our
              policy across all classes of customers that all sales are final. As
              is common in
              the consumer products industry, customers return products for a variety
              of
              reasons including products damaged in transit, discontinuance of a
              particular
              size or form of product and shipping errors. As sales are recorded,
              we accrue an
              estimated amount for product returns, as a reduction of these sales,
              based upon
              our historical experience and any known specific events that affect
              the accrual.
              We charge the allowance account resulting from this accrual with any
              authorized
              deduction from remittance by the customer or product returns upon receipt
              of the
              product.
 
 In
              accordance with industry practice, we allow our customers to return
              unsold sun
              care products (i.e. *Bullfrog* and *Sun
              In* lines of
              products) at the end of the sun care season. We record the sales at
              the time the
              products are shipped and title transfers. At the time of shipment,
              we also
              record a reduction in sales and an allowance on our balance sheet for
              anticipated returns based upon an estimated return level. The level
              of returns
              may fluctuate from our estimates due to several factors including weather
              conditions, customer inventory levels and competitive conditions. Each
              percentage point change in our return rate would impact our net sales
              by
              approximately $0.2 million. During fiscal 2005, we reduced our estimate
              of
              seasonal returns by approximately $0.2 million, to a balance of $0.2
              million,
              which resulted in an increase to net sales in our consolidated financial
              statements in fiscal 2005, as compared to an approximately $0.9 million
              reduction in our estimate in fiscal 2004 and an approximately $0.3
              million
              increase in our estimate in fiscal 2003, which resulted in an increase
              and
              decrease to net sales in our consolidated financial statements in fiscal
              2004
              and 2003, respectively. During fiscal 2005, as a result of our estimate
              of
              customer inventory levels and based on historical non-seasonal product
              returns,
              we increased our estimate of non-seasonal returns by approximately
              $0.6 million,
              to a balance of $0.6 million, which resulted in a decrease to net sales
              in our
              consolidated financial statements in fiscal 2005. During fiscal 2004
              and 2003,
              we reduced our estimate of non-seasonal returns by approximately $0.8
              million
              and $0.7 million, respectively, which resulted in an increase in net
              sales in
              our consolidated financial statements in fiscal 2004 and 2003, respectively.
              At
              November 30, 2005 we recorded an allowance for returns of pHisoderm
              of $0.7
              million as a result of the sale of pHisoderm.
 
 We
              routinely enter into agreements with our customers to participate in
              promotional
              programs. These programs generally take the form of coupons, temporary
              price
              reductions, scan downs, display activity and participations in advertising
              vehicles provided uniquely by the customer. The ultimate cost of these
              programs
              is often variable based on the number of units actually sold. Estimated
              unit
              sales of a product under a promotional program are used to estimate
              the total
              cost of the program, which is recorded as a reduction of sales. Actual
              results
              can differ from the original estimate. In addition, increases and decreases
              in
              total program commitments each year impact the accrual. We also consider
              customer delays in requesting promotional program payments when evaluating
              the
              required accrual. Some customers audit programs significantly after
              the date of
              performance to determine the actual amount due and make a claim for
              reimbursement at that time. As a result, changes in the unit sales
              trends under
              promotional programs as well as the timing of payments could result
              in changes
              in the accrual. During fiscal 2005, 2004 and 2003, we reduced our estimate
              of
              promotional accruals by approximately $1.6 million, $1.6 million and
              $2.3
              million, respectively, which resulted in an increase to net sales or
              a decrease
              in advertising and promotion expense in our consolidated financial
              statements.
 
 ***Income
              Taxes***
 
 We
              account
              for income taxes using the asset and liability approach as prescribed
              by SFAS
              No. 109, “Accounting for Income Taxes”. This approach requires recognition of
              deferred tax assets and liabilities for the expected future tax consequences
              of
              events that have been included in the consolidated financial statements
              or tax
              returns. Using the enacted tax rates in effect for the year in which
              the
              differences are expected to reverse, deferred tax assets and liabilities
              are
              determined based on the differences between the financial reporting
              and the tax
              basis of an asset or liability. We record income tax expense in our
              consolidated
              financial statements based on an estimated annual effective income
              tax rate. We
              revised our annual estimated annual effective income tax rate during
              fiscal 2005
              to 32%, as compared to 33% in fiscal 2004 and 34% in fiscal 2003, as
              a result of
              the implementation of a number of foreign and state tax planning
              initiatives.
 
 For
              additional information regarding our significant accounting policies,
              see note 2
              of notes to consolidated financial statements.
 
 35
 ***Fiscal
              2005 Compared to Fiscal 2004***
 
 To
              facilitate discussion of our operating results for the years ended
              November 30,
              2005 and 2004, we have included the following selected data from our
              consolidated statements of income:
  **For
                        the Year Ended November 30,****Increase
                        (Decrease)****2005**
                    
                    **2004**
                    
                    **Amount**
                    
                    **Percentage**as
                        adjusted**(1)****(dollars
                        in thousands)**Domestic
                        net sales
                    
                    $
                    252,436
                    
                    $
                    234,003
                    
                    $
                    18,433
                    
                    
                    7.9
                    %International
                        revenues (including royalties)
                    
                    
                    26,882
                    
                    
                    24,152
                    
                    
                    2,730
                    
                    
                    11.3Total
                        revenues
                    
                    
                    279,318
                    
                    
                    258,155
                    
                    
                    21,163
                    
                    
                    8.2Cost
                        of sales
                    
                    
                    79,884
                    
                    
                    73,358
                    
                    
                    6,526
                    
                    
                    8.9Advertising
                        and promotion expense
                    
                    
                    76,763
                    
                    
                    74,929
                    
                    
                    1,834
                    
                    
                    2.4Selling,
                        general and administrative expense
                    
                    
                    47,322
                    
                    
                    44,169
                    
                    
                    3,153
                    
                    
                    7.1Executive
                        severance charges
                    
                    
                    2,269
                    
                    
                    —
                    
                    
                    2,269
                    
                    
                    100.0Impairment
                        of indefinite-lived intangible assets
                    
                    
                    —
                    
                    
                    20,000
                    
                    
                    (20,000
                    )
                    
                    (100.0
                    )Loss
                        on product divestures
                    
                    
                    8,678
                    
                    
                    —
                    
                    
                    8,678
                    
                    
                    100.0Litigation
                        settlement charges
                    
                    
                    (2,086
                    )
                    
                    15,836
                    
                    
                    (17,922
                    )
                    
                    (113.2
                    )Interest
                        expense
                    
                    
                    13,814
                    
                    
                    15,049
                    
                    
                    (1,235
                    )
                    
                    (8.2
                    )Loss
                        on early extinguishment of debt
                    
                    
                    750
                    
                    
                    12,958
                    
                    
                    (12,208
                    )
                    
                    (94.2
                    )Net
                        income
                    
                    
                    36,047
                    
                    
                    1,451
                    
                    
                    34,596
                    
                    
                    2,384.3
 
 (1)
                    The
                        fiscal 2004 selected financial data has been adjusted to
                        reflect
                        retroactively the change in method of valuing our domestic
                        inventory from
                        the LIFO to the FIFO method adopted in fiscal 2005.
  ***Domestic
              Net Sales***
 
 Domestic
              net sales for fiscal 2005 increased $18.4 million, or 7.9%, to $252.4
              million
              from $234.0 million in fiscal 2004. For a description of each brand
              included in
              the following categories, see “Products” in Item 1 of this Form 10-K. 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)****2005**
                    
                    **2004**
                    
                    **Amount**
                    
                    **Percentage****(dollars
                        in thousands)**Topical
                        analgesics
                    
                    $
                    89,539
                    
                    $
                    76,300
                    
                    $
                    13,239
                    
                    
                    17.4
                    %Medicated
                        skin care products
                    
                    
                    62,458
                    
                    
                    60,495
                    
                    
                    1,963
                    
                    
                    3.2Dietary
                        supplements
                    
                    
                    33,828
                    
                    
                    33,011
                    
                    
                    817
                    
                    
                    2.5Medicated
                        dandruff shampoos and conditioner
                    
                    
                    34,880
                    
                    
                    31,309
                    
                    
                    3,571
                    
                    
                    11.4Other
                        OTC and toiletry products
                    
                    
                    31,731
                    
                    
                    32,888
                    
                    
                    (1,157
                    )
                    
                    (3.5
                    )Total
                    
                    $
                    252,436
                    
                    $
                    234,003
                    
                    $
                    18,433
                    
                    
                    7.9
 
 Net
              sales
              growth in the topical analgesics category was led by 38% and 15% increases
              in
              sales of *Aspercreme* and *Icy
              Hot* ,
              respectively. *Aspercreme’s* sales
              increase was driven by the launch of the Odor-Free Therapy Back and
              Body Patch. *Icy
              Hot* continued
              to benefit from the strength of the *Icy
              Hot* Back
              Patch and a full year of sales from the Medicated Sleeve. Net sales
              growth in
              this category also resulted from 15%, 9% and 2% sales increases in *Capzasin* , *Sportscreme* and *Flexall* ,
              respectively. The overall sales growth in this category was partially
              offset by
              decreased sales of *Arthritis
              Hot* .
 
 Net
              sales
              growth in the medicated skin care products category resulted from an
              8% increase
              in the *Gold
              Bond* franchise. *Gold
              Bond* sales
              growth was attributable to 26%, 7%, 6% and 2% increases from the lotion,
              powder,
              foot care and cream lines, respectively, and was partially offset by
              lost sales
              from our discontinued first aid and antifungal foot swab products.
              The increase
              in sales from the *Gold
              Bond* lotion
              line of products was attributable to continued sales increases of *Gold
              Bond Ultimate* Healing
              Lotion. The increase in net sales of *Gold
              Bond* powder
              was driven by the launch of *Gold
              Bond Ultimate* Comfort
              Body Powder, and the sales increase of *Gold
              Bond* foot
              care
              products resulted from increased distribution. Although pHisoderm benefited
              from
              the launch of the new *pH* 2 *O* line,
              this line extension was more than offset by weakness in sales and
  36
 lost
              distribution from its acne and base skin care business. The pHisoderm
              brand and
              related inventories were sold on November 30, 2005 to The Mentholatum
              Co., Inc.
 
 Net
              sales
              for the dietary supplements category improved primarily due to 15%
              and 8%
              increases in *New
              Phase* and *Garlique* ,
              respectively. Net sales of *New
              Phase* increased
              due to the introduction of *New
              Phase* Extra
              Strength, and *Garlique* sales
              benefited from an effective new advertising campaign. *Dexatrim* diet pill
              sales increased 30% due to the successful launch of *Dexatrim
              Max,* but were
              offset in part by declining sales of the *Dexatrim
              All in One* bar *.*
  Domestic
              net sales of our medicated dandruff shampoos increased 11%, reflecting
              continued
              sales growth of *Selsun
              Blue* resulting
              from an effective advertising campaign and the launch of *Selsun
              Salon* in the
              fourth quarter of fiscal 2005.
 
 The
              decrease in net sales for the other OTC and toiletry products category
              was due
              primarily to sales decreases of *Pamprin* , *Bullfrog* and *Prēmsyn* .
              The
              decreases in sales of *Pamprin* and *Prēmsyn* were
              primarily attributable to lost distribution with a major retailer.
              The 3%
              decrease in sales of *Bullfrog* was
              primarily attributable to unfavorable weather principally at the beginning
              of
              the suncare season and the timing and magnitude of returns in the fourth
              quarter
              of fiscal 2005. The decrease in sales was partially offset by sales
              growth of *Sun-In* , *UltraSwim* , *Herpecin-L* and *Benzodent* .
 
 Domestic
              sales variances were principally the result of changes in unit sales
              volumes
              with the exception of certain selected products, for which we implemented
              a unit
              sales price increase.
 
 ***International
              Revenues***
 
 For
              fiscal
              2005, international revenues increased $2.7 million, or 11.3%, to $26.9
              million from $24.1 million in fiscal 2004. The increase was primarily
              due to the
              introduction of *Icy
              Hot* in Canada
              and strengthening distributor sales in certain European and Middle
              Eastern
              countries offset in part by sales declines in the U.K. market.
 
 ***Cost
              of Sales***
 
 Cost
              of
              sales in fiscal 2005 increased $6.5 million, or 8.9%, to $79.9 million
              from
              $73.4 million in fiscal 2004 due primarily to an increase in sales
              volume. Cost
              of sales as a percentage of total revenues was 28.6% for fiscal 2005
              as compared
              to 28.4% for fiscal 2004. The increase in cost of sales as a percentage
              of total
              revenues was primarily due to increases in raw materials and transportation
              costs, offset in part by price increases for several products. It is
              anticipated
              that costs of sales may increase as a percentage of sales in fiscal
              2006 as a
              result of the introduction of *Icy
              Hot Pro-Therapy* and *Selsun
              Salon.*
 
 ***Advertising
              and Promotion Expense***
 
 Advertising
              and promotion expenses in fiscal 2005 increased $1.8 million, or 2.4%, to
              $76.8 million from $74.9 million in fiscal 2004 and were 27.5% of total
              revenues
              for 2005 compared to 29.0% for the comparable period of fiscal 2004.
              Support for
              new product introductions resulted in an increase in advertising and
              promotion
              expenditures in fiscal 2005 for *Dexatrim,
              Aspercreme* , *Gold
              Bond* powder, *Bullfrog* , *New
              Phase* and
              pHisoderm. The decrease in advertising and promotion expense as a percentage
              of
              total revenues was attributable to a more cost-effective use of advertising
              expenditures and higher sales.
 
 ***Selling,
              General and Administrative Expense***
 
 Selling,
              general and administrative expenses increased $3.2 million, or 7.1%, to
              $47.3 million from $44.2 million in fiscal 2004. Selling, general and
              administrative expenses were 16.9% and 17.1% of total revenues for
              fiscal 2005
              and 2004, respectively. An increase in sales was primarily responsible
              for
              higher selling expenses. In addition, freight expenses increased due
              to higher
              fuel costs. The increase in general and administrative expenses was
              largely a
              result of higher levels of product development expenses, compensation
              expense
              and insurance expense during fiscal 2005.
  ***Executive
              Severance Charges***
 
 During
              the
              third quarter of fiscal 2005, we entered into a separation agreement
              with our
              former president and chief operating officer. In connection with the
              separation
              agreement, we incurred a $2.3 million executive severance charge consisting
              of a
              $0.9 million lump-sum cash payment and a $1.4 million non-cash charge
              as a
              result of accelerating the removal of restrictions on restricted
              stock.
 
 37
 ***Impairment
              of Indefinite-Lived Assets***
 
 As
              a
              result of a decline in sales and reforecasted expected future cash
              flows in the
              fourth quarter of fiscal 2004, we performed the impairment test as
              prescribed by
              SFAS 142 and determined that a revaluation was required for our *Dexatrim* product
              line at November 30, 2004. We obtained an independent appraisal to
              determine the
              fair value of the indefinite-lived intangible asset related to this
              product
              line. As a result, we incurred an impairment charge of $20.0 million
              in the
              fourth quarter of fiscal 2004. No corresponding charge was incurred
              in fiscal
              2005.
 
 ***Loss
              on Product Divestures***
 
 During
              the
              fourth quarter of fiscal 2005, we sold the pHisoderm line of skin care
              products
              for a purchase price of $8.5 million plus inventories of approximately
              $1.1
              million. As a result of this transaction, we recorded a loss on product
              divestures of $8.7 million in the fourth quarter of fiscal 2005.
 
 ***Litigation
              Settlement Charges***
  Litigation
              settlement items decreased $17.9 million in fiscal 2005 to a gain of
              $2.1
              million from an expense of $15.8 million in fiscal 2004. The change
              was
              principally due to a $6.0 million reversal of previously estimated
              costs related
              to the *Dexatrim* litigation, net of legal expenses, recorded in the second quarter of
              fiscal 2005
              and reduced *Dexatrim* legal and
              administrative costs in fiscal 2005 compared to fiscal 2004.
 
 ***Interest
              Expense***
 
 Interest
              expense decreased $1.2 million, or 8.2%, in fiscal 2005 to $13.8 million
              from $15.0 million in fiscal 2004. The decrease was largely the result
              of
              reductions in outstanding debt as a result of our repurchase of $17.5
              million of
              our 7.0% Senior Subordinated Notes completed in the second quarter
              of fiscal
              2005 and the remaining benefit from the debt refinancing completed
              during the
              first quarter of fiscal 2004. Until our indebtedness is reduced substantially,
              interest expense will continue to represent a significant percentage
              of our
              total revenues.
 
 ***Loss
              on Early Extinguishment of Debt***
 
 During
              the
              second quarter of fiscal 2005, we repurchased $17.5 million of our
              7.0% Senior
              Subordinated Notes, which resulted in a loss on early extinguishment
              of debt
              of ****** $0.7
              million. During the fourth quarter of fiscal 2005, we called our $75.0
              million
              Floating Rate Senior Notes for full redemption on December 30, 2005.
              The $75
              million of Floating Rate Senior Notes were fully redeemed on December
              30, 2005.
              As a result of the redemption, a loss on early extinguishment of debt
              of $2.9
              million will be recorded ****** in
              the
              first quarter of fiscal 2006.
  ***Fiscal
              2004 Compared to Fiscal 2003***
 
 To
              facilitate discussion of our operating results for the years ended
              November 30,
              2004 and 2003, we have included the following selected data from our
              Consolidated Statements of Income:
  **For
                        the Year Ended November 30,****Increase
                        ( Decrease)****2004**
                    
                    **2003**
                    
                    **Amount**
                    
                    **Percentage**as
                        adjusted(**1)**
                    
                    as
                        adjusted(**1)****(dollars
                        in thousands)**Domestic
                        net sales
                    
                    $
                    234,003
                    
                    $
                    209,874
                    
                    $
                    24,129
                    
                    
                    11.5
                    %International
                        revenues (including royalties)
                    
                    
                    24,152
                    
                    
                    23,875
                    
                    
                    277
                    
                    
                    1.2Total
                        revenues
                    
                    
                    258,155
                    
                    
                    233,749
                    
                    
                    24,406
                    
                    
                    10.4Cost
                        of sales
                    
                    
                    73,358
                    
                    
                    66,424
                    
                    
                    6,934
                    
                    
                    10.4Advertising
                        and promotion expense
                    
                    
                    74,929
                    
                    
                    70,622
                    
                    
                    4,307
                    
                    
                    6.1Selling,
                        general and administrative expense
                    
                    
                    44,169
                    
                    
                    40,803
                    
                    
                    3,366
                    
                    
                    8.2Impairment
                        of indefinite-lived intangible assets
                    
                    
                    20,000
                    
                    
                    —
                    
                    
                    20,000
                    
                    
                    nmLitigation
                        settlement charges
                    
                    
                    15,836
                    
                    
                    —
                    
                    
                    15,836
                    
                    
                    nmInterest
                        expense
                    
                    
                    15,049
                    
                    
                    20,431
                    
                    
                    (5,382
                    )
                    
                    (26.3
                    )Loss
                        on early extinguishment of debt
                    
                    
                    12,958
                    
                    
                    —
                    
                    
                    12,958
                    
                    
                    nmNet
                        income
                    
                    
                    1,
                        451
                    
                    
                    23,347
                    
                    
                    (21,896
                    )
                    
                    (93.8
                    )
 
 (1)
                    The
                        selected financial data has been adjusted to reflect retroactively
                        the
                        change in method of valuing our domestic inventory from the
                        LIFO to the
                        FIFO method adopted in fiscal 2005.
 
 38
 ***Domestic
              Net Sales***
 
 Domestic
              net sales for fiscal 2004 increased $24.1 million, or 11.5%, to $234.0
              million
              from $209.9 million in fiscal 2003. For a description of each brand
              included in
              the following categories, see “Products” in Item 1 of this Form 10-K. 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)****2004**
                    
                    **2003**
                    
                    **Amount**
                    
                    **Percentage****(dollars
                        in thousands)**Topical
                        analgesics
                    
                    $
                    76,300
                    
                    $
                    58,594
                    
                    $
                    17,706
                    
                    
                    30.2
                    %Medicated
                        skin care products
                    
                    
                    60,495
                    
                    
                    56,528
                    
                    
                    3,967
                    
                    
                    7.0Dietary
                        supplements
                    
                    
                    33,011
                    
                    
                    37,420
                    
                    
                    (4,409
                    )
                    
                    (11.8
                    )Medicated
                        dandruff shampoos and conditioner
                    
                    
                    31,309
                    
                    
                    28,351
                    
                    
                    2,958
                    
                    
                    10.4Other
                        OTC and toiletry products
                    
                    
                    32,888
                    
                    
                    28,981
                    
                    
                    3,907
                    
                    
                    13.5Total
                    
                    $
                    234,003
                    
                    $
                    209,874
                    
                    $
                    24,129
                    
                    
                    11.5
 
 Net
              sales
              growth in the topical analgesics category was led by a 57% increase in
              sales of *Icy
              Hot* ,
              which
              was primarily driven by the continued strength of the *Icy
              Hot* Back
              Patch and the newly introduced *Icy
              Hot* Medicated
              Sleeve. Net sales growth in this category also resulted from 34% and
              12% sales
              increases in *Capzasin* and *Aspercreme* ,
              respectively. The overall sales growth in this category was partially
              offset by
              a decline in sales of *Flexall* as
              competition from inside and outside the category increased and media
              support was
              curtailed.
 
 Net
              sales
              growth in the medicated skin care products category resulted from a
              14% increase
              in the *Gold
              Bond* franchise. *Gold
              Bond* sales
              growth was attributable to 46%, 27% and 24% increases from the lotion,
              foot care
              and cream lines, respectively, and was partially offset by declines
              in the first
              aid portion of the business. The increase in sales from the *Gold
              Bond* lotion
              line of products was attributable to the successful launch of *Gold
              Bond Ultimate* Healing
              Skin Therapy Lotion in the third quarter of fiscal 2003. Sales growth
              in the
              medicated skin care products category was also offset by a 15% decrease
              in
              pHisoderm sales due to increased competition.
 
 Net
              sales
              for the dietary supplements category declined primarily due to a 47%
              decrease in *Dexatrim* diet pill
              sales. Sales of *Dexatrim* were
              impacted by the overall decline in the diet pill market resulting in
              part from
              negative ephedrine publicity and the impact of low carbohydrate diet
              products.
              The decline in net sales of *Dexatrim* diet
              pills was partially offset by sales of the *Dexatrim*  *All
              in
              One* bar,
              which was introduced in the first quarter of fiscal 2004. The *Dexatrim*  *All
              in
              One* bar sales
              were lower than expected for fiscal 2004, as the category has proved
              to be more
              promotional and seasonal than we expected.
  Domestic
              net sales of *Selsun
              Blue* medicated
              dandruff shampoo increased due to an effective advertising campaign
              and sales of *Selsun
              Blue* conditioner, which was launched in the first quarter of fiscal 2004.
 
 The
              increase in net sales for the other OTC and toiletry products category
              was due
              primarily to sales increases of *Pamprin* and *Bullfrog* .
              The
              increase in sales of *Pamprin* was
              primarily attributable to the introduction of *Pamprin* All Day
              in the first quarter of fiscal 2004. The increase in sales of *Bullfrog* was
              primarily attributable to expanded distribution and increased sales
              of pre-pack
              displays.
 
 Domestic
              sales variances were principally the result of changes in unit sales
              volumes
              with the exception of *Pamprin,* *Prēmsyn
              PMS* *,* pHisoderm *,
              Flexall, Aspercreme, Capzasin* and *Sportscreme* ,
              for
              which we implemented a unit sales price increase.
 
 ***International
              Revenues***
 
 For
              fiscal
              2004, international revenues increased $0.3 million, or 1.2%, to $24.2
              million from $23.9 million in fiscal 2003 due principally to an increase
              in *Selsun* sales in
              Canada, Europe and Latin America and favorable foreign currency translation.
              International sales variances were principally the result of changes
              in unit
              sales volumes.
 
 39
 ***Cost
              of Sales***
 
 Cost
              of
              sales in fiscal 2004 increased $6.9 million, or 10.4%, to $73.4 million
              from
              $66.4 million in fiscal 2003 due primarily to sales of the *Dexatrim
              All in One* bar,
              the *Icy
              Hot* Back
              Patch and the *Icy
              Hot* Medicated
              Sleeve, all of which have lower profit margins than many of our other
              products.
              Cost of sales as a percentage of total revenues was 28.4% for both
              fiscal 2004
              and fiscal 2003.
  ***Advertising
              and Promotion Expense***
 
 Advertising
              and promotion expenses in fiscal 2004 increased $4.3 million, or 6.1%, to
              $74.9 million from $70.6 million in fiscal 2003 and were 29.0% of total
              revenues
              for 2004 compared to 30.2% for fiscal 2003. Support for new product
              introductions resulted in an increase in advertising and promotion
              expenditures
              for fiscal 2004 for *Icy
              Hot,*  *Pamprin,* the *Dexatrim
              All in One* bar *,
              Selsun Blue* and the *Gold
              Bond* lotion
              and foot care lines.
 
 ***Selling,
              General and Administrative Expense***
 
 Selling,
              general and administrative expenses increased $3.4 million, or 8.2%, to
              $44.2 million from $40.8 million in fiscal 2003. Selling, general and
              administrative expenses were 17.1% and 17.5% of total revenues for
              fiscal 2004
              and 2003, respectively. An increase in sales was primarily responsible
              for the
              higher selling expenses. In addition, freight expenses increased due
              to the
              higher fuel costs. The increase in general and administrative expenses
              was
              largely a result of increased incentive compensation and new product
              development
              expenses as well as expenses related to compliance with the Sarbanes-Oxley
              Act
              of 2002.
 
 ***Impairment
              of Indefinite-Lived Intangible Assets***
 
 As
              a
              result of a decline in sales and reforecasted expected future cash
              flows in the
              fourth quarter, we performed the impairment test as prescribed by SFAS
              142 and
              determined that a revaluation was required for our *Dexatrim* product
              line at November 30, 2004. We obtained an independent appraisal to
              determine the
              fair value of the indefinite-lived intangible asset related to this
              product
              line. As a result, we incurred an impairment charge of $20.0 million
              in the
              fourth quarter of fiscal 2004. No corresponding charge was incurred
              in fiscal
              2003.
 
 ***Litigation
              Settlement Charges***
  Litigation
              settlement charges were $15.8 million in fiscal 2004. This expense was
              attributable to legal, administrative and estimated settlement costs
              related to
              our *Dexatrim* litigation.
 
 ***Interest
              Expense***
 
 Interest
              expense decreased $5.4 million, or 26.3%, in fiscal 2004 to $15.0 million
              from $20.4 million in fiscal 2003. The decrease was largely the result
              of lower
              interest rates and a reduction in outstanding debt as a result of our
              debt
              refinancing completed during the first quarter of fiscal 2004. Until
              our
              indebtedness is reduced substantially, interest expense will continue
              to
              represent a significant percentage of our total revenues.
 
 ***Loss
              on Early Extinguishment of Debt***
 
 During
              fiscal 2004, we retired $204.5 million principal amount of our 8.875%
              senior
              subordinated notes and the remaining outstanding balance of our $60.0
              million
              senior secured credit facility, which resulted in a loss on early extinguishment
              of debt of ****** $13.0
              million. ****** No
              corresponding charge was incurred in fiscal 2003.
 
 ***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.
 
 Cash
              of
              $55.0 million and $44.7 million was provided by operations in fiscal
              2005 and
              2004, respectively. The increase in cash provided by operating activities
              was
              due to the loss on early extinguishment of debt of $13.0 million incurred
              in
              fiscal
  40
 2004
              year
              compared to $0.8 million incurred in fiscal 2005. Increased net income,
              refundable income taxes and deferred income taxes also contributed
              to the
              increase in cash flow from operations. These increases were partially
              offset by
              decreases in the tax benefit realized from stock option exercises,
              prepaid
              expenses and accounts payable and accrued liabilities.
 
 Investing
              activities used cash of $0.7 million and $5.5 million in fiscal 2005
              and 2004,
              respectively. The decrease in the usage of cash was primarily due to
              proceeds
              received from the sale of our *Selsun* business
              in certain countries in Africa and Asia in fiscal 2005.
 
 Financing
              activities used cash of $46.5 million and $26.2 million in fiscal 2005
              and 2004,
              respectively. The increase in cash used primarily was attributable
              to the $34.1
              million repurchase of common stock in fiscal 2005 as compared to $5.0
              million of
              common stock repurchased in fiscal 2004.
 
 As
              of
              November 30, 2005, our total debt was $182.5 million, consisting of
              our Floating
              Rate Senior Notes of $75.0 million and 7.0% Subordinated Notes of $107.5
              million. As of November 30, 2005, we had no borrowings outstanding
              under our
              Amended Revolving Credit Facility with available borrowings up to $100.0
              million. As of February 17, 2006, our total debt was $145.5 million,
              consisting
              of borrowings outstanding under our Amended Revolving Credit Facility
              totaling
              $38.0 million and $107.5 million of our 7.0% Subordinated Notes. Borrowings
              under our Amended Revolving Credit Facility bear interest at LIBOR
              plus
              applicable percentages of 1.00% to 2.00% or a base rate (the higher
              of the
              federal funds rate plus 0.5% or the prime rate) plus applicable percentages
              of
              0.0% to 0.5% (7.00% as of November 30, 2005). The applicable percentages
              are
              calculated based on our leverage ratio. The Floating Rate Senior Notes
              bear
              interest at a three-month LIBOR plus 3.00% per year (6.87% as of November
              30,
              2005). On March 8, 2004, we entered into an interest rate cap agreement
              effective June 1, 2004 with decreasing annual notional principal amounts
              of
              $15.0 million beginning March 1, 2006 and cap rates ranging from 4.0%
              to 5.0%
              over the life of the agreement. We paid a $1.4 million premium to enter
              into the
              interest rate cap agreement, which will be amortized over the life
              of the
              agreement. The current portion of the premium on the interest rate
              cap agreement
              of $0.4 million is included in prepaid expenses and other current assets,
              and
              the long-term portion of $0.7 million is included in other non-current
              assets.
              During fiscal 2005, the amortized value of the premium on the interest
              rate cap
              was compared to the fair value of the interest rate cap and the change
              in the
              market value of the premium of $0.2 million, net of tax, was recorded
              to other
              comprehensive income. Also as of November 30, 2005, a portion of the
              interest
              rate cap was deemed to be an ineffective cash flow hedge due to the
              reduction of
              variable rate debt upon the subsequent redemption of the Floating Rate
              Senior
              Notes, resulting in a loss of $0.1 million, net of tax, reflected in
              the income
              statement as interest expense. The balance of the cash flow hedge was
              deemed to
              be effective as of November 30, 2005. The interest rate cap agreement
              terminates
              on March 1, 2010.
 
 In
              October
              2005, our board of directors increased the total authorization to repurchase
              our
              common stock under our stock buyback program to $30.0 million, which
              became
              effective on November 29, 2005 upon consummation of the Amended Revolving
              Credit
              Facility. During fiscal 2005, we repurchased 882,267 shares of our common
              stock for $34.1 million. We are limited in our ability to repurchase shares
              due to restrictions under the terms of our Amended Revolving Credit
              Facility and
              the indenture pursuant to which the 7.0% Subordinated Notes were issued.
  We
              believe
              that cash provided by operating activities, our cash and cash equivalents
              balance and funds available under our Amended Revolving Credit Facility
              will be
              sufficient to fund our capital expenditures, debt service and working
              capital
              requirements for the foreseeable future as our business is currently
              conducted.
              It is likely that any acquisitions we make in the future will require
              us to
              obtain additional financing.
  ***Contractual
              Obligations***
 
 The
              following data summarizes our contractual obligations as of November
              30, 2005.
              We had no commercial obligations as of November 30, 2005:
  **Payments
                        due by****Contractual
                      Obligations:**
                    
                    **Total**
                    
                    **Within
                        1 year**
                    
                    **2-3
                        years**
                    
                    **4-5
                        years**
                    
                    **After
                        5 years****(dollars
                        in thousands)**Long-term
                        debt
                    
                    $
                    182,500
                    
                    $
                    37,000
                    
                    $
                    —
                    
                    $
                    —
                    
                    $
                    145,500Operating
                        leases
                    
                    
                    3,796
                    
                    
                    1,470
                    
                    
                    1,190
                    
                    
                    588
                    
                    
                    548Purchase
                        commitments
                    
                    
                    3,979
                    
                    
                    1,495
                    
                    
                    2,484
                    
                    
                    —
                    
                    
                    —Endorsements
                    
                    
                    5,525
                    
                    
                    1,500
                    
                    
                    3,225
                    
                    
                    800
                    
                    
                    —Total
                    
                    $
                    195,800
                    
                    $
                    41,465
                    
                    $
                    6,899
                    
                    $
                    1,388
                    
                    $
                    146,048
  41
 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. We do not
              have
              significant agreements for the purchase of inventory or other goods
              specifying
              minimum quantities or set prices that exceed our expected requirements
              for three
              months.
  ***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. 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 2005 and 2004, these subsidiaries accounted for 8%
              and 7% of total revenues, respectively, and 4% of total assets,
              respectively. It has not been our practice to hedge our assets and
              liabilities
              in Canada, the U.K. and Ireland or our intercompany transactions due
              to the
              inherent risks associated with foreign currency hedging transactions
              and the
              timing of payments between us and our foreign subsidiaries. Following
              our
              acquisition of *Selsun
              Blue* ,
              which is
              sold in approximately 70 foreign countries, our international business
              operations have expanded significantly, which has increased our exposure
              to
              fluctuations in foreign exchange rates. During fiscal 2005, a portion
              of these
              foreign sales was reflected as royalties, which have been paid to us
              in U.S.
              dollars. In addition, until July 2005 Abbott Laboratories (“Abbott”), from whom
              we acquired *Selsun
              Blue* ,
              continued to supply a portion of our international supply of *Selsun* and
              billed us in U.S. dollars in certain instances. Beginning April 1,
              2004, a
              portion of our international supply of *Selsun* was
              billed to us in local currencies. Historically, gains or losses from
              foreign
              currency transactions have not had a material impact on our operating
              results.
              Gains of $0.2 million and $0.2 million for the years ended November
              30, 2005 and
              2004, respectively, resulted from foreign currency transactions and
              are included
              in selling, general and administrative expenses in the consolidated
              statements
              of income. ****
 
 ***Recent
              Accounting Pronouncements***
 
 In
              December 2003, the Financial Accounting Standards Board (“FASB”) issued
              Interpretation No. 46R, “Consolidation of Variable Interest Entities” (“FIN
              46R”), which supersedes Interpretation No. 46, “Consolidation of Variable
              Interest Entities” issued in January 2003. FIN 46R requires a company to
              consolidate a variable interest entity (“VIE”), as defined, when the company
              will absorb a majority of the VIE’s expected losses, receives a majority of the
              VIE’s expected residual returns or both. FIN 46R also requires consolidation
              of
              existing, non-controlled affiliates if the VIE is unable to finance
              its
              operations without investor support, or where the other investors do
              not have
              exposure to the significant risks and rewards of ownership. FIN 46R
              applies
              immediately to a VIE created or acquired after January 31, 2003. For
              a VIE
              created before February 1, 2003, FIN 46R applies in the first fiscal
              year or
              interim period beginning after March 15, 2004, our third fiscal quarter
              beginning June 1, 2004. Application of FIN 46R is also required in
              financial
              statements that have interests in structures that are commonly referred
              to as
              special-purpose entities for periods ending after December 15, 2003.
              The
              adoption of FIN 46R did not have a material impact on our financial
              position,
              results of operations or cash flows.
 
 In
              November 2004, the FASB issued Statement of Financial Accounting Standards
              (“SFAS”) No. 151, “Inventory Costs” (“SFAS 151”). SFAS 151 amends the guidance
              in Accounting Research Bulletin No. 43, Chapter 4, “Inventory Pricing”, to
              clarify that abnormal amounts of idle facility expense, freight, handling
              costs
              and wasted materials (spoilage) should be recognized as current-period
              charges
              and requires the allocation of fixed production overheads to inventory
              based on
              normal capacity of the production facilities. This statement is effective
              for
              inventory costs incurred during fiscal years beginning after June 15,
              2005. The
              adoption of SFAS 151 is not expected to have an impact on our financial
              position, results of operations or cash flows.
 
 In
              November 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on
              Issue No. 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No.
              144, “Accounting for the Impairment or Disposal of Long-Lived Assets” in
              Determining Whether to Report Discontinued Operations” (“EITF 03-13”). Under the
              consensus, the approach for assessing whether cash flows of the component
              have
              been eliminated from the ongoing operations of the entity focuses on
              whether
              continuing cash flows are direct or indirect cash flows. Cash flows
              of the
              component would not be eliminated if the continuing cash flows to the
              entity are
              considered direct cash flows. The consensus should be applied to a
              component of
              an enterprise that is either disposed of or classified as held for
              sale in
              fiscal periods beginning after December 15, 2004. The adoption of EITF
              03-13 did
              not have an impact on our financial position, results of operations
              or cash
              flows.
 
 42
 In
              December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based
              Payment” (“SFAS 123R”), which is a revision of SFAS No. 123, “Accounting for
              Stock-Based Compensation”. SFAS 123R supersedes APB Opinion No. 25, “Accounting
              for Stock Issued to Employees” and amends SFAS No. 95, “Statement of Cash
              Flows”. SFAS 123R focuses primarily on accounting for transactions in which
              an
              entity obtains employee services in share-based payment transactions
              and
              requires all share-based payments to employees, including grants of
              employee
              stock options, to be recognized in the income statement based on their
              fair
              values. Accordingly, the adoption of SFAS 123R’s fair value method will have a
              significant impact on our results of operations, although it will have
              no impact
              on our overall financial position. We are currently evaluating the
              impact of
              this standard, but we estimate the impact of applying the various provisions
              of
              SFAS 123R will result in an expense, net of tax, of approximately $2.1
              million
              during fiscal 2006 if all current unvested stock options vest on the
              scheduled
              dates and the assumptions in the Black-Scholes model remain the same.
              Had we
              adopted SFAS 123R in prior periods, the impact of that standard would
              have
              approximated the impact of SFAS 123 as described in the disclosure
              of proforma
              net income and earnings per share in note 2, stock-based compensation,
              of notes
              to consolidated financial statements. SFAS 123R also requires the benefits
              of
              tax deductions in excess of recognized compensation costs to be reported
              as a
              financing cash flow, rather than as an operating cash flow as required
              under
              current literature. This requirement will reduce net operating cash
              flows and
              increase net financing cash flows in periods after adoption. While
              we cannot
              estimate what those amounts will be in the future (because they depend
              on, among
              other things, when employees exercise stock options), the amount of
              operating
              cash flows recognized in prior periods for such excess tax deductions
              were not
              material to our consolidated financial position or results of operations.
              This
              statement is effective for our fiscal year that begins December 1,
              2005.
 
 In
              December 2004, the FASB issued SFAS 153, “Exchanges of Nonmonetary Assets”
(“SFAS 153”). SFAS 153 amends the guidance in APB Opinion No. 29, “Accounting
              for Nonmonetary Transactions” to eliminate certain exceptions to the principle
              that exchanges of nonmonetary assets be measured based on the fair
              value of the
              assets exchanged. SFAS 153 eliminates the exception for nonmonetary
              exchanges of
              similar productive assets and replaces it with a general exception
              for exchanges
              of nonmonetary assets that do not have commercial substance. This statement
              is
              effective for nonmonetary asset exchanges in fiscal years beginning
              after June
              15, 2005. The adoption of SFAS 153 is not expected to have an impact
              on our
              financial position, results of operations or cash flows.
 
 The
              American Jobs Creation Act of 2004 (the “AJCA”) was enacted on October 22, 2004.
              The AJCA repeals an export incentive, creates a new deduction for qualified
              domestic manufacturing activities and includes a special one-time deduction
              of
              85% of certain foreign earnings repatriated to the U.S.
 
 In
              December 2004, the FASB issued FASB Staff Position No. 109-1, “Application
              of FASB Statement No. 109 (SFAS 109), Accounting for Income Taxes, to
              the Tax Deduction on Qualified Production Activities Provided by the
              American
              Jobs Creation Act of 2004” (FSP 109-1). FSP 109-1 clarifies that the
              manufacturer’s deduction provided for under the American Jobs Creation Act of
              2004 (AJCA) should be accounted for as a special deduction in accordance
              with SFAS 109 and not as a tax rate reduction. We have not completed the
              process of evaluating the impact that will result from adopting this
              statement
              and are therefore unable to disclose the impact that adopting FSP 109-1
              will
              have on our financial position and results of operations.
 
 The
              FASB
              also issued FASB Staff Position No. 109-2, Accounting and Disclosure
              Guidance for the Foreign Earnings Repatriation Provision within the
              American
              Jobs Creation Act of 2004 (FSP 109-2). The AJCA introduces a special
              one-time
              dividends received deduction on the repatriation of certain foreign
              earnings to
              a U.S. taxpayer (repatriation provision), provided certain criteria are
              met. FSP 109-2 provides accounting and disclosure guidance for the
              repatriation
              provision. We have described the impact of FSP 109-2 on our financial
              statements
              in note 7, Income Taxes.
 
 In
              May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error
              Corrections,” (“SFAS 154”). 
SFAS
              No. 154 replaces APB No. 20, “Accounting Changes” and SFAS No. 3,
“Reporting Accounting Changes in Interim Financial Statements” and establishes
              retrospective application as the required method for reporting a change
              in
              accounting principle.  The reporting of a correction of an error by
              restating previously issued financial statements is also addressed.
              SFAS
              No. 154 is effective for accounting changes and corrections of errors made
              in fiscal years beginning after December 15, 2005.  We do not believe
              that the adoption of SFAS No. 154 will have a material effect on our
              results of operations or consolidated financial position.
 
 In
              October
              2005, the FASB issued FASB Staff Position (“FSP”) 123R-2, “Practical
              Accommodation to the Application of Grant Date as Defined in FASB Statement
              No.
              123(R) (“FSP 123R-2”)”. FSP 123R-2 provides companies with a “practical
              accommodation” when determining the grant date of an award that is subject to
              the accounting provisions in SFAS 123R. Specifically, assuming a company
              meets
              all of the other criteria in the definition of grant date in SFAS 123R,
              a mutual
              understanding (between the company and the recipient) of the key terms
              and
              conditions of an award is presumed to exist at the date the award is
              approved
              (in accordance with the company’s normal corporate governance policy) if (1) the
              award is unilateral grant meaning that the recipient does not have
              the ability
              to negotiate the key terms and conditions of the award, and (2) the
              key
  43
 terms
              and
              conditions of the award are expected to be communicated to the recipient
              within
              a relatively short period of time (as defined in the FSP 123R-2) after
              the grant
              was approved. This FSP is effective upon initial adoption of SFAS 123-R
              on
              December 1, 2005.
 
 In
              November 2005, the FASB issued FSP 123R-3, “Transition Election Related to
              Accounting for the Tax Effects of Share-Based Payment Awards” (“FSP 123R-3”).
              FSP 123R-3 provides a practical exception when a company transitions
              to the
              accounting requirements in SFAS 123R. SFAS 123R requires a company
              to calculate
              the pool of excess tax benefits available to absorb tax deficiencies
              recognized
              subsequent to adopting SFAS 123R (“APIC Pool”), assuming the company had been
              following the recognition provisions prescribed by SFAS 123. The FASB
              learned
              that several companies do not have the necessary historical information
              to
              calculate the APIC pool as envisioned by SFAS 123R and accordingly,
              the FASB
              decided to allow a practical exception as documented in FSP 123R-3.
              This FSP is
              effective immediately.
 
 ***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. 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. The risks, uncertainties
              and
              assumptions of the forward-looking statements include, but are not
              limited to,
              the lack of availability, limits of coverage and expense related to
              product
              liability insurance, the reduction of available insurance coverage
              as proceeds
              are used to fund any product liability settlements or awards; the possibility
              of
              other product liability claims, including claims relating to the prior
              existence
              of ephedrine in *Dexatrim* products
              or arising from the FDA’s rule banning the sale of dietary supplements
              containing ephedrine; our ability to fund liabilities from product
              liability
              claims greater than our insurance coverage or outside the scope of
              insurance
              coverage; the possible effect of the negative public perception resulting
              from
              product liability claims on sales of *Dexatrim* products
              without PPA or ephedrine; the impact of brand acquisitions and divestures;
              the
              impact of gains or losses resulting from product acquisitions or divestures;
              product demand and market acceptance risks; product development risks,
              such as
              delays or difficulties in developing, producing and marketing new products
              or
              line extensions; the impact of competitive products, pricing and advertising;
              our ability to sell and market *Selsun* internationally where we have only limited experience and infrastructure;
              constraints resulting from our financial condition, including the degree
              to
              which we are leveraged, debt service requirements and restrictions
              under
              indentures and loan agreements; government regulations; risks of loss
              of
              material customers; public perception regarding our products; dependence
              on
              third party manufacturers; environmental matters; 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 consists of our Floating Rate
              Senior
              Notes, which were redeemed on December 30, 2005, and our Amended Revolving
              Credit Facility. The aggregate balance outstanding under the Floating
              Rate
              Senior Notes as of November 30, 2005 was $75.0 million. The Floating Rate
              Senior Notes bear interest at a three-month LIBOR plus 3.00% per year
              (6.87% as
              of November 30, 2005). Loans under our Amended Revolving Credit Facility
              bear
              interest at LIBOR plus applicable percentages of 1.00% to 2.00% or
              a base rate
              (the higher of the federal funds rate plus 0.5% or the prime rate)
              plus
              applicable percentages of 0.0% to 0.5%. The applicable percentages
              are
              calculated based on our leverage ratio. As of November 30, 2005, no
              amounts had
              been borrowed under the Amended Revolving Credit Facility, and the
              variable rate
              on the Amended Revolving Credit Facility was 7.0%. The Floating Rate
              Senior
              Notes were fully redeemed on December 30, 2005 utilizing $38.9 million
              of cash
              on hand plus $38.0 million drawn from the Amended Revolving Credit
              Facility. The
              7.0% Subordinated Notes are fixed interest rate obligations. On March
              8, 2004,
              we entered into an interest rate cap agreement effective June 1, 2004
              with
              decreasing annual notional principal amounts of $15.0 million beginning
              March 1,
              2006 and cap rates ranging from 4.0% to 5.0% over the life of the agreement.
              The
              amortized value of the premium on the interest rate cap was compared
              to its fair
              value as of November 30, 2005, and a charge of $0.1 million, net of
              tax, was
              recorded to other comprehensive income. The interest rate cap agreement
              terminates on March 1, 2010. The impact on our results of operations
  44
 of
              a
              one-point rate change on the February 17, 2006 outstanding balance
              of our
              Amended Revolving Credit Facility for the next twelve months would
              be
              approximately $0.3 million, net of tax.
 
 We
              are
              subject to risk from changes in the foreign exchange rates relating
              to our
              Canadian, U.K. and Irish subsidiaries. Assets and liabilities of these
              subsidiaries are translated to U.S. dollars at year-end exchange rates.
              Income
              and expense items are translated at average rates of exchange prevailing
              during
              the year. Translation adjustments are accumulated as a separate component
              of
              shareholders' equity. Gains and losses, which result from foreign currency
              transactions, are included in the consolidated statements of income.
              Until July
              2005, Abbott continued to supply us with a portion of our international
              supply
              of *Selsun* and
              billed us in U.S. dollars in certain instances. Beginning April 1,
              2004, a
              portion of our international supply of *Selsun* was
              billed to us in local currencies.  The
              potential loss resulting from a hypothetical 10.0% adverse change in
              the quoted
              foreign currency exchange rate amounts to approximately $1.0 million as of
              November 30, 2005.
 
 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.
                 45
 ***Item
          8. Financial Statements and Supplementary Data***
 
 
 
 ***REPORT
          OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM***
 
 To
          the
          Board of Directors and Shareholders Chattem, Inc.
 
 We
          have
          audited the accompanying consolidated balance sheet of Chattem, Inc. (a
          Tennessee corporation) and subsidiaries (the “Company”) as of November 30, 2005,
          and the related consolidated statements of income, shareholders’ equity, and
          cash flows for the year then ended. These financial statements are the
          responsibility of the Company's management. Our responsibility is to express
          an
          opinion on these financial statements 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 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 audit provides 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, 2005, and the results of their operations
          and
          their cash flows for the year then ended in conformity with accounting
          principles generally accepted in the United States of America.
 
 Our
          audit
          was conducted for the purpose of forming an opinion on the basic financial
          statements taken as a whole. The schedule titled “Schedule II - Valuation and
          Qualifying Accounts” is presented for purposes of additional analysis and is not
          a required part of the basic financial statements. This schedule has been
          subjected to the auditing procedures applied in the audit of the basic
          financial
          statements and, in our opinion, is fairly stated in all material respects
          in
          relation to the basic financial statements taken as a whole.
 
 We
          also
          have audited, in accordance with the standards of the Public Company Accounting
          Oversight Board (United States), the effectiveness of Chattem, Inc. and
          subsidiaries’ internal control over financial reporting as of November 30, 2005,
          based on criteria established in Internal Control— Integrated Framework issued
          by the Committee of Sponsoring Organizations of the Treadway Commission
          (COSO)
          and our report dated February 17, 2006 expressed an unqualified opinion
          on
          management’s assessment of, and an adverse opinion on the effectiveness of,
          internal control over financial reporting.
 
 As
          discussed in Note 2 of the consolidated financial statements, during fiscal
          2005, the Company’s domestic operations changed the method of accounting for
          inventories from the last-in, first-out inventory method to the first-in
          first-out inventory method. The consolidated financial statements as of
          November
          30, 2004 and for the year then ended and the consolidated statement of
          income
          for the year ended November 30, 2003 have been adjusted to apply this new
          methodology retroactively.
 
 
 /s/
          GRANT
          THORNTON LLP
 
 Charlotte,
          North Carolina
 February
          17, 2006
  46
  
 ***Report
          of Independent Registered Public Accounting Firm***
 
 *To
          the
          Board of Directors and Shareholders*
 *Chattem,
          Inc.*
 
 We
          have
          audited the accompanying consolidated balance sheet of Chattem, Inc. and
          subsidiaries as of November 30, 2004 and the related consolidated statements
          of
          income, shareholders' equity and cash flows for each of the two years in
          the
          period ended November 30, 2004. These financial statements are the
          responsibility of the Company's management. Our responsibility is to express
          an
          opinion on these financial statements 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 financial statements referred to above present fairly, in
          all
          material respects, the consolidated financial position of Chattem, Inc.
          and
          subsidiaries at November 30, 2004 and the consolidated results of their
          operations and their cash flows for each of the two years in the period
          ended
          November 30, 2004, in conformity with U.S. generally accepted accounting
          principles.
 
 As
          described in Note 2 to the consolidated financial statements, during fiscal
          2005
          the Company changed its method of accounting for inventories in the U.S.
          from
          the last-in, first-out inventory method to the first-in, first-out inventory
          method.
 
 We
          also
          have audited, in accordance with the standards of the Public Company Accounting
          Oversight Board (United States), the effectiveness of Chattem, Inc.’s internal
          control over financial reporting as of November 30, 2004, based on criteria
          established in Internal Control-Integrated Framework issued by the Committee
          of
          Sponsoring Organizations of the Treadway Commission and our report dated
          January
          31, 2005 (not provided herein) expressed an unqualified opinion
          thereon.
  
  
 
 /s/ ERNST & YOUNG
                    LLP
 
 
 Chattanooga,
          Tennessee
 January
          31, 2005, except for the section “Inventories” included in Note 2
 as
          to
          which the date is February 17, 2006
 
 
 
 
  
 
 
 
 
 
 
  47
  Consolidated
          Balance Sheets
 *November
          30, 2005 and 2004*
 *(In
          thousands)*
 
 
 ASSETS
                
                2005
                
                2004as
                    adjusted(1)CURRENT
                    ASSETS:
                  Cash
                    and cash equivalents
                
                $
                47,327
                
                $
                40,193Accounts
                    receivable, less allowances of $2,338 in 2005
                  and $1,682 in 2004
                
                
                33,672
                
                
                32,098Other
                    receivables
                
                
                9,600
                
                
                —Inventories
                
                
                23,631
                
                
                23,124Refundable
                    income taxes
                
                
                1,207
                
                
                4,186Deferred
                    income taxes
                
                
                2,478
                
                
                4,308Prepaid
                    expenses and other current assets
                
                
                5,106
                
                
                3,683Total
                    current assets
                
                
                123,021
                
                
                107,592PROPERTY,
                    PLANT AND EQUIPMENT, NET
                
                
                29,254
                
                
                28,765OTHER
                    NONCURRENT ASSETS:Patents,
                    trademarks and other purchased
                  product
                    rights, net
                
                
                206,387
                
                
                225,560Debt
                    issuance costs, net
                
                
                4,297
                
                
                5,174Other
                
                
                5,334
                
                
                5,551Total
                    other noncurrent assets
                
                
                216,018
                
                
                236,285TOTAL
                    ASSETS
                
                $
                368,293
                
                $
                372,642
 
 
 *The
          accompanying notes are an integral part of these consolidated financial
          statements.*
 
 (1)
          The
          consolidated balance sheet has been adjusted to reflect retroactively the
          change
          in method of valuing our domestic inventory from the last-in, first-out
          (“LIFO”)
          method to the first-in, first-out (“FIFO”) method adopted in fiscal
          2005.
 
  48
  **Consolidated
          Balance Sheets**
 *November
          30, 2005 and 2004*
 *(In
          thousands)*
  LIABILITIES
                    AND SHAREHOLDERS’
                    EQUITY
                
                2005
                
                2004*as
                    adjusted*(**1)**CURRENT
                    LIABILITIES:Current
                    maturities of long-term debt
                
                $
                37,000
                
                $
                —Accounts
                    payable and other
                
                
                17,238
                
                
                13,341Accrued
                    liabilities
                
                
                16,327
                
                
                23,763Total
                    current liabilities
                
                
                70,565
                
                
                37,104LONG-TERM
                    DEBT, less current maturities
                
                
                145,500
                
                
                200,000DEFERRED
                    INCOME TAXES
                
                
                27,736
                
                
                25,732OTHER
                    NONCURRENT LIABILITIES
                
                
                1,865
                
                
                1,776COMMITMENTS
                    AND CONTINGENCIES (Note 13)SHAREHOLDERS’
                    EQUITY:Preferred
                    shares, without par value, authorized 1,000, none issued
                
                
                —
                
                
                —Common
                    shares, without par value, authorized 50,000, issued 19,668 in
                    2005
                  and
                    19,882 in 2004
                
                
                63,876
                
                
                85,949Retained
                    earnings
                
                
                60,853
                
                
                24,806124,729
                
                
                110,755Unamortized
                    value of restricted common shares issued
                
                
                (1,818
                )
                
                (2,386
                )Cumulative
                    other comprehensive income, net of taxes:Interest
                    rate cap adjustment
                
                
                (83
                )
                
                (316
                )Foreign
                    currency translation adjustment
                
                
                (201
                )
                
                (23
                )Total
                    shareholders’
                    equity
                
                
                122,627
                
                
                108,030TOTAL
                    LIABILITIES AND SHAREHOLDERS’
                    EQUITY
                
                $
                368,293
                
                $
                372,642
 
 *The
          accompanying notes are an integral part of these consolidated financial
          statements.*
 
 (1)
          The
          consolidated balance sheet has been adjusted to reflect retroactively the
          change
          in method of valuing our domestic inventory from the LIFO method to the
          FIFO
          method adopted in fiscal 2005.
   49
  **Consolidated
          Statements of Income**
 *For
          the Years Ended November 30, 2005, 2004 and 2003*
 *(In
          thousands, except per share amounts)*
 
 **2005**
                
                **2004**
                
                **2003**as
                    adjusted(**1)**
                
                as
                    adjusted(**1)**TOTAL
                    REVENUES:Net
                    sales
                
                $
                279,140
                
                $
                257,534
                
                $
                232,527Royalties
                
                
                178
                
                
                621
                
                
                1,222Total
                    revenues
                
                
                279,318
                
                
                258,155
                
                
                233,749COSTS
                    AND EXPENSES:Cost
                    of sales
                
                
                79,884
                
                
                73,358
                
                
                66,424Advertising
                    and promotion
                
                
                76,763
                
                
                74,929
                
                
                70,622Selling,
                    general and administrative
                
                
                47,322
                
                
                44,169
                
                
                40,803Executive
                    severance charges
                
                
                2,269
                
                
                —
                
                
                —Impairment
                    of indefinite-lived intangible assets
                
                
                —
                
                
                20,000
                
                
                —Loss
                    on product divestures
                
                
                8,678
                
                
                —
                
                
                —Litigation
                    settlement
                
                
                (2,086
                )
                
                15,836
                
                
                —Total
                    costs and expenses
                
                
                212,830
                
                
                228,292
                
                
                177,849INCOME
                    FROM OPERATIONS
                
                
                66,488
                
                
                29,863
                
                
                55,900OTHER
                    INCOME (EXPENSE):Interest
                    expense
                
                
                (13,814
                )
                
                (15,049
                )
                
                (20,431
                )Investment
                    and other income, net
                
                
                1,086
                
                
                298
                
                
                124Loss
                    on early extinguishment of debt
                
                
                (750
                )
                
                (12,958
                )
                
                —Total
                    other income (expense)
                
                
                (13,478
                )
                
                (27,709
                )
                
                (20,307
                )INCOME
                    BEFORE INCOME TAXES
                
                
                53,010
                
                
                2,154
                
                
                35,593PROVISION
                    FOR INCOME TAXES
                
                
                16,963
                
                
                703
                
                
                12,246NET
                    INCOME
                
                $
                36,047
                
                $
                1,451
                
                $
                23,347NUMBER
                    OF COMMON SHARES:Weighted
                    average outstanding, basic
                
                
                19,652
                
                
                19,379
                
                
                18,925Weighted
                    average and potential dilutive outstanding
                
                
                20,366
                
                
                20,225
                
                
                19,632NET
                    INCOME PER COMMON SHARE:Basic
                
                $
                1.83
                
                $
                .07
                
                $
                1.23Diluted
                
                $
                1.77
                
                $
                .07
                
                $
                1.19
 
 
 *The
          accompanying notes are an integral part of these consolidated financial
          statements.*
 
 (1)
          The
          consolidated statements of income have been adjusted to reflect retroactively
          the change in method of valuing our domestic inventory from the LIFO method
          to
          the FIFO method adopted in fiscal 2005.
 
 50
  **Consolidated
          Statements of Shareholders’ Equity**
 *For
          the Years Ended November 30, 2005, 2004 and 2003*
 *(In
          thousands, except per share amounts)*
 Common
                    Shares
                  
                  
                  Retained
                    Earnings
                    (Deficit)
                  
                  
                  Unamortized
                    Value
                      of
                    Restricted
                    Common
                    Shares
                    Issued
                  
                  
                  Interest
                      Rate
                    Cap
                    Adjustment
                  
                  
                  Foreign
                    Currency
                    Translation
                    Adjustment
                  
                  
                  Minimum
                    Pension
                    Liability
                    Adjustment,
                    Net
                  
                  
                  TotalBalance,
                      November 30, 2002, as previously reported
                  
                  $
                  79,313
                  
                  $
                  (1,097
                  )
                  $
                  (1,713
                  )
                  $
                  —
                  
                  $
                  (1,759
                  )
                  $
                  —
                  
                  $
                  74,744Adjustment
                      for the cumulative effect on prior years of applying
                    retroactively
                      the LIFO to FIFO change in accounting
                  
                  
                  
                  
                  
                  1,105
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  1,105Balance,
                      November 30, 2002, as adjusted
                      (**1)**
                  
                  
                  79,313
                  
                  
                  8
                  
                  
                  (1,713
                  )
                  
                  —
                  
                  
                  (1,759
                  )
                  
                  —
                  
                  
                  75,849Comprehensive
                      income (loss):Net
                      income, as adjusted(1)
                  
                  
                  —
                  
                  
                  23,347
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  23,347Foreign
                      currency translation adjustment
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  939
                  
                  
                  —
                  
                  
                  939Minimum
                      pension liability adjustment
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  (1,640
                  )
                  
                  (1,640
                  )Total
                      comprehensive income
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  22,646Stock
                      options exercised
                  
                  
                  1,555
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  1,555Tax
                      benefit realized from stock option plans
                  
                  
                  1,259
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  1,259Stock
                      repurchases
                  
                  
                  (5,351
                  )
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  (5,351
                  )Issuance
                      of 2.1 common shares for non-employee
                    directors’ compensation
                  
                  
                  39
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  39Issuance
                      of 69 shares of restricted common stock at a
                    value of $14.50
                      per share
                  
                  
                  1,000
                  
                  
                  —
                  
                  
                  (1,000
                  )
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —Amortization
                      of value of restricted common shares issued
                  
                  
                  —
                  
                  
                  —
                  
                  
                  655
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  655Balance,
                      November 30, 2003, as adjusted
                      (**1)**
                  
                  
                  77,815
                  
                  
                  23,355
                  
                  
                  (2,058
                  )
                  
                  —
                  
                  
                  (820
                  )
                  
                  (1,640
                  )
                  
                  96,652Comprehensive
                      income (loss):Net
                      income, as adjusted(1)
                  
                  
                  —
                  
                  
                  1,451
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  1,451Interest
                      rate cap adjustment
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  (316
                  )
                  
                  —
                  
                  
                  —
                  
                  
                  (316
                  )Foreign
                      currency translation adjustment
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  797
                  
                  
                  —
                  
                  
                  797Minimum
                      pension liability adjustment
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  1,640
                  
                  
                  1,640Total
                      comprehensive income
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  3,572Stock
                      options exercised
                  
                  
                  6,148
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  6,148Tax
                      benefit realized from stock option plans
                  
                  
                  5,568
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  5,568Stock
                      repurchases
                  
                  
                  (5,034
                  )
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  (5,034
                  )Issuance
                      of 2.8 common shares for non- employee
                    directors’ compensation
                  
                  
                  53
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  53Issuance
                      of 70 shares of restricted common stock at a
                    value of $19.98
                      per share
                  
                  
                  1,399
                  
                  
                  —
                  
                  
                  (1,399
                  )
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —Amortization
                      of value of restricted common shares issued
                  
                  
                  —
                  
                  
                  —
                  
                  
                  1,071
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  1,071Balance,
                      November 30, 2004, as adjusted
                      (**1)**
                  
                  
                  85,949
                  
                  
                  24,806
                  
                  
                  (2,386
                  )
                  
                  (316
                  )
                  
                  (23
                  )
                  
                  —
                  
                  
                  108,030
 
 (1)
          The
          consolidated statements of shareholders’ equity have been adjusted to reflect
          retroactively the change in method of valuing our domestic inventory from
          the
          LIFO method to the FIFO method adopted in fiscal 2005.
  51
    Common
                      Shares
                    
                    Retained
                      Earnings
                      (Deficit)
                    
                    Unamortized
                      Value
                        of
                      Restricted
                      Common
                      Shares
                      Issued
                    
                    Interest
                        Rate
                      Cap
                      Adjustment
                    
                    Foreign
                      Currency
                      Translation
                      Adjustment
                    
                    Minimum
                      Pension
                      Liability
                      Adjustment,
                      Net
                    
                    TotalComprehensive
                        income (loss):Net
                        income
                    
                    —
                    
                    36,047
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    36,047Interest
                        rate cap adjustment
                    
                    —
                    
                    —
                    
                    —
                    
                    233
                    
                    —
                    
                    —
                    
                    233Foreign
                        currency translation adjustment
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    (178
                    )
                    —
                    
                    (178
                    )Total
                        comprehensive income
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    36,102Stock
                        options exercised
                    
                    6,681
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    6,681Tax
                        benefit realized from stock option plans
                    
                    3,292
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    3,292Stock
                        repurchases
                    
                    (34,084
                    )
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    (34,084
                    )Issuance
                        of 1.8 common shares for
                        non- employee directors’ compensation
                    
                    70
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    70Issuance
                        of 50 shares of restricted common stock at
                        a value of $ 35.37 per share
                    
                    1,769
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    1,769Modification
                        of restricted stock agreement
                    
                    199
                    
                    —
                    
                    (257
                    )
                    —
                    
                    —
                    
                    —
                    
                    (58
                    )Amortization
                        of value of restricted common shares issued
                    
                    —
                    
                    —
                    
                    825
                    
                    —
                    
                    —
                    
                    —
                    
                    825Balance,
                        November 30, 2005
                    
                    $
                    63,876
                    
                    $
                    60,853
                    
                    $
                    (1,818
                    )
                    $
                    (83
                    )
                    $
                    (201
                    )
                    
                    —
                    
                    $
                    122,627
  *The
          accompanying notes are an integral part of these consolidated financial
          statements.*
  52
  **Consolidated
          Statements of Cash Flows**
 *For
          the Years Ended November 30, 2005, 2004 and 2003*
 *(In
          thousands, except per share amounts)*
  **2005**
                    
                    **2004**
                    
                    **2003**OPERATING
                        ACTIVITIES:
                    
                    
                    
                    as
                        adjusted (1)
                    
                    as
                        adjusted (1)Net
                        income
                    
                    $
                    36,047
                    
                    $
                    1,451
                    
                    $
                    23,347Adjustments
                        to reconcile net income to net cash provided by operating
                        activities:Depreciation
                        and amortization
                    
                    
                    6,115
                    
                    
                    6,131
                    
                    
                    6,584Deferred
                        income taxes
                    
                    
                    3,894
                    
                    
                    (1,931
                    )
                    
                    6,627Loss
                        on early extinguishment of debt
                    
                    
                    750
                    
                    
                    12,958
                    
                    
                    —Impairment
                        of indefinite-lived assets
                    
                    
                    —
                    
                    
                    20,000
                    
                    
                    —Loss
                        on product line divestures
                    
                    
                    8,678
                    
                    
                    —
                    
                    
                    —Tax
                        benefit realized from stock option exercises
                    
                    
                    3,292
                    
                    
                    5,568
                    
                    
                    1,259Stock
                        option expense
                    
                    
                    1,360
                    
                    
                    —
                    
                    
                    —Other,
                        net
                    
                    
                    800
                    
                    
                    (249
                    )
                    
                    (66
                    )Changes
                        in operating assets and liabilities, net of acquisitions:Accounts
                        receivable
                    
                    
                    (2,224
                    )
                    
                    (6,620
                    )
                    
                    195Inventories
                    
                    
                    (1,457
                    )
                    
                    (3,876
                    )
                    
                    1,248Refundable
                        income taxes
                    
                    
                    2,979
                    
                    
                    (363
                    )
                    
                    (403
                    )Prepaid
                        expenses and other current assets
                    
                    
                    (726
                    )
                    
                    (200
                    )
                    
                    (617
                    )Accounts
                        payable and accrued liabilities
                    
                    
                    (4,492
                    )
                    
                    11,841
                    
                    
                    (6,723
                    )Net
                        cash provided by operating activities
                    
                    
                    55,016
                    
                    
                    44,710
                    
                    
                    31,451INVESTING
                        ACTIVITIES:Purchases
                        of property, plant and equipment
                    
                    
                    (3,943
                    )
                    
                    (3,239
                    )
                    
                    (5,527
                    )Sales
                        (purchases) of patents, trademarks and other product
                        rights
                    
                    
                    3,199
                    
                    
                    (7
                    )
                    
                    (400
                    )(Increase)
                        decrease in other assets
                    
                    
                    86
                    
                    
                    (2,245
                    )
                    
                    1,479Net
                        cash used in investing activities
                    
                    
                    (658
                    )
                    
                    (5,491
                    )
                    
                    (4,448
                    )FINANCING
                        ACTIVITIES:Repayment
                        of long-term debt
                    
                    
                    (17,500
                    )
                    
                    (212,288
                    )
                    
                    (12,250
                    )Proceeds
                        from long-term debt
                    
                    
                    —
                    
                    
                    200,000
                    
                    
                    —Proceeds
                        from borrowings under revolving credit facility
                    
                    
                    —
                    
                    
                    25,000
                    
                    
                    —Repayments
                        of revolving credit facility
                    
                    
                    —
                    
                    
                    (25,000
                    )
                    
                    —Repayments
                        of policy loans
                    
                    
                    (1,031
                    )
                    
                    —
                    
                    
                    —Repurchase
                        of common shares
                    
                    
                    (34,084
                    )
                    
                    (5,034
                    )
                    
                    (5,351
                    )Proceeds
                        from exercise of stock options
                    
                    
                    6,681
                    
                    
                    6,148
                    
                    
                    1,555Increase
                        in debt issuance costs
                    
                    
                    (313
                    )
                    
                    (5,743
                    )
                    
                    (25
                    )Debt
                        retirement costs
                    
                    
                    (282
                    )
                    
                    (7,861
                    )
                    
                    —Premium
                        on interest rate cap agreement
                    
                    
                    —
                    
                    
                    (1,375
                    )
                    
                    —Net
                        cash used in financing activities
                    
                    
                    (46,529
                    )
                    
                    (26,153
                    )
                    
                    (16,071
                    )EFFECT
                        OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
                    
                    
                    (695
                    )
                    
                    196
                    
                    
                    75CASH
                        AND CASH EQUIVALENTS:Increase
                        for the year
                    
                    
                    7,134
                    
                    
                    13,262
                    
                    
                    11,007At
                        beginning of year
                    
                    
                    40,193
                    
                    
                    26,931
                    
                    
                    15,924At
                        end of year
                    
                    $
                    47,327
                    
                    $
                    40,193
                    
                    $
                    26,931SCHEDULE
                        OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
 Issuance
                        of 50 shares of restricted common stock at a value of $35.37
                        per share
                      in
                        2005, 70 shares at a value of $19.98 per share in 2004 and
                        69 shares at a
                      value
                        of $14.50 per share in 2003
                    
                    $
                    1,769
                    
                    $
                    1,399
                    
                    $
                    1,000
 
 *The
          accompanying notes are an integral part of these consolidated financial
          statements* .
 
 (1)
          The
          consolidated statements of cash flows have been adjusted to reflect
          retroactively the change in method of valuing our domestic inventory from
          the
          LIFO method to the FIFO method adopted in fiscal 2005.
 
 53
  Notes
          to
          Consolidated Financial Statements
 
 *All
          monetary and share amounts are expressed in thousands. Our fiscal years
          ended
          November 30, 2003, November 30, 2004 and November 30, 2005 are referred
          to
          herein as fiscal 2003, fiscal 2004 and fiscal 2005,
          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, Inc. 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.
 
 **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. The
          Company estimates reserves for inventory obsolescence based on its judgment
          of
          future realization.
 
 Prior
          to
          November 30, 2005, all of the Company’s domestic inventories were accounted for
          at the lower of cost using the last-in, first-out (“LIFO”) basis or market,
          while inventories of the Company’s foreign subsidiaries were stated at the lower
          of cost using the first-in, first-out (“FIFO”) basis or market. During the
          quarter ended November 30, 2005, the Company’s domestic operations changed the
          method of accounting for the cost of inventories from the LIFO method to
          the
          FIFO method. The new method of accounting for inventories results in conforming
          all of the Company’s inventories to a uniform method of accounting to more
          accurately measure operating results, to more accurately present financial
          position by reflecting more recent costs at the balance sheet date, and
          to
          provide more meaningful reporting to lenders. The November 30, 2004 consolidated
          balance sheet and the related consolidated statements of income, shareholders’
equity and cash flows for each of the two years in the period ended November
          30,
          2004 have been adjusted to apply the new method retroactively.
 
 Due
          to the
          change in accounting principle, inventory previously reported as of November
          30,
          2004 increased $1,434, refundable income taxes decreased $516 and retained
          earnings increased $918. The effect of the accounting change on net income
          previously reported for the years ended November 30, 2004 and 2003 is presented
          in the following table.
 
 November
                    30, 2004
                
                November
                    30, 2003Previously
                  reported
                
                As
                    adjusted
                
                Previously
                  reported
                
                As
                    adjustedNet
                    income
                
                $
                1,614
                
                $
                1,451
                
                $
                23,371
                
                $
                23,347Net
                    income per common shareBasic
                
                $
                .08
                
                $
                .07
                
                $
                1.23
                
                $
                1.23Diluted
                
                $
                .08
                
                $
                .07
                
                $
                1.19
                
                $
                1.19
  54
  **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 2005, fiscal 2004 and fiscal
          2003 was
          $3,419, $3,302 and $3,493, 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. Prior
          to the
          adoption of SFAS 142 (see below), trademarks were amortized over 40 years.
 
 In
          June
          2001, the Financial Accounting Standards Board (“FASB”) issued Statement of
          Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible
          Assets” (“SFAS 142”). The provisions of SFAS 142, which were adopted by us on
          December 1, 2001, require us to discontinue the amortization of the cost
          of
          intangible assets with indefinite lives and also require certain
          fair-value-based tests of the carrying value of indefinite-lived intangible
          assets upon adoption and thereafter 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 indicated that
          finite-lived assets should have been evaluated for possible impairment,
          we used
          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.
 
 **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 $727, $843 and $1,501 in fiscal
          2005,
          fiscal 2004 and fiscal 2003, respectively. Accumulated amortization of
          these
          costs was $689 and $569 at November 30, 2005 and 2004, respectively. Due
          to the
          repurchase of $17,500 of our 7.0% Senior Subordinated Notes due 2014 (the
“7.0%
          Subordinated Notes”) during the second quarter of 2005, we recorded a loss on
          early extinguishment of debt of $744. Due to our refinancing transactions
          (described in Note 5) in fiscal 2004, tender premiums and related fees
          of $7,861
          were paid and net debt issuance costs of $5,097 were written off and charged
          to
          loss on early extinguishment of debt in the consolidated statements of
          income.
          In addition, during fiscal 2004 new debt issuance costs of $5,743 were
          capitalized. Due to prepayments on the Credit Facility (as defined in Note
          5) in
          fiscal 2003, net debt issuance cost of $145 was written off and charged
          to
          interest expense included in the consolidated statements of income.
 
 **PRODUCT
          DEVELOPMENT**
 
 Product
          development costs relate primarily to the development of new products and
          are expensed as incurred. Such expenses were $3,618, $3,051 and $2,696
          in fiscal
          2005, 2004 and 2003, respectively.
 
 **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
          2005, 2004 and 2003 was $53,096, $54,263 and $50,462, respectively. At
          November
          30, 2005 and 2004, we reported $2,087 and $1,168, respectively, of
          advertising paid for in fiscal 2005 and fiscal 2004, 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.”) and Irish 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 which result from foreign currency transactions amounted to
          $189, $194 and $220 in fiscal 2005, 2004 and 2003, respectively, and are
          included in the consolidated statements of income as investment and other
          income, net of expense.
  55
  **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 2005, 2004 and 2003.
  **Allowance
          For Doubtful Accounts**
 
 As
          of
          November 30, 2005, 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, 2005, we performed a detailed assessment
          of
          the collectibility of trade accounts receivable and reduced our estimate
          of
          allowance for doubtful accounts by approximately $447, which resulted in
          a
          decrease to selling, general and administrative expense in our consolidated
          financial statements. The balance of allowance for doubtful accounts was
          $303
          and $750 at November 30, 2005 and 2004, respectively.
 
 **Revenue
          Recognition**
 
 Revenue
          is
          recognized when our products are shipped to our customers. It is generally
          our
          policy across all classes of customers that all sales are final. As is
          common in
          the consumer products industry, customers return products for a variety
          of
          reasons including products damaged in transit, discontinuance of a particular
          size or form of product and shipping errors. As sales are recorded, we
          accrue an
          estimated amount for product returns, as a reduction of these sales, based
          upon
          our historical experience and any known specific events that affect the
          accrual.
          We charge the allowance account resulting from this accrual with any authorized
          deduction from remittance by the customer or product returns upon receipt
          of the
          product.
 
 In
          accordance with industry practice, we allow our customers to return unsold
          sun
          care products (i.e. *Bullfrog* and *Sun
          In* lines of
          products) at the end of the sun care season. We record the sales at the
          time the
          products are shipped and title transfers. At the time of shipment, we also
          record a reduction in sales and an allowance on our balance sheet for
          anticipated returns based upon an estimated return level. The level of
          returns
          may fluctuate from our estimates due to several factors including weather
          conditions, customer inventory levels and competitive conditions. Each
          percentage point change in our return rate would impact our net sales by
          approximately $167. During fiscal 2005, we reduced our estimate of seasonal
          returns by approximately $202, to a balance of $248, which resulted in
          an
          increase to net sales in our consolidated financial statements in fiscal
          2005,
          as compared to an approximately $934 reduction in our estimate in fiscal
          2004
          and an approximately $323 increase in our estimate in fiscal 2003, which
          resulted in an increase and decrease to net sales in our consolidated financial
          statements in fiscal 2004 and 2003, respectively. During fiscal 2005, as
          a
          result of our estimate of customer inventory levels and based on historical
          non-seasonal product returns, we increased our estimate of non-seasonal
          returns
          by approximately $582, to a balance of $647, which resulted in a decrease
          to net
          sales in our consolidated financial statements in fiscal 2005. During fiscal
          2004 and 2003, we reduced our estimate of non-seasonal returns by approximately
          $765 and $692, respectively, which resulted in an increase to net sales
          in our
          consolidated financial statements in fiscal 2004 and 2003, respectively.
          At
          November 30, 2005 we recorded an allowance for returns of pHisoderm of
          $650 as a
          result of the sale of pHisoderm as discussed in note 9.
 
 We
          routinely enter into agreements with our customers to participate in promotional
          programs. These programs generally take the form of coupons, temporary
          price
          reductions, scan downs, display activity and participations in advertising
          vehicles provided uniquely by the customer. The ultimate cost of these
          programs
          is often variable based on the number of units actually sold. Estimated
          unit
          sales of a product under a promotional program are used to estimate the
          total
          cost of the program, which is recorded as a reduction of sales or as an
          advertising and promotion expense based on the type of promotional program.
          Actual results can differ from the original estimate. In addition, increases
          and
          decreases in total program commitments each year impact the accrual. We
          also
          consider customer delays in requesting promotional program payments when
          evaluating the required accrual. Some customers audit programs significantly
          after the date of performance to determine the actual amount due and make
          a
          claim for reimbursement at that time. As a result, changes in the unit
          sales
          trends under
  56
  promotional
          programs as well as the timing of payments result in changes in the accrual.
          During fiscal 2005, 2004 and 2003, promotional accruals decreased by
          approximately $1,575, $1,642 and $2,251, respectively, which resulted in
          an
          increase to net sales or a decrease in advertising and promotion expense
          in our
          consolidated financial statements.
 
 **Income
          Taxes**
 
 We
          account
          for income taxes using the asset and liability approach as prescribed by
          SFAS
          No. 109, “Accounting for Income Taxes”. This approach requires recognition of
          deferred tax assets and liabilities for the expected future tax consequences
          of
          events that have been included in the consolidated financial statements
          or tax
          returns. Using the enacted tax rates in effect for the year in which the
          differences are expected to reverse, deferred tax assets and liabilities
          are
          determined based on the differences between the financial reporting and
          the tax
          basis of an asset or liability. We record income tax expense in our consolidated
          financial statements based on an estimated annual effective income tax
          rate. We
          revised our annual estimated income tax rate during fiscal 2005 to 32%,
          as
          compared to 33% in fiscal 2004 and 34% in fiscal 2003, as a result of the
          implementation of a number of foreign and state tax planning
          initiatives.
 
 
 **DERIVATIVE
          FINANCIAL INSTRUMENTS**
 
 We
          entered
          into an interest rate cap agreement effective June 1, 2004 as a means of
          managing our interest rate exposure and not for trading purposes. The agreement
          has the effect of converting a portion of our variable rate obligations
          to fixed
          rate obligations (see Note 5). In accordance with SFAS 133, Accounting
          for
          Derivative Instruments and Hedging Activities, as of November 30, 2005,
          a
          portion of the interest rate cap was deemed to be an ineffective cash flow
          hedge
          due to the reduction of variable rate debt upon the subsequent redemption
          of our
          Floating Rate Senior Notes, resulting in a loss of $60, net of tax, reflected
          in
          the income statement as interest expense. The balance of the cash flow
          hedge was
          deemed to be effective and the remaining change in the fair value of the
          interest rate cap during fiscal 2005 as compared to the amortized value
          of its
          premium during the year was recorded in other comprehensive income in the
          amount
          of $233, net of tax.
 
 **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
          36%, 34% and 34% of consolidated sales in fiscal 2005, 2004 and 2003,
          respectively. No other customer exceeded 10% of our consolidated sales
          during
          the period. Shoppers Drug Mart, a Canadian retailer, accounts for more
          than 10%
          of our international revenues. Our ten largest customers represented
          approximately 70% of total revenues during fiscal 2005, and approximately
          64% of
          our total accounts receivable at November 30, 2005.
 
 **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 2005 represented approximately $8,864 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 $7,998, $7,482 and $6,310 for fiscal 2005, 2004 and
          2003,
          respectively, are included in selling expenses in our consolidated statements
          of
          income.
  **STOCK-BASED
          COMPENSATION**
 
 We
          account
          for our stock-based compensation plans under Accounting Principles Board
          Opinion
          No. 25, “Accounting for Stock Issued to Employees”. Under APB 25, generally no
          compensation expense is recorded when the terms of the award are fixed
          and the
          exercise price of the employee stock option equals or exceeds the fair
          value of
          the underlying stock on the
  57
  date
          of
          grant. We adopted the disclosure-only provision of Statement of Financial
          Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS
          123”). In December 2004, the Financial Accounting Standards Board (“FASB”)
          issued 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 measurement
          based on the grant date fair value of the award. It also requires the cost
          to be
          recognized over the period during which an employee is required to provide
          service in exchange for the award (the vesting period).
 
 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 Stock Incentive Plan provides
          for the
          issuance of up to 1,500 shares of common stock. The 2005 Stock Incentive
          Plan,
          which was adopted by our board of directors on January 25, 2005 and was
          approved by our shareholders at the April 13, 2005 annual shareholders’ meeting,
          provides for the issuance of up to 1,500 shares of common stock. Options
          vest 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.
 
 On
          October
          27, 2005, the compensation committee of our board of directors approved
          the
          immediate acceleration of vesting for all unvested outstanding stock options
          granted under our 2005 Non-Statutory Stock Option Plan whose exercise price
          exceeded the closing sale price of the shares of our common stock on the
          last
          business day prior to November 30, 2005, the effective date of the acceleration.
          As a result, options to purchase approximately 436 shares, including options
          to
          purchase approximately 260 shares held by our executive officers, became
          immediately exercisable.
 
 The
          decision to accelerate vesting of these options was made primarily to minimize
          future compensation expense that we would otherwise recognize in our
          consolidated statements of income upon effectiveness of SFAS 123R. As a
          result
          of the acceleration, stock option expense will be reduced by approximately
          $10,500, $6,700 net of tax, over the next four fiscal years.
 
 For
          SFAS
          123 purposes, as amended by SFAS 148 “Accounting for Stock Based Compensation -
          Transition and disclosure - an amendment of FASB No. 123,” the fair value of
          each option grant has been estimated as of the date of grant using the
          Black-Scholes option-pricing model with the following weighted average
          assumptions for grants in fiscal 2005, 2004 and 2003: expected dividend
          yield of
          0%, expected volatility of 55%, 58% and 60%, respectively, risk-free interest
          rates of 4.49%, 4.35% and 4.33%, respectively, and expected lives of
          approximately six, five and six years in fiscal 2005, 2004 and 2003,
          respectively.
 
 58
 
 Had
          compensation expense for stock option grants been determined based on the
          fair
          value at the grant dates consistent with the method prescribed by SFAS
          123, our
          net income (loss) and net income (loss) per share would have been adjusted
          to
          the pro forma amounts for fiscal 2005, 2004 and 2003 as indicated
          below:
 
 
 2005
                
                2004
                
                2003as
                    adjusted(1)
                
                as
                    adjusted(1)Net
                    income (loss):As
                    reported
                
                $
                36,047
                
                $
                1,451
                
                $
                23,347Recognized
                    stock-based
                  compensation
                    costs, net
                
                
                —
                
                
                —
                
                
                —Fair
                    value method compensation
                  costs,
                    net
                
                
                (10,005
                )
                
                (4,465
                )
                
                (2,879
                )Pro
                    forma
                
                $
                26,042
                
                $
                (3,014
                )
                $
                20,468Net
                    income (loss) per share, basic:As
                    reported
                
                $
                1.83
                
                $
                .07
                
                $
                1.23Pro
                    forma
                
                $
                1.33
                
                $
                (.16
                )
                $
                1.08Net
                    income (loss) per share, diluted:As
                    reported
                
                $
                1.77
                
                $
                .07
                
                $
                1.19Pro
                    forma
                
                $
                1.28
                
                $
                (.15
                )
                $
                1.04
 
 (1)
          Net
          income for fiscal 2004 and 2003 has been adjusted to reflect retroactively
          the
          change in method of valuing our domestic inventory from the LIFO method
          to the
          FIFO method adopted in fiscal 2005.
 
 **RECLASSIFICATIONS
          AND ADJUSTMENTS**
 
 Certain
          prior year amounts have been reclassified to conform to the current period’s
          presentation. In addition, all financial information presented has been
          adjusted
          to reflect retroactively the change, during the fourth quarter of 2005,
          in
          method of determining the cost of our domestic inventory from the LIFO
          method to
          the FIFO method. Since the annual adjustment to the LIFO allowance has
          been
          insignificant in previous years, we have determined that the effect of
          this
          change was not material to prior quarters.
 
 **RECENT
          ACCOUNTING PRONOUNCEMENTS**
 
 In
          December 2003, the Financial Accounting Standards Board (“FASB”) issued
          Interpretation No. 46R, “Consolidation of Variable Interest Entities” (“FIN
          46R”), which supersedes Interpretation No. 46, “Consolidation of Variable
          Interest Entities” issued in January 2003. FIN 46R requires a company to
          consolidate a variable interest entity (“VIE”), as defined, when the company
          will absorb a majority of the VIE’s expected losses, receives a majority of the
          VIE’s expected residual returns or both. FIN 46R also requires consolidation
          of
          existing, non-controlled affiliates if the VIE is unable to finance its
          operations without investor support, or where the other investors do not
          have
          exposure to the significant risks and rewards of ownership. FIN 46R applies
          immediately to a VIE created or acquired after January 31, 2003. For a
          VIE
          created before February 1, 2003, FIN 46R applies in the first fiscal year
          or
          interim period beginning after March 15, 2004, our third fiscal quarter
          beginning June 1, 2004. Application of FIN 46R is also required in financial
          statements that have interests in structures that are commonly referred
          to as
          special-purpose entities for periods ending after December 15, 2003. The
          adoption of FIN 46R did not have a material impact on our financial position,
          results of operations or cash flows.
 
 In
          November 2004, the FASB issued Statement of Financial Accounting Standards
          (“SFAS”) No. 151, “Inventory Costs” (“SFAS 151”). SFAS 151 amends the guidance
          in Accounting Research Bulletin No. 43, Chapter 4, “Inventory Pricing”, to
          clarify that abnormal amounts of idle facility expense, freight, handling
          costs
          and wasted materials (spoilage) should be recognized as current-period
          charges
          and requires the allocation of fixed production overheads to inventory
          based on
          normal capacity of the production facilities. This statement is effective
          for
          inventory costs incurred during fiscal years beginning after June 15, 2005.
          The
          adoption of SFAS 151 is not expected to have an impact on our financial
          position, results of operations or cash flows.
 
 59
  In
          November 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on
          Issue No. 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No.
          144, “Accounting for the Impairment or Disposal of Long-Lived Assets” in
          Determining Whether to Report Discontinued Operations” (“EITF 03-13”). Under the
          consensus, the approach for assessing whether cash flows of the component
          have
          been eliminated from the ongoing operations of the entity focuses on whether
          continuing cash flows are direct or indirect cash flows. Cash flows of
          the
          component would not be eliminated if the continuing cash flows to the entity
          are
          considered direct cash flows. The consensus should be applied to a component
          of
          an enterprise that is either disposed of or classified as held for sale
          in
          fiscal periods beginning after December 15, 2004. The adoption of EITF
          03-13 did
          not have an impact on our financial position, results of operations or
          cash
          flows.
 
 In
          December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based
          Payment” (“SFAS 123R”), which is a revision of SFAS No. 123, “Accounting for
          Stock-Based Compensation”. SFAS 123R supersedes APB Opinion No. 25, “Accounting
          for Stock Issued to Employees” and amends SFAS No. 95, “Statement of Cash
          Flows”. SFAS 123R focuses primarily on accounting for transactions in which an
          entity obtains employee services in share-based payment transactions and
          requires all share-based payments to employees, including grants of employee
          stock options, to be recognized in the income statement based on their
          fair
          values. Accordingly, the adoption of SFAS 123R’s fair value method will have a
          significant impact on our results of operation, although it will have no
          impact
          on our overall financial position. We are currently evaluating the impact
          of
          this standard, but we estimate the impact of applying the various provisions
          of
          SFAS 123R will result in an expense, net of tax, of approximately $2,100
          during
          fiscal 2006 if all current unvested stock options vest on the scheduled
          dates
          and the assumptions in the Black-Scholes model remain the same. Had we
          adopted
          SFAS 123R in prior periods, the impact of that standard would have approximated
          the impact of SFAS 123 as described in the disclosure of proforma net income
          and
          earnings per share in Note 2, stock-based compensation. SFAS 123R also
          requires
          the benefits of tax deductions in excess of recognized compensation costs
          to be
          reported as a financing cash flow, rather than as an operating cash flow
          as
          required under current literature. This requirement will reduce net operating
          cash flows and increase net financing cash flows in periods after adoption.
          While we cannot estimate what those amounts will be in the future (because
          they
          depend on, among other things, when employees exercise stock options),
          the
          amount of operating cash flows recognized in prior periods for such excess
          tax
          deductions were not material to our consolidated financial position or
          results
          of operations. This statement is effective for our fiscal year that begins
          December 1, 2005.
 
 In
          December 2004, the FASB issued SFAS 153, “Exchanges of Nonmonetary Assets”
(“SFAS 153”). SFAS 153 amends the guidance in APB Opinion No. 29, “Accounting
          for Nonmonetary Transactions” to eliminate certain exceptions to the principle
          that exchanges of nonmonetary assets be measured based on the fair value
          of the
          assets exchanged. SFAS 153 eliminates the exception for nonmonetary exchanges
          of
          similar productive assets and replaces it with a general exception for
          exchanges
          of nonmonetary assets that do not have commercial substance. This statement
          is
          effective for nonmonetary asset exchanges in fiscal years beginning after
          June
          15, 2005. The adoption of SFAS 153 is not expected to have an impact on
          our
          financial position, results of operations or cash flows.
 
 The
          American Jobs Creation Act of 2004 (the “AJCA”) was enacted on October 22, 2004.
          The AJCA repeals an export incentive, creates a new deduction for qualified
          domestic manufacturing activities and includes a special one-time deduction
          of
          85% of certain foreign earnings repatriated to the U.S.
 
 In
          December 2004, the FASB issued FASB Staff Position No. 109-1, “Application
          of FASB Statement No. 109 (SFAS 109), Accounting for Income Taxes, to
          the Tax Deduction on Qualified Production Activities Provided by the American
          Jobs Creation Act of 2004” (FSP 109-1). FSP 109-1 clarifies that the
          manufacturer’s deduction provided for under the American Jobs Creation Act of
          2004 (AJCA) should be accounted for as a special deduction in accordance
          with SFAS 109 and not as a tax rate reduction. We have not completed the
          process of evaluating the impact that will result from adopting this statement
          and are therefore unable to disclose the impact that adopting FSP 109-1
          will
          have on our financial position and results of operations.
  The
          FASB
          also issued FASB Staff Position No. 109-2, Accounting and Disclosure
          Guidance for the Foreign Earnings Repatriation Provision within the American
          Jobs Creation Act of 2004 (FSP 109-2). The AJCA introduces a special one-time
          dividends received deduction on the repatriation of certain foreign earnings
          to
          a U.S. taxpayer (repatriation provision), provided certain criteria are
          met. FSP 109-2 provides accounting and disclosure guidance for the repatriation
          provision. We have described the impact of FSP 109-2 on our financial statements
          in note 7, Income Taxes.
  In
          May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error
          Corrections,” (“SFAS 154”). 
SFAS
          No. 154 replaces APB No. 20, “Accounting Changes” and SFAS No. 3,
“Reporting Accounting Changes in Interim Financial Statements” and establishes
          retrospective application as the required method for reporting a change
          in
          accounting
  60
  principle.
           The reporting of a correction of an error by restating previously issued
          financial statements is also addressed. SFAS No. 154 is effective for
          accounting changes and corrections of errors made in fiscal years beginning
          after December 15, 2005.  We do not believe that the adoption of SFAS
          No. 154 will have a material effect on our results of operations or
          consolidated financial position.
 
 In
          October
          2005, the FASB issued FASB Staff Position (“FSP”) 123R-2, “Practical
          Accommodation to the Application of Grant Date as Defined in FASB Statement
          No.
          123(R) (“FSP 123R-2”)”. FSP 123R-2 provides companies with a “practical
          accommodation” when determining the grant date of an award that is subject to
          the accounting provisions in SFAS 123R. Specifically, assuming a company
          meets
          all of the other criteria in the definition of grant date in SFAS 123R,
          a mutual
          understanding (between the company and the recipient) of the key terms
          and
          conditions of an award is presumed to exist at the date the award is approved
          (in accordance with the company’s normal corporate governance policy) if (1) the
          award is unilateral grant meaning that the recipient does not have the
          ability
          to negotiate the key terms and conditions of the award, and (2) the key
          terms
          and conditions of the award are expected to be communicated to the recipient
          within a relatively short period of time (as defined in the FSP 123R-2)
          after
          the grant was approved. This FSP is effective upon initial adoption of
          SFAS
          123-R on December 1, 2005.
 
 In
          November 2005, the FASB issued FSP 123R-3, “Transition Election Related to
          Accounting for the Tax Effects of Share-Based Payment Awards” (“FSP 123R-3”).
          FSP 123R-3 provides a practical exception when a company transitions to
          the
          accounting requirements in SFAS 123R. SFAS 123R requires a company to calculate
          the pool of excess tax benefits available to absorb tax deficiencies recognized
          subsequent to adopting SFAS 123R (“APIC Pool”), assuming the company had been
          following the recognition provisions prescribed by SFAS 123. The FASB learned
          that several companies do not have the necessary historical information
          to
          calculate the APIC pool as envisioned by SFAS 123R and accordingly, the
          FASB
          decided to allow a practical exception as documented in FSP 123R-3. This
          FSP is
          effective immediately.
 
 **(3)** **SHAREHOLDERS'
          EQUITY**
  **COMPUTATION
          OF EARNINGS PER SHARE**
 
 The
          following table presents the computation of per share earnings for the
          years
          ended November 30, 2005, 2004 and 2003, respectively:
 For
                    the year ended November
                    30,2005
                
                2004
                
                2003as
                    adjusted**(1)**
                
                as
                    adjusted**(1)**NET
                    INCOME:
                
                $
                36,047
                
                $
                1,451
                
                $
                23,347NUMBER
                    OF COMMON SHARES:Weighted
                    average outstanding
                
                
                19,652
                
                
                19,379
                
                
                18,925Issued
                    upon assumed exercise of
                  outstanding
                    stock options
                
                
                684
                
                
                786
                
                
                651Effect
                    of issuance of restricted common shares
                
                
                30
                
                
                60
                
                
                56Weighted
                    average and potential dilutive
                  outstanding(2**)**
                
                
                20,366
                
                
                20,225
                
                
                19,632NET
                    INCOME PER COMMON SHARE:Basic
                
                $
                1.83
                
                $
                .07
                
                $
                1.23Diluted
                
                $
                1.77
                
                $
                .07
                
                $
                1.19
 
 (1)
          The
          computation of earnings per share for fiscal 2004 and fiscal 2003 has been
          adjusted to reflect retroactively the change in method of valuing our domestic
          inventory from the LIFO to the FIFO method adopted in fiscal 2005.
 
 (2)
          Because their effects are anti-dilutive, excludes shares issuable under
          stock
          option plans and restricted stock issuance whose grant price was greater
          than
          the average market price of common shares outstanding as follows:  267
          shares in fiscal 2005, 303 shares in fiscal 2004 and 104 shares in fiscal
          2003.
  61
  **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 2005, 2004 and 2003 is presented
          below:
  2005
                    
                    2004
                    
                    2003Shares
                        Under
                      Option
                    
                    Weighted
                      Average
                      Exercise
                      Price
                    
                    Shares
                      Under
                      Option
                    
                    Weighted
                      Average
                      Exercise
                      Price
                    
                    SharesUnder
                      Option
                    
                    Weighted
                      Average
                      Exercise
                      PriceOutstanding
                        at beginning of year
                    
                    
                    2,032
                    
                    $
                    15.38
                    
                    
                    2,444
                    
                    $
                    9.72
                    
                    
                    1,913
                    
                    $
                    7.05Granted
                    
                    
                    548
                    
                    
                    41.99
                    
                    
                    545
                    
                    
                    28.33
                    
                    
                    816
                    
                    
                    14.58Exercised
                    
                    
                    (635
                    )
                    
                    10.51
                    
                    
                    (839
                    )
                    
                    7.33
                    
                    
                    (273
                    )
                    
                    5.70Cancelled
                    
                    
                    (192
                    )
                    
                    27.85
                    
                    
                    (118
                    )
                    
                    15.22
                    
                    
                    (12
                    )
                    
                    4.94Outstanding
                        at end of year
                    
                    
                    1,753
                    
                    $
                    23.94
                    
                    
                    2,032
                    
                    $
                    15.38
                    
                    
                    2,444
                    
                    $
                    9.72Options
                        exercisable at year-end
                    
                    
                    989
                    
                    $
                    25.93
                    
                    
                    418
                    
                    $
                    9.99
                    
                    
                    579
                    
                    $
                    7.15Weighted
                        average fair value of options granted
                    
                    
                    
                    
                    $
                    19.73
                    
                    
                    
                    
                    $
                    13.86
                    
                    
                    
                    
                    $
                    7.95
 A
          summary
          of the exercise prices for options outstanding under our stock-based
          compensation plans at November 30, 2005 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$
                       2.44 - $  4.25
                  
                  
                  25
                  
                  $
                  4.14
                  
                  
                  1.16
                  
                  
                  25
                  
                  $
                  4.14$
                       4.66 - $  6.54
                  
                  
                  179
                  
                  
                  4.99
                  
                  
                  5.41
                  
                  
                  179
                  
                  
                  4.99$
                       6.88 - $  7.81
                  
                  
                  25
                  
                  
                  7.19
                  
                  
                  3.90
                  
                  
                  25
                  
                  
                  7.19$
                       8.44 - $11.72
                  
                  
                  33
                  
                  
                  8.69
                  
                  
                  6.26
                  
                  
                  6
                  
                  
                  8.63$13.55
                      - $14.38
                  
                  
                  22
                  
                  
                  13.74
                  
                  
                  6.41
                  
                  
                  13
                  
                  
                  13.55$14.45
                      - $15.75
                  
                  
                  530
                  
                  
                  14.51
                  
                  
                  7.36
                  
                  
                  185
                  
                  
                  14.50$15.86
                      - $19.53
                  
                  
                  23
                  
                  
                  18.78
                  
                  
                  5.83
                  
                  
                  13
                  
                  
                  18.91$20.48
                      - $26.58
                  
                  
                  33
                  
                  
                  23.05
                  
                  
                  7.56
                  
                  
                  12
                  
                  
                  21.63$27.25
                      - $34.63
                  
                  
                  422
                  
                  
                  28.65
                  
                  
                  8.42
                  
                  
                  80
                  
                  
                  28.37$37.05
                      - $43.78
                  
                  
                  461
                  
                  
                  41.70
                  
                  
                  6.51
                  
                  
                  451
                  
                  
                  41.65Total
                  
                  
                  1,753
                  
                  
                  23.94
                  
                  
                  7.01
                  
                  
                  989
                  
                  
                  25.93
 
 **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, 2005 and 2004, no
          shares
          of any series of preferred stock were issued and outstanding.
 
 **STOCK
          BUYBACK**
 
 In
          January
          2005, 2004 and 2003, the board of directors increased to $30,000, $20,000
          and
          $10,000, respectively, the total authorization to repurchase our common
          stock
          under the buyback program. A total of $17,250 remained available under
          the stock
          buyback authority prior to July 29, 2005, when our board of directors increased
          the total buyback authorization back to $30,000. Under these authorizations,
          360.0 shares at a cost of $5,351 were repurchased in fiscal
          2003, 190.7 shares at a
  62
  cost
          of
          $5,034 were repurchased in fiscal 2004 and 882.3 shares at a cost of
          $34,084 were repurchased in fiscal 2005. The repurchased shares were
          retired and returned to unissued. In October 2005, our board of directors
          increased the total buyback authorization back to $30,000, which became
          effective on November 29, 2005 upon consummation of the Amended Revolving
          Credit
          Facility. As of November 30, 2005, $30,000 was available for share repurchases
          under the board of directors’ current authorization; however, we are limited in
          our ability to repurchase shares due to restrictions under the terms of
          our
          Amended Revolving Credit Facility and the indenture pursuant to which the
          7.0%
          Subordinated Notes were issued.
 
 **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, 2005,
          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, 70 and 69 restricted shares of common stock to certain employees in
          fiscal
          2005, 2004 and 2003, respectively. The market value of these shares on
          the dates
          of issuance was $1,769, $1,399 and $1,000 in fiscal 2005, 2004 and 2003,
          respectively. 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 was $825, $1,071 and $655 in fiscal
          2005,
          2004 and 2003, respectively, with the unamortized value of $1,818 and $2,386
          being included as a component of shareholders’ equity in the November 30, 2005
          and 2004 consolidated balance sheets, respectively. The shares issued in
          fiscal
          2005, 2004 and 2003 reduced the number of shares available for issuance
          under
          our 2003 Stock Incentive Plan.
 
 Effective
          September 1, 2005, our former president and chief operating officer, A.
          Alexander Taylor II, resigned his positions with the Company, after which
          Robert
          E. Bosworth assumed responsibility for both positions. In connection with
          such
          resignation, Mr. Taylor and the Company entered into a separation agreement,
          which, among other things, included accelerated removal of restrictions
          on a
          portion of his restricted stock, which resulted in a $1,360 non-cash
          charge.
  **(4)** **PATENT,
          TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS**
 
 With
          our
          adoption of SFAS 142 in fiscal 2001, we obtained independent appraisals
          to
          determine the fair values of our intangible assets and compared their fair
          values with their carrying values to determine the write-down of $8,877,
          net of
          income tax benefit of $5,440, or $.46 per diluted share in fiscal 2002.
          These
          charges related to our *Sunsource* product
          line, which experienced a decline in sales volume since its initial purchase
          in
          1997, and to a lesser degree, our *Dexatrim* product
          line, which discontinued the marketing of one of its products in November
          2000.
 
 As
          a
          result of a decline in sales and reforecasted expected future cash flows
          in the
          fourth quarter of fiscal 2004, we reperformed the impairment test as prescribed
          by SFAS 142 and determined that a revaluation was required for our *Dexatrim* product
          line at November 30, 2004. We obtained an independent appraisal to determine
          the
          fair value of the indefinite-lived intangible asset related to this product
          line. As a result, we incurred an impairment charge of $20,000, which is
          included in our consolidated statement of income for fiscal 2004. During
          fiscal
          2005 and fiscal 2003, 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 $205,983 and $224,797 as of November 30, 2005 and November
          30,
          2004, respectively.
 
 The
          gross
          carrying amount of intangible assets subject to amortization at both November
          30, 2005 and November 30, 2004, which consist primarily of non-compete
          agreements, was $2,139 and $2,400, respectively. The related accumulated
          amortization of these intangible assets at November 30, 2005 and November
          30,
          2004, was $1,735 and $1,637, respectively. Amortization of our intangible
          assets
          subject to amortization under the provisions of SFAS 142 was $251, $294
          and $340
          for fiscal 2005, 2004 and 2003, respectively. Estimated annual amortization
          expense for these assets for fiscal 2006, 2007, 2008, 2009 and 2010 is
          $290,
          $123, $40, $20 and $0, respectively. Royalty expense related to other purchased
          product rights for fiscal 2005, 2004 and 2003 was $112, $107 and $128,
          respectively. Amortization and royalty expense are included in
          advertising and promotion expense in the Consolidated Statements of
          Income.
  63
 
 **(5)** **LONG-TERM
          DEBT**
 
 Long-term
          debt consisted of the following as of November 30, 2005 and 2004:
 2005
                  
                  2004Amended
                      Revolving Credit Facility due 2010
                    at
                      a
                      variable rate of 7.00%  and 5.50% as of
                    November
                      30, 2005 and 2004, respectively
                  
                  $
                  —
                  
                  $
                  —Floating
                      Rate Senior Notes due 2010at
                      a
                      variable rate of 6.87% and 4.78% as of
                    November
                      30, 2005 and 2004, respectively
                  
                  
                  75,000
                  
                  
                  75,0007.0%
                      Senior Subordinated Notes due 2014
                  
                  
                  107,500
                  
                  
                  125,000Total
                      long-term debt
                  
                  
                  182,500
                  
                  
                  200,000Less:
                      current maturities
                  
                  
                  37,000
                  
                  
                  —Total
                      long-term debt, net of current maturities
                  
                  $
                  145,500
                  
                  $
                  200,000
 
 On
          February 26, 2004, we entered into a new Senior Secured Revolving Credit
          Facility that matures February 26, 2009 (the “Revolving Credit Facility”) with
          Bank of America, N.A. that provided an initial borrowing capacity of $25,000
          and
          an additional $25,000, subject to successful syndication. On March 9, 2004,
          we
          entered into a new commitment agreement with a syndicate of commercial
          banks led
          by Bank of America, N.A., as agent, that enables us to borrow up to a total
          of
          $50,000 under the Revolving Credit Facility. On November 29, 2005, we entered
          into an amendment to our Revolving Credit Facility (the “Amended Revolving
          Credit Facility”) that, among other things, increased our borrowing capacity
          under the facility from $50,000 to $100,000, increased our flexibility
          to
          repurchase shares of our stock and improved our borrowing rate under the
          facility. Borrowings under our Amended Revolving Credit Facility bear interest
          at LIBOR plus applicable percentages of 1.0% to 2.0% or a base rate (the
          higher
          of the federal funds rate plus 0.5% or the prime rate) plus applicable
          percentages of 0.0% to 0.5%. The applicable percentages are calculated
          based on our leverage ratio. As of November 30, 2005, no amounts have been
          borrowed under the Amended Revolving Credit Facility, and the variable
          rate was
          7.0%. Borrowings under our Amended Revolving Credit Facility are secured
          by
          substantially all of our assets, except real property, and shares of capital
          stock of our domestic subsidiaries held by us and by the assets of the
          guarantors (our domestic subsidiaries). The Amended Revolving Credit Facility
          contains covenants, representations, warranties and other agreements by
          us that
          are customary in credit agreements and security instruments relating to
          financings of this type. The significant financial covenants include fixed
          charge coverage ratio, leverage ratio, senior secured leverage ratio, net
          worth
          and brand value calculations. On February 17, 2006, we had $38,000 of borrowings
          outstanding under our Amended Revolving Credit Facility.
 
 On
          March
          28, 2002, we obtained a $60,000 senior secured credit facility from a syndicate
          of commercial banks led by Bank of America, N.A., as agent (the “Credit
          Facility”). The Credit Facility included a $15,000 revolving credit line and a
          $45,000 term loan. The remaining balance of the term loan under the Credit
          Facility was repaid as part of the refinancing transactions discussed herein,
          and the revolving credit line under the Credit Facility was terminated
          on
          February 26, 2004 . ****
  On
          February 10, 2004, we commenced a cash tender offer and consent solicitation
          for
          the $204,538 outstanding principal amount of our 8.875% Senior Subordinated
          Notes due 2008 (the “8.875% Subordinated Notes”). The consent solicitation
          expired on February 24, 2004, and a total of approximately $174,530, or
          approximately 85.3% of the 8.875% Subordinated Notes, were tendered and
          accepted
          for payment on February 26, 2004. The remaining principal outstanding,
          call
          premium, accrued interest and interest to call date amounting to $32,227
          was
          placed in escrow with the indenture trustee to fund the purchase of additional
          8.875% Subordinated Notes tendered prior to March 9, 2004, the expiration
          date
          of the tender offer, and the redemption of the remaining 8.875% Subordinated
          Notes not tendered. The remaining 8.875% Subordinated Notes not tendered
          in such
          offer were called in accordance with their terms on April 1, 2004 at a
          redemption price of 102.9583% of their aggregate principal amount. On April
          1,
          2004, the remaining amount held in escrow was released for payment and
          all
          outstanding 8.875% Subordinated Notes were redeemed.
 
 The
          completion of our refinancing of the Revolving Credit Facility in February
          2004
          and purchase of approximately $174,530 of our 8.875% Subordinated Notes
          that
          were tendered on February 26, 2004 resulted in a loss on early extinguishment
          of
          debt of $11,309 in the first quarter of fiscal 2004. In the second quarter
          of
          fiscal 2004, we recorded a loss on early extinguishment of debt of $1,649
          related to the redemption of the remaining $30,008 of our 8.875% Subordinated
          Notes.
 
 Also
          on
          February 26, 2004, we issued and sold $75,000 of Floating Rate Senior Notes
          due
          March 1, 2010 (the “Floating Rate Senior Notes”) and $125,000 of the 7.0%
          Subordinated Notes, the proceeds of which were used to purchase our 8.875%
          Subordinated Notes and refinance the Credit Facility as discussed above.
  64
 
 During
          the
          second quarter of fiscal 2005, we repurchased $17,500 of our 7.0% Subordinated
          Notes in the open market at an average premium of 1.6% over the principal
          amount
          of the notes. The repurchases resulted in a loss on early extinguishment
          of
          debt, including related expenses of $744. The outstanding balance of the
          remaining 7.0% Subordinated Notes was reduced to $107,500.
 
 The
          Floating Rate Senior Notes bear interest at a three-month LIBOR plus 3.00%
          per
          year (6.87% as of November 30, 2005). Interest payments are due quarterly
          in
          arrears commencing on June 1, 2004. On March 8, 2004, we entered into an
          interest rate cap agreement effective June 1, 2004 with decreasing annual
          notional principal amounts of $15,000 beginning March 1, 2006 and cap rates
          ranging from 4.0% to 5.0% over the life of the agreement. We paid a $1,375
          premium to enter into the interest rate cap agreement, which will be amortized
          over the life of the agreement. The current portion of the premium on the
          interest rate cap agreement of $380 is included in prepaid expenses and
          other current assets, and the long-term portion of $700 is included in
          other
          noncurrent assets. During fiscal 2005, the amortized value of the premium
          on the
          interest rate cap was compared to the fair value of the interest rate cap
          and
          the change in the market value of the premium of $233, net of tax, was
          recorded
          to other comprehensive income. Also as of November 30, 2005, a portion
          of the
          interest rate cap was deemed to be an ineffective cash flow hedge due to
          the
          reduction of variable rate debt upon the subsequent redemption of the Floating
          Rate Senior Notes, resulting in a loss of $60, net of tax, reflected in
          the
          income statement as interest expense. The balance of the cash flow hedge
          was
          deemed to be effective as of November 30, 2005. The fair value of the interest
          rate cap agreement is valued by a third party. The interest rate cap agreement
          terminates on March 1, 2010. Our domestic subsidiaries are guarantors of
          the
          Floating Rate Senior Notes. The guarantees of the Floating Rate Senior
          Notes are
          unsecured senior obligations of the guarantors and rank equally with all
          of the
          current and future unsecured senior debt of the guarantors. The guarantees
          of
          the Floating Rate Senior Notes effectively rank junior to any secured debt
          of
          the guarantors, including the guarantors’ guarantee of our indebtedness under
          the Amended Revolving Credit Facility.
 
 On
          November 30, 2005, we called our $75,000 of Floating Rate Senior Notes
          for full
          redemption on December 30, 2005. On December 30, 2005, we fully redeemed
          our
          $75,000 of Floating Rate Senior Notes at a price of 102% of par plus accrued
          interest to December 30, 2005. We utilized borrowings of $38,000 under
          our
          Amended Revolving Credit Facility and $38,948 of our cash on hand to fund
          the
          redemption of the Notes. As a result of the redemption, a loss on early
          extinguishment of debt of approximately $2,880 will be recorded in the
          first
          quarter of fiscal 2006. As of February 17, 2006, our borrowing capacity
          under
          the Amended Revolving Credit Facility was $62,000.
 
 Interest
          payments on the 7.0% Subordinated Notes are due semi-annually in arrears
          on
          March 1 and September 1, commencing on September 1, 2004. Our domestic
          subsidiaries are guarantors of the 7.0% Subordinated Notes. The guarantees
          of
          the 7.0% Subordinated Notes are unsecured senior subordinated obligations
          of the
          guarantors. At any time after March 1, 2009, we may redeem any of the 7.0%
          Subordinated Notes upon not less than 30 nor more than 60 days’ notice at
          redemption prices (expressed in percentages of principal amount), plus
          accrued
          and unpaid interest, if any, and liquidation damages, if any, to the applicable
          redemption rate, if redeemed during the twelve-month periods beginning
          March 1,
          2009 at 103.500%, March 1, 2010 at 102.333%, March 1, 2011 at 101.167%
          and March
          1, 2012 and thereafter at 100.000%. At any time prior to March 1, 2007,
          we may
          redeem up to 35% of the aggregate principal amount of the 7.0% Subordinated
          Notes (including any additional 7.0% Subordinated Notes) at a redemption
          price
          of 107.0% of the principal amount thereof, plus accrued and unpaid interest
          and
          liquidated damages, if any, thereon to the applicable redemption rate,
          with the
          net cash proceeds of one or more qualified equity offerings; provided,
          that (i)
          at least 65.0% of the aggregate principal amount of the 7.0% Subordinated
          Notes
          remains outstanding immediately after the occurrence of such redemption
          (excluding the 7.0% Subordinated Notes held by us and our subsidiaries);
          and
          (ii) the redemption must occur within 90 days of the date of the closing
          of such
          qualified equity offering.
 
 The
          indenture governing the 7.0% Subordinated Notes, among other things, limits
          our
          ability and the ability of our restricted subsidiaries to: (i) borrow money
          or
          sell preferred stock, (ii) create liens, (iii) pay dividends on or redeem
          or
          repurchase stock, (iv) make certain types of investments, (v) sell stock
          in our
          restricted subsidiaries, (vi) restrict dividends or other payments from
          restricted subsidiaries, (vii) enter into transactions with affiliates,
          (viii)
          issue guarantees of debt and (ix) sell assets or merge with other companies.
          In
          addition, if we experience specific kinds of changes in control, we must
          offer
          to purchase the 7.0% Subordinated Notes at 101.0% of their principal amount
          plus
          accrued and unpaid interest.
 
 65
  The
          future
          maturities of long-term debt outstanding as of November 30, 2005 are as
          follows:
 
 2006
                
                $
                37,0002007
                
                
                —2008
                
                
                —2009
                
                
                —2010
                
                
                38,000Thereafter
                
                
                107,500$
                182,500
 
 Cash
          interest payments during 2005, 2004 and 2003 were $12,791, $14,092 and
          $19,043.
 
 **(6)** **FAIR
          VALUE OF FINANCIAL INSTRUMENTS**
 
 Unless
          otherwise indicated elsewhere in the Notes to the Consolidated Financial
          Statements, the carrying value of our financial instruments approximates
          fair
          value.
 
 At
          November 30, 2005, the estimated fair value of the Floating Rate Senior
          Notes
          exceeded their carrying value by approximately $750 based on last trade
          date of
          November 22, 2005 as reported by Bank of America. The carrying value of
          the 7.0%
          Subordinated Notes exceeded their estimated fair market value by approximately
          $5,945. The fair value was estimated based on quoted market prices for
          the same
          or similar issues.
 
 **(7)** **INCOME
          TAXES**
 
 The
          provision for income taxes includes the following components for fiscal
          2005, 2004 and 2003:
 
 2005
                
                2004
                
                2003Current:
                
                
                
                as
                    adjusted(1)
                
                as
                    adjusted(1)Federal
                
                $
                12,710
                
                $
                2,916
                
                $
                4,030State
                
                
                359
                
                
                14
                
                
                667Deferred
                
                
                3,894
                
                
                (2,227
                )
                
                7,549$
                16,963
                
                $
                703
                
                $
                12,246
 (1) Income
            taxes for fiscal 2004 and 2003 have been adjusted to reflect retroactively
            the
            tax effect of the change in method of valuing our domestic inventory
            from the
            LIFO to the FIFO method adopted in fiscal 2005.
 
 As
          of
          November 30, 2005, we had a foreign tax credit of $1,853, which will expire
          over
          ten years in fiscal 2009 through 2014, and state net operating loss carry
          forwards of $25,220, which will begin to expire in 2017 through 2020 if
          unused.
          In fiscal 2005, 2004 and 2003 income tax benefits of $5,839, $5,568 and
          $1,259,
          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, 2005 and 2004, are
          as
          follows:
 
 2005
                
                2004Deferred
                    tax assets:Allowances
                    and accruals
                
                $
                1,511
                
                $
                3,695Inventory
                    reserve
                
                
                166
                
                
                121Accrued
                    promotional expenses
                
                
                —
                
                
                442Allowance
                    for product returns
                
                
                651
                
                
                181State
                    net operating loss carryforwards
                
                
                836
                
                
                610Accrued
                    postretirement health care benefits
                
                
                671
                
                
                639Other
                
                
                2,422
                
                
                1,909Gross
                    deferred tax assets
                
                
                6,257
                
                
                7,597Valuation
                    allowance
                
                
                —
                
                
                (610
                )Net
                    deferred tax assets
                
                
                6,257
                
                
                6,987Deferred
                    tax liabilities:Depreciation
                    and amortization
                
                
                29,402
                
                
                26,325Prepaid
                    advertising
                
                
                751
                
                
                421Inventory
                
                
                —
                
                
                181Other
                
                
                1,362
                
                
                1,484Gross
                    deferred tax liabilities
                
                
                31,515
                
                
                28,411Net deferred liability
                
                $
                25,258
                
                $
                21,424
  The
          deferred provision for income taxes excludes the tax effect of the interest
          rate
          cap adjustment of $131 and $178, the foreign currency translation adjustment
          of
          $191 and $448 and the minimum pension liability adjustment of $0 and $922,
          each
          for fiscal 2005 and 2004, respectively, all of which are included in the
          consolidated statements of shareholders’ equity.
  In
          fiscal
          2004, we recorded a valuation allowance to reflect the estimated amount
          of
          deferred tax assets that may not be realized due to the expiration of state
          net
          operating losses. We evaluate quarterly the realizability of our deferred
          assets
          by assessing our valuation allowance and by adjusting the amount of such
          allowance, if necessary. In fiscal 2005, we released the valuation allowance
          due
          to our forecast of future taxable income and available tax planning strategies
          that could be implemented to realize the net deferred tax assets .
 
 The
          difference between the provision for income taxes and the amount computed
          by
          multiplying income before income taxes and change in accounting principle
          by the
          United States statutory rate for fiscal 2005, 2004 and 2003 is summarized
          as
          follows:
  2005
                
                2004
                
                2003as
                    adjusted(1)
                
                
                as
                    adjusted(1)Expected
                    federal tax provision
                
                $
                18,544
                
                $
                751
                
                $
                12,457State
                    income taxes, net of federal income tax benefit
                
                
                424
                
                
                29
                
                
                433Foreign
                    permanently reinvested
                
                
                —
                
                
                (643
                )
                
                —Reversal
                      of valuation allowance
                
                
                (610
                )
                
                —
                
                
                —Other,
                    net
                
                
                (1,395
                )
                
                566
                
                
                (644
                )$
                16,963
                
                $
                703
                
                $
                12,246
 (1) Income
            taxes for fiscal 2004 and 2003 have been adjusted to reflect retroactively
            the
            tax effect of the change in method of valuing our domestic inventory
            from the
            LIFO to the FIFO method adopted in fiscal 2005.
 
 Undistributed
          earnings of Chattem (Canada), a wholly-owned subsidiary, during fiscal
          2004
          amounted to approximately $1,788. These earnings were considered to be
          reinvested indefinitely and, accordingly, no provision for U.S. federal
          and
          state income taxes was provided thereon. During fiscal 2005, pursuant to
          the
          provisions of the American Jobs Creation Act of 2004, we adopted a domestic
          reinvestment plan for purposes of facilitating the repatriation of dividends
          from our Canadian affiliates. Upon distribution of fiscal 2004 and 2005
          earnings, we were subject to U.S. income taxes of $213. The majority of
          the cash
          distribution was treated as an extraordinary dividend and qualified for
          the 85
          percent dividend received deduction.
 
 Income
          taxes paid in fiscal 2005, 2004 and 2003 were $ 6,733, $323, and $4,345,
          respectively. We received income tax refunds of $97, $2,554, and $434 during
          fiscal 2005, 2004 and 2003, respectively.
 
 67
 
 **(8)** **SUPPLEMENTAL
          FINANCIAL INFORMATION**
 
 Inventories
          consisted of the following at November 30, 2005 and 2004:
 
 2005
                
                2004as
                    adjusted(1)Raw
                    materials and work in process
                
                $
                12,388
                
                $
                10,729Finished
                    goods
                
                
                11,243
                
                
                12,395Total
                    inventories
                
                $
                23,631
                
                $
                23,124
 
 International
          inventories included above were $3,009 and $1,989 at November 30, 2005 and
          2004, respectively.
 
 (1) Inventories for fiscal 2004 have been adjusted to reflect retroactively
          the
          change in method of valuing our domestic inventory from the LIFO to the
          FIFO
          method adopted in fiscal 2005.
 
 Property,
          plant and equipment consisted of the following at November 30, 2005 and
          2004:
 
 2005
                
                2004Land
                
                $
                1,046
                
                $
                886Buildings
                    and improvements
                
                
                9,727
                
                
                8,557Machinery
                    and equipment
                
                
                53,500
                
                
                50,421Construction
                    in progress
                
                
                2,288
                
                
                2,944Total
                    property, plant and equipment
                
                
                66,561
                
                
                62,808Less
                    - accumulated depreciation
                
                
                (37,307
                )
                
                (34,043
                )Property,
                    plant and equipment, net
                
                $
                29,254
                
                $
                28,765
 
 Accrued
          liabilities consisted of the following at November 30, 2005 and
          2004:
  2005
                
                2004Interest
                
                $
                3,201
                
                $
                3,152Salaries,
                    wages and commissions
                
                
                5,991
                
                
                4,886Product
                    advertising and promotion
                
                
                2,589
                
                
                3,750Litigation
                    settlements and legal fees
                
                
                2,212
                
                
                10,046Other
                
                
                2,334
                
                
                1,929Total
                    accrued liabilities
                
                $
                16,327
                
                $
                23,763
 
 **(9)** **ACQUISITION
          AND SALE OF BRANDS**
 
 In
          March
          2002, we acquired worldwide rights (except in India) to manufacture, sell
          and
          market *Selsun
          Blue,* which
          is
          marketed internationally as *Selsun* ,
          plus
          related intellectual property and certain manufacturing equipment from
          Abbott
          Laboratories (“Abbott”). Abbott, or manufacturers under contract to Abbott,
          manufactured *Selsun
          Blue* for us
          domestically until June 2003 and internationally until the end of March
          2004. We
          entered into an amendment to the manufacturing agreement with Abbott under
          which
          Abbott continued to manufacture *Selsun* for us
          for the European, Middle East and several Latin American markets until
          at agreed
          upon rates, which varied by market. This agreement ended, as scheduled,
          in July
          2005. Abbott also continues to serve as our distributor for *Selsun* in
          certain
          foreign countries under separate distribution agreements. All of our North
          American *Selsun
          Blue* product
          lines are presently being manufactured at our Chattanooga facilities. During
          a
          transition period which ended March 28, 2004, Abbott also marketed, sold
          and
          distributed *Selsun* products
          for us in certain foreign countries until we could satisfy various foreign
          regulatory requirements, new distributors were in place and any applicable
          marketing permits were transferred. During the transition period, Abbott
          paid us
          an initial royalty equal to 28% of international sales of *Selsun* in these
          countries with the royalty reduced to 14% of international sales in certain
          countries if foreign regulatory requirements were satisfied prior to our
          assumption of sales and marketing responsibility in such countries. During
          the
          transition period, Abbott paid all costs and expenses related to the
          manufacture, marketing and sales of *Selsun* in these
          countries. As we assumed responsibility for the sales and marketing effort
          in a
          country, the royalty arrangement with respect to such country terminated.
          We
          then recorded these international sales directly as well as the costs and
          expenses associated with these sales. Abbott has agreed to extend the transition
          beyond March 28, 2004 in several countries where we are still awaiting
          regulatory approval of the transfer. In certain international markets,
          we sell *Selsun* through a
          distributor and receive a royalty based on a percentage of distributor
          sales. In
          the first quarter of fiscal 2005, we sold our *Selsun* business
          in certain
          countries in Africa and Asia to The Mentholatum Company, Inc. We maintain
          our
          rights to*Selsun*elsewhere
          in the world (except India).
  68
  On
          November 30, 2005, we sold the pHisoderm line of skin care products to
          The
          Mentholatum Company, Inc. for a purchase price of $8,500 plus inventories
          of
          approximately $1,100. As a result of this transaction, we recorded a loss
          on
          product divestures of $8,678 in the fourth quarter of fiscal 2005.
  **(10)** **RETIREMENT
          PLANS**
 
 We
          have a
          noncontributory defined benefit pension plan (“the Plan”), which covers
          substantially all employees. The Plan provides benefits based upon years
          of
          service and the employee's compensation. Our contributions are based on
          computations by independent actuaries. Plan assets at November 30, 2005
          and 2004
          were invested primarily in United States government and agency securities
          and
          corporate debt and equity securities. In October 2000, our board of directors
          adopted an amendment to the Plan that freezes benefits of the Plan and
          prohibits
          new entrants to the Plan effective December 31, 2000. In fiscal 2004, a
          curtailment loss of $88 resulted from benefits paid exceeding interest
          costs.
 
 Net
          periodic pension cost for fiscal 2005, 2004 and 2003 comprised the following
          components:
 2005
                
                2004
                
                2003Service
                    cost
                
                $
                —
                
                $
                —
                
                $
                —Interest
                    cost on projected benefit obligation
                
                
                622
                
                
                609
                
                
                606Actual
                    return on plan assets
                
                
                (858
                )
                
                (2,626
                )
                
                (629
                )Net
                    amortization and deferral
                
                
                28
                
                
                2,038
                
                
                (142
                )Curtailment
                    loss
                
                
                —
                
                
                88
                
                
                —Net
                    pension cost (benefit)
                
                $
                (208
                )
                $
                109
                
                $
                (165
                )
 
 The
          change
          in the projected benefit obligation, which equals the accumulated benefit
          obligation at the end of the year for frozen plans, resulted from the following
          components for fiscal 2005 and 2004:
 2005
                
                2004Projected
                    benefit obligation, beginning of year
                
                $
                10,998
                
                $
                10,236Interest
                    cost
                
                
                622
                
                
                609Actuarial
                    loss
                
                
                —
                
                
                830Benefits
                    paid
                
                
                (501
                )
                
                (802
                )Settlements
                
                
                —
                
                
                125Projected
                    benefit obligation, end of year
                
                $
                11,119
                
                $
                10,998
 
 The
          change
          in Plan assets resulted from the following components for fiscal 2005 and
          2004:
 2005
                
                2004Fair
                    value of plan assets, beginning of year
                
                $
                11,020
                
                $
                9,196Actual
                    return on plan assets
                
                
                1,045
                
                
                2,626Employer
                    contribution
                
                
                —
                
                
                —Benefits
                    paid
                
                
                (501
                )
                
                (802
                )Fair
                    value of plan assets, end of year
                
                $
                11,564
                
                $
                11,020
 
 The
          following table sets forth the funded status of the Plan as of November
          30, 2005
          and 2004:
 
 2005
                
                2004Plan
                    assets at fair market value
                
                $
                11,564
                
                $
                11,020Projected
                    benefit obligation
                
                
                11,119
                
                
                10,998Funded
                    status
                
                
                445
                
                
                22Unrecognized
                    net loss
                
                
                1,176
                
                
                1,391Prepaid
                    pension costs
                
                
                1,621
                
                
                1,413Net
                    pension asset (liability) recognized in balance sheets
                  at
                    end of year
                
                $
                1,621
                
                $
                1,413
  The
          discount rate used in determining the actuarial present value of the projected
          benefit obligation was 5.75% in fiscal 2005 and 2004, respectively. The
          expected long-term rate of return on plan assets was 8% in fiscal 2005 and
          2004, respectively. The Plan’s long-term return on assets is based on the
          weighted-average of the Plan’s invested allocation as of
  69
  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 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**
                **Range**Corporate & Government
                  Bonds
                40.0 - 70.0%Equities
                40.0 -
                  70.0%
 
 In
          addition, the existing investment policy requires a performance review
          annually.
          The weighted-average asset allocations at November 30, 2005 and 2004 by
          asset
          class are as follows:
 
 Plan
                    Assets at
                  November
                    30,Asset
                    Class
                
                2005
                
                2004Mutual
                    funds
                
                
                93
                %
                
                —
                %Equity
                    securities
                
                
                6
                
                
                70Debt
                    securities
                
                
                —
                
                
                26Money
                    Market
                
                
                1
                
                
                4Total
                
                
                100
                %
                
                100
                %
 
 As
          of
          November 30, 2005, we had 20 shares of our common stock in the Plan with
          a fair
          value of $635.
 
 Using
          the
          Ibbotson data, the estimated weighted-average asset returns would be 8.4%
          according to investment policy asset mix. The weighted-average asset returns
          based on current asset mix (assuming equities are all in large cap) are
          8.44%
          for fiscal 2005 and 8.71% for fiscal 2004.
 
 The
          following benefit payments, which reflect expected future service, as
          appropriate, are expected to be paid:
 
 Estimated
                    Benefit
                  Payment2006
                
                $
                5752007
                
                
                6002008
                
                
                6502009
                
                
                6252010
                
                
                6002011-2015
                
                $
                2,750
 
 No
          employer contributions are expected to be required to be paid in fiscal
          2006.
 
 We
          have a
          defined contribution plan covering substantially all employees. Eligible
          participants can contribute up to 15% of their annual compensation and
          receive a
          25% matching employer contribution on the first 6% of compensation contributed
          by participants. The defined contribution plan expense was $235, $223 and
          $206
          in fiscal 2005, 2004 and 2003, respectively. In fiscal 2001, we enhanced
          our
          savings investment plan to include an additional 3% employer contribution
          made
          on behalf of eligible participants. This additional employer contribution
          was
          $751, $698 and $672 in fiscal 2005, 2004 and 2003,
          respectively.
 
 **(11)** **ACCRUED
          POSTRETIREMENT HEALTH CARE BENEFITS**
 
 We
          maintain certain postretirement health care benefits for eligible employees.
          Employees become eligible for these benefits if they meet certain age and
          service requirements. We pay a portion of the cost of medical benefits
          for
          certain retired employees over the age of 65. Effective January 1, 1993,
          our
          contribution is a service-based percentage of the full premium. We pay
          these
          benefits as claims are incurred.
  70
  Net
          periodic postretirement health care benefits cost for fiscal 2005, 2004
          and 2003
          included the following components:
 
 
 2005
                
                2004
                
                2003Service
                    cost
                
                $
                72
                
                $
                63
                
                $
                58Interest
                    cost on accumulated postretirement
                  benefit
                    obligation
                
                
                82
                
                
                80
                
                
                80Amortization
                    of prior service cost
                
                
                15
                
                
                15
                
                
                15Amortization
                    of net gain
                
                
                (17
                )
                
                (30
                )
                
                (31
                )Net
                    periodic postretirement benefits cost
                
                $
                152
                
                $
                128
                
                $
                122
 
 The
          change
          in the accumulated benefit obligation resulted from the following components
          for
          fiscal 2005 and 2004:
 
 2005
                
                2004Accumulated
                    benefit obligation, beginning of year
                
                $
                1,488
                
                $
                1,316Service
                    cost
                
                
                72
                
                
                63Interest
                    cost
                
                
                82
                
                
                80Actuarial
                    loss
                
                
                (13
                )
                
                70Benefits
                    paid
                
                
                (63
                )
                
                (41
                )Accumulated
                    benefit obligation, end of year
                
                $
                1,566
                
                $
                1,488
 
 The
          following table sets forth the funded status of the plan at November 30,
          2005
          and 2004:
 
 2005
                
                2004Accumulated
                    benefit obligation
                
                $
                1,566
                
                $
                1,488Fair
                    value of plan assets
                
                
                —
                
                
                —Funded
                    status
                
                
                (1,566
                )
                
                (1,488
                )Unrecognized
                    prior service cost
                
                
                69
                
                
                84Unrecognized
                    actuarial gain
                
                
                (368
                )
                
                (372
                )Accrued
                    postretirement benefits cost
                
                $
                (1,865
                )
                $
                (1,776
                )
  The
          weighted-average discount rate used in determining the accumulated
          postretirement benefit obligation was 5.75% at November 30, 2005 and 2004,
          respectively.
 
 For
          measurement purposes in fiscal 2005 and 2004, the trend rate was assumed
          to be
          12% decreasing 1% per year to an ultimate level of 5% by fiscal 2011. Due
          to
          premium caps in place which limit our expense, a 1% increase in the assumed
          health care cost trend rate would not affect the accumulated postretirement
          benefit obligation as of November 30, 2005 or the aggregate of the service
          and
          interest cost components of the net annual postretirement benefit cost for
          the year ended November 30, 2005.
 
 The
          following benefit payments, which reflect expected future services, as
          appropriate, are expected to be paid. Benefit payments are shown net of
          employee
          contributions:
 
 Estimated
                    BenefitPayment2006
                
                $
                732007
                
                
                752008
                
                
                812009
                
                
                852010
                
                
                852011-2015
                
                
                477
 
 Employer
          contributions expected for fiscal 2006 are approximately $73.
 
 71
  **(12)** **PRODUCT
          AND GEOGRAPHICAL SEGMENT INFORMATION**
 
 We
          currently operate in only one primary segment - OTC health care. This segment
          includes topical analgesics, medicated skin care, dietary supplement, medicated
          dandruff shampoo and other OTC products.
 
 Geographical
          segment information is as follows for fiscal 2005, 2004 and 2003:
 
 2005
                
                2004
                
                2003Revenues:Domestic
                
                $
                252,436
                
                $
                234,003
                
                $
                209,874International(1)
                
                
                26,882
                
                
                24,152
                
                
                23,875Total
                
                $
                279,318
                
                $
                258,155
                
                $
                233,749Long-Lived
                    Assets(2)Domestic
                
                $
                235,099
                
                $
                254,059
                
                $
                274,217International
                
                
                542
                
                
                266
                
                
                352Total
                
                $
                235,641
                
                $
                254,325
                
                $
                274,569(1)International sales include export sales from United States operations
                    and
                    royalties from international sales of*Selsun*.
                    These
                    royalties were $178, $621 and $1,222 for fiscal 2005, 2004 and
                    2003,
                    respectively.(2)Consists of book value of property, plant, equipment, trademarks
                    and other
                    product rights.
 
 Net
          sales
          of our domestic product categories within our single healthcare business
          segment
          are as follows for fiscal 2005, 2004 and 2003:
 
 2005
                
                2004
                
                2003Revenues:Topical
                    analgesics
                
                $
                89,539
                
                $
                76,300
                
                $
                58,594Medicated
                    skin care products
                
                
                62,458
                
                
                60,495
                
                
                56,528Dietary
                    supplements
                
                
                33,828
                
                
                33,011
                
                
                37,420Medicated
                    dandruff shampoos
                
                
                34,880
                
                
                31,309
                
                
                28,351Other
                    OTC and toiletry products
                
                
                31,731
                
                
                32,888
                
                
                28,981Total
                
                $
                252,436
                
                $
                234,003
                
                $
                209,874
 
 **(13)** **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 Jacobs 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. After the final judgment was entered, two parties who had objected
          to the settlement filed appeals challenging and seeking to set aside the
          final
          judgment. Both of these appeals have now been dismissed.
  The *Dexatrim* PPA
          settlement includes claims against us involving alleged injuries by *Dexatrim* products
          containing PPA in which the alleged injury occurred after December 21,
          1998, the
          date we acquired the *Dexatrim* brand. In
          accordance with the terms of the class action settlement agreement, we
          previously published notice of the settlement and details as to the manner
          in
          which claims could be submitted. The deadline for submission of claims
          was July
          7, 2004. A total of 391 claims were certified by the court as timely submitted.
          Of these 391 claims, 173 alleged stroke as an injury and 218 alleged other
          non-
  72
  stroke
          injuries. Of the 391 total claims, only 371 claimants actually had alleged
          injuries that occurred after December 21, 1998 and continued to pursue
          their
          claims in the settlement. The remaining claimants have either withdrawn
          their
          claims or cannot be located. 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 nine of the opt out claims. The five remaining
          opt
          out claimants may pursue claims for damages against us in separate lawsuits.
          As
          of February 17, 2006, two of the five remaining opt out claimants have
          filed
          lawsuits against us that we are continuing to defend.
  We
          previously reached an agreement with Kemper Indemnity Insurance Company
          ("Kemper") to settle its lawsuit that sought to rescind our policy for
          $50,000
          of excess coverage for product liability claims. After giving effect to
          the
          settlement with Kemper, we have available for the claims against us related
          to
          the PPA litigation, through our first three layers of insurance coverage,
          approximately $60,885 of the $77,000 of product liability coverage provided
          by
          these insurance policies. The $60,885 of available coverage consists of
          $37,500
          of insurance under the Kemper policy and approximately $23,385 under policies
          with two other insurance companies. In accordance with the terms of the
          class
          action settlement agreement, this $60,885 of coverage has been funded into
          a
          settlement trust. In addition, on July 14, 2004, we entered into a settlement
          agreement with Sidmak Laboratories, Inc. (“Sidmak”), the manufacturer of *Dexatrim* products
          containing PPA, pursuant to which Sidmak has contributed $10,000 into the
          settlement trust. We have also entered into a settlement agreement with
          Interstate Fire & Casualty Company (“Interstate”) with regard to its $25,000
          of coverage in excess of the insurance funds available in the settlement
          trust.
  During
          the
          fourth quarter of fiscal 2005, we resolved substantially all of the claims
          submitted in the *Dexatrim* PPA
          settlement and now estimate that the total cost of the *Dexatrim* settlement will be approximately $56,000. As indicated above, a total of
          $70,885
          has been funded into a settlement trust by our insurers and Sidmak and
          is
          available to pay claims in the settlement. Any funds remaining in the settlement
          trust after all claims and expenses of the trust have been paid will be
          distributed as approved by the court in accordance with the class action
          settlement agreement and our settlement agreements with each of Kemper
          and
          Sidmak. We currently expect that after all claims and expenses of the settlement
          trust have been paid, we could recover up to approximately $8,500 from
          the
          settlement trust. If realized, this potential recovery is estimated to
          occur in
          the first half of fiscal 2006. We currently do not expect to record any
          additional charges relative to the settlement of the PPA litigation, except
          for
          legal expenses that will be recorded in the period incurred. During the
          fourth
          quarter of fiscal 2005, we incurred and recorded $315 of legal expenses
          related
          to the *Dexatrim* litigation.
  We
          are
          also named as a defendant in approximately 206 lawsuits relating to *Dexatrim* containing PPA which involve alleged injuries by *Dexatrim* products
          containing PPA manufactured and sold prior to our acquisition of *Dexatrim* on
          December 21, 1998. In these lawsuits, we are being defended on the basis
          of
          indemnification obligations assumed by The DELACO Company (“DELACO”), successor
          by merger to the Thompson Medical Company, Inc., which owned the brand
          prior to
          December 21, 1998. On February 12, 2004, DELACO filed a Chapter 11 bankruptcy
          petition in the United States Bankruptcy Court for the Southern District
          of New
          York. Accordingly, it is uncertain whether DELACO will be able to indemnify
          us
          for claims arising from products manufactured and sold prior to our acquisition
          of *Dexatrim* on
          December 21, 1998. However, DELACO is seeking to resolve all *Dexatrim* cases
          with injury dates prior to December 21, 1998 as part of a liquidating Chapter
          11
          bankruptcy plan. We understand that DELACO’s product liability insurance
          carriers and other sources are expected to fund this plan. We have filed
          a claim
          in DELACO’s bankruptcy case in order to preserve our claims for indemnification
          against DELACO.
  In
          order
          to resolve DELACO’s indemnity obligations to us, we have entered into a
          settlement agreement with DELACO dated June 30, 2005 (“the DELACO Agreement”).
          Pursuant to the DELACO Agreement, we will assume responsibility for all
          claims
          against DELACO and its predecessor, Thompson Medical Company, Inc., or
          us
          relating to *Dexatrim* products involving an injury date after December
          21, 1998, and will hold the DELACO bankruptcy estate harmless from any
          such
          claims. In exchange, a settlement trust to be established under DELACO’s
          bankruptcy plan will pay us $8,750 and will assume responsibility for all
          claims
          related to *Dexatrim* products alleging injury dates on or before
          December 21, 1998. Upon the effective date of the bankruptcy plan, we expect
          that the plan will release us from all liability from holders of
*Dexatrim* claims with injury dates prior to December 21,1998, whether
          brought by an injured party or a co-defendant to a *Dexatrim* products
          liability case. We expect all claims with injury dates prior to December
          21,
          1998 to be channeled to the DELACO settlement trust, which we expect to
          come
          into existence and be funded prior to the effective date of the DELACO
          bankruptcy plan. This payment and the channeling injunction and release
          described above will conclusively compromise and settle our previously
          filed
          claim in the DELACO bankruptcy case. The DELACO Agreement was approved
          by the
          bankruptcy court on July 28, 2005 in the DELACO bankruptcy. The DELACO
          Agreement
          and our receipt of $8,750 from the DELACO settlement trust is conditioned
          upon
          final confirmation and approval of the DELACO bankruptcy plan, and funding
          of
          the DELACO settlement trust by the insurance companies and other parties
          obligated to fund the trust.  At the confirmation hearing on February 15,
          2006, the bankruptcy court indicated that it would enter an order confirming
          the
          DELACO bankruptcy plan. Absent any appeals being filed, the order confirming
          the
          plan would become final ten days after the bankruptcy court enters the
          order.
          Substantial funding of the DELACO settlement trust is due to occur on or
          before
          March 13, 2006. Counsel for DELACO announced at the confirmation hearing
          that
          the effective date of the plan is anticipated to be March 13, 2006. On
          the
          effective date, we will be released from all liability from holders of
          Dexatrim
          claims with injury dates prior to December 21, 1998, and if the settlement
          trust
          is funded as anticipated, we expect to receive a payment of $8,750 before
          the
          end of March 2006.
 73
  Our
          product liability insurance, as described above, would not apply to claims
          arising from products manufactured and sold prior to our acquisition of *Dexatrim* .
          If the
          DELACO bankruptcy plan does not resolve these cases as we expect, we will
          also
          seek to defend ourselves in these lawsuits on the basis that we did not
          manufacture and sell products containing PPA prior to December 21, 1998.
          In the
          approximately 206 cases that have been filed against us for products
          manufactured and sold prior to December 21, 1998, approximately half of
          the
          plaintiffs are in cases filed in states that we believe do not under current
          law
          impose liability upon a successor. The remaining plaintiffs are in cases
          filed
          in states that may in some circumstances permit liability against a successor.
          Even in these cases, although there can be no assurances, we do not believe
          that
          successor liability would be imposed against us. The reasons for our belief,
          among others, are that we did not purchase all of DELACO’s assets and DELACO
          continued to operate its remaining business after December 21, 1998; we
          did not
          cause DELACO’s bankruptcy; and many plaintiffs included in cases filed in states
          that in some circumstances impose successor liability are actually residents
          of
          other states. If the DELACO bankruptcy plan is confirmed with the terms
          required
          by the DELACO Agreement, we will be released from potential liability in
          these
          cases.
  We
          maintain a significantly lower level of insurance coverage for all other
          potential claims relating to our products including *Dexatrim* products
          containing ephedrine. For the current policy period, we are insured for
          product
          liability insurance for all of our other products, including *Dexatrim* products
          containing ephedrine, for up to $20,000 through our captive insurance
          subsidiary, of which approximately $5,545 is funded as of February 17,
          2006. We
          also have $30,000 of excess coverage through third party insurers. We are
          currently defending two lawsuits related to *Dexatrim* containing ephedrine.
  On
          December 30, 2003, the United States Food and Drug Administration ("FDA")
          issued
          a consumer alert on the safety of dietary supplements containing ephedrine
          alkaloids and on February 6, 2004 published a final rule with respect to
          these
          products. The final rule prohibits the sale of dietary supplements containing
          ephedrine alkaloids because such supplements present an unreasonable risk
          of
          illness or injury. The final rule became effective on April 11, 2004. Although
          we discontinued the manufacturing and shipment of *Dexatrim* containing ephedrine in September 2002, the FDA's final rule may result
          in
          additional lawsuits being filed against us alleging damages related to
          the use
          or purchase of *Dexatrim* containing ephedrine.
  We
          have
          been named as a defendant in a putative class action suit filed in the
          Superior
          Court of the State of California for the County of Los Angeles on February
          11,
          2004. The lawsuit seeks certification of classes consisting of residents
          of the
          United States, or residents of the State of California, who have purchased
          our *Bullfrog* sun
          care
          products during the past four years. The lawsuit seeks injunctive relief
          and
          compensatory damages under the California Business and Professions Code
          against
          us arising out of alleged deceptive, untrue or misleading advertising,
          and
          breach of warranty, in connection with the manufacturing, labeling, advertising,
          promotion and sale of *Bullfrog* products.
          The plaintiff has stipulated that the amount in controversy with respect
          to
          plaintiff’s individual claim and each member of the proposed class does not
          exceed $75. We filed an answer on June 28, 2004 and are vigorously defending
          the
          lawsuit.
  We
          have
          been named as a defendant in a putative class action suit filed in the
          Superior
          Court of the State of California, County of Los Angeles, on January 13,
          2005.
          The lawsuit seeks injunctive relief, compensatory damages and attorney
          fees
          against us under the California Business and Professions Code, arising
          out of
          alleged deceptive, untrue or misleading advertising and breach of express
          warranty in connection with the manufacturing, labeling, advertising, promotion
          and sale of certain *Dexatrim* Natural
          products. The lawsuit seeks certification of a class consisting of all
          persons
          who purchased *Dexatrim* Natural
          in California during the four year period prior to the filing of the lawsuit
          up
          to the date of any judgment obtained. The plaintiff has stipulated that
          the
          amount in controversy with respect to each individual claim and each member
          of
          the proposed class in the action does not exceed $75. We filed an answer
          on
          March 1, 2005, and are vigorously defending the lawsuit.
  Other
          claims, suits and complaints arise in the ordinary course of our business
          involving such matters as patents and trademarks, product liability,
          environmental matters, employment law issues and other alleged injuries
          or
          damage. The outcome of such litigation cannot be predicted, but, in the
          opinion
          of management, based in part upon assessments from counsel, all such other
          pending matters are without merit or are of such kind or involve such other
          amounts as would not have a material adverse effect on our financial position,
          results of operations or cash flows if disposed of unfavorably.
 
 74
 
 **REGULATORY**
 
 The
          FDA,
          the Drug Enforcement Administration and a number of state and local governments
          have enacted or proposed restrictions or prohibitions on the sale of products
          that contain ephedrine. Ephedrine can refer to the herbal substance derived
          from
          the plant ephedra or the plant heart leaf, which, until September 2002,
          was used
          in the manufacturing of some forms of *Dexatrim* Natural
          and *Dexatrim* Results,
          or synthetic ephedrine, a FDA regulated ingredient used in some OTC drug
          products, which has not been used in our products. These restrictions include
          the prohibition of OTC sales, required warnings or labeling statements,
          record
          keeping and reporting requirements, the prohibition of sales to minors,
          per
          transaction limits on the quantity of product that may be purchased and
          limitations on advertising and promotion. The enactment of further restrictions
          or prohibitions on sales, the perceived safety concerns related to ephedrine
          and
          the possibility of further regulatory action could result in an increase
          in the
          number of ephedrine related lawsuits filed including ones in which we are
          named
          as a defendant.
 
 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 has 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. Although we discontinued the manufacturing
          and
          shipment of *Dexatrim* containing ephedrine in September 2002, the FDA’s final rule may result in
          lawsuits in addition to those we currently have being filed against us
          alleging
          damages related to the use or purchase of *Dexatrim* containing ephedrine. In April 2005, a Utah federal court called into question
          the 2004 final rule. The court decision is being appealed and may have
          an effect
          on the FDA’s enforcement of the ephedrine alkaloid final rule.
 
 We
          were
          notified in October 2000 that the FDA denied a citizen petition submitted
          by
          Thompson Medical Company, Inc., the previous owner of *Sportscreme* and *Aspercreme.* The
          petition sought a determination that 10% trolamine salicylate, the active
          ingredient in *Sportscreme* and *Aspercreme* ,
          was
          clinically proven to be an effective active ingredient in external analgesic
          OTC
          drug products and should be included in the FDA's yet-to-be finalized monograph
          for external analgesics. We have met with the FDA and submitted a proposed
          protocol study to evaluate the efficacy of 10% trolamine salicylate as
          an active
          ingredient in OTC external analgesic drug products. We are working to develop
          alternate formulations for *Sportscreme* and *Aspercreme* in the
          event that the FDA does not consider the available clinical data to conclusively
          demonstrate the efficacy of trolamine salicylate when the OTC external
          analgesic
          monograph is finalized. If 10% trolamine salicylate is not included in
          the final
          monograph, we would likely be required to discontinue these products as
          currently formulated and remove them from the market after expiration of
          an
          anticipated grace period. If this occurred, we believe we could still market
          these products as homeopathic products or reformulate them using ingredients
          included in the FDA monograph. We are uncertain as to when the monograph
          is
          likely to become final.
 
 Certain
          of
          our topical analgesic products are currently marketed under a FDA tentative
          final external analgesic monograph. The FDA has proposed that the final
          monograph exclude external analgesic products in patch, plaster or poultice
          form, unless the FDA receives additional data supporting the safety and
          efficacy
          of these products. On October 14, 2003, we submitted to the FDA information
          regarding the safety of our *Icy
          Hot* patches
          and arguments to support our product’s inclusion in the final monograph. We have
          also participated in an industry effort coordinated by Consumer Healthcare
          Products Association (“CHPA”) to establish with the FDA a protocol of additional
          research that will allow the patches to be marketed under the final monograph
          even if the final monograph does not explicitly allow them. The CHPA submission
          to FDA was made on October 15, 2003. Thereafter, in April 2004, we launched
          the *Icy
          Hot* Sleeve, a
          flexible, non-occlusive fabric patch containing 16% menthol. In February
          2006,
          we launched the *Icy
          Hot Pro-Therapy* Medicated
          Foam Pad with Knee Wrap containing 5% menthol, and the *Capzasin* Back
& Body patch containing 0.025% capsaicin. All of these drug products contain
          levels of active ingredients consistent with levels permitted in the OTC
          monograph. If additional research is required either as a preliminary to
          final
          FDA monograph approval and/or as a requirement of future individual product
          sale, we may need to invest in a considerable amount of expensive testing
          and
          data analysis. Any preliminary cost may be shared with other patch
  75
  manufacturers.
          Because the submissions made into the FDA docket have been forwarded from
          its
          OTC Division to its Dermatological Division within the Center for Drug
          Evaluation and Research (“CDER”), we are uncertain as to when this matter is
          likely to become final. For example, the FDA could choose to hold in abeyance
          a
          final ruling on alternative dose forms even if the monograph is otherwise
          finalized. If neither action described above is successful and the final
          monograph excludes such products, we will have to file a new drug application
          (“NDA”) for previously marketed drugs in order to continue to market the *Icy
          Hot* and *Aspercreme* Patches,
          the *Icy
          Hot* Sleeve,
          the *Icy
          Hot Pro-Therapy* Medicated
          Foam Pad with Knee Wrap, *Capzasin* Back
& Body Patch and/or similar delivery systems under our other topical
          analgesic brands. In such case, we would have to remove the existing products
          from the market one year from the effective date of the final monograph,
          pending
          FDA review and approval of an NDA. The preparation of an NDA would likely
          take
          us six to 18 months and would be expensive. It typically takes the FDA
          at least
          12 months to rule on an NDA once it is submitted.
 
 We
          have
          responded to certain questions with respect to efficacy received from the
          FDA in
          connection with clinical studies for pyrilamine maleate, one of the active
          ingredients used in certain of the *Pamprin* and *Prēmsyn
          PMS* products.
          While we addressed all of the FDA questions in detail, the final monograph
          for
          menstrual drug products, which has not yet been issued, will determine
          if the
          FDA considers pyrilamine maleate safe and effective for menstrual relief
          products. If pyrilamine maleate were not included in the final monograph,
          we
          would be required to reformulate the products to continue to provide the
          consumer with multi-symptom relief benefits. We have been actively monitoring
          the process and do not believe that either *Pamprin* or *Prēmsyn
          PMS,* as
          brands, will be materially affected by the FDA review. We believe that
          any
          adverse finding by the FDA would likewise affect our principal competitors
          in
          the menstrual product category and that finalization of the menstrual products
          monograph is not imminent. Moreover, we have formulated alternative *Pamprin* products
          that fully comply with both the internal analgesic and menstrual product
          monographs.
 
 In
          early
          2005, infrequent, but serious, adverse cardiovascular events were reported
          to
          the FDA associated with patients who were prescribed a subclass of COX-2
          inhibitor non-steroidal anti-inflammatory drugs (“NSAID’s”) for long periods to
          relieve pain of chronic diseases such as arthritis. These products include
          Vioxx®, Bextra®, and Celebrex®. In February 2005, the FDA held a joint advisory
          committee meeting to seek external counsel on the extent to which manufacturers
          might further warn patients of these cardiovascular risks on prescription
          product labeling, or prohibit sale of these prescription products. As part
          of
          its response on this issue, the FDA has recommended labeling changes for
          both
          the prescription and OTC NSAID’s. Well-known OTC NSAID’s such as ibuprofen and
          naproxen, which have been sold in vast quantities since the 1970s, were
          affected
          by this regulatory action. Manufacturers of OTC NSAID’s were asked to revise
          their labeling to provide more specific information about the potential
          cardiovascular and gastrointestinal risks recognizing the limited dose
          and
          duration of treatment of these products. Our *Pamprin
          All Day* product,
          which contains naproxen sodium, is subject to these new labeling requirements. *Pamprin
          All Day* is
          manufactured for us by The Perrigo Company (“Perrigo”), holder of an abbreviated
          NDA for naproxen sodium. As holder of the abbreviated NDA, Perrigo has
          made the
          mandated labeling changes within the time frame required by the FDA. Product
          with revised labeling compliant with new FDA regulations is being shipped
          in
          February, 2006. We are also aware of the FDA's concern about the potential
          toxicity due to concomitant use of OTC and prescription products that contain
          the analgesic ingredient acetaminophen, an ingredient also found in *Pamprin* and *Prēmsyn
          PMS* .
          We are
          participating in an industry-wide effort to reassure the FDA that the current
          recommended dosing regimen is safe and effective and that proper labeling
          and
          public education by both OTC and prescription drug companies are the best
          policies to abate the FDA's concern. The FDA will address this issue in
          its
          effort to finalize the monograph on internal analgesic products. We believe
          the
          FDA may issue revised labeling requirements within the next year, perhaps
          prior
          to monograph closure, that will cause the industry to relabel its analgesic
          products to better inform consumers of concomitant use.
 
 During
          the
          finalization of the monograph on sunscreen products the FDA chose to hold
          in
          abeyance specific requirements relating to the characterization of a product’s
          ability to reduce UVA radiation. A final ruling on this matter would be
          expected
          to result in new UVA testing requirements and subsequent labeling changes
          related to sun protection factor, or SPF, ratings, and other labeling claims.
          We
          expect that the FDA may take action on this matter within the next six
          months.
          If implemented, the final rules would likely result in new testing requirements
          and revised labeling of our *Bullfrog* product
          line, and all of our competitors’ products in the suncare category, within one
          year after issuance of the final rules.
 
 Our
          business is also regulated by the California Safe Drinking Water and Toxic
          Enforcement Act of 1986, known as Proposition 65. Proposition 65 prohibits
          businesses from exposing consumers to chemicals that the state has determined
          cause cancer or reproduction toxicity without first giving fair and reasonable
          warning unless the level of exposure to the carcinogen or reproductive
          toxicant
          falls below prescribed levels. From time to time, one or more ingredients
          in our
          products could become subject to an inquiry under Proposition 65. If an
          ingredient is on the state’s list as a carcinogen, it is possible that a claim
          could be brought, in which case we would be required to demonstrate that
          exposure is below a “no significant risk” level for consumers. Any such claims
          may cause us to incur significant expense, and we may face monetary penalties
          or
          injunctive relief, or both, or be required to reformulate our product to
          acceptable levels. The State of California under Proposition 65 is also
          considering the inclusion of titanium dioxide on the state’s list of suspected
          carcinogens. Titanium dioxide has a long history of
  76
  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.
  **LEASES
          AND ENDORSEMENTS**
 
 The
          minimum rental commitments under all noncancelable operating leases, primarily
          real estate, in effect at November 30, 2005 are as follows:
  2006
                
                $
                1,4702007
                
                
                6322008
                
                
                5582009
                
                
                4002010
                
                
                188Thereafter
                
                
                548$
                3,796
 
 Rental
          expense was $2,135, $1,960, and $1,676 for fiscal 2005, 2004 and 2003,
          respectively.
 
 The
          minimum commitments under noncancelable endorsement contracts related to
          our
          advertising in effect at November 30, 2005 are as follows:
  2006
                
                $
                1,5002007
                
                
                1,6752008
                
                
                1,5502009
                
                
                800$
                5,525
  We
          have
          entered into a supply agreement for the supply of selenium sulfide, the
          active
          ingredient in *Selsun
          Blue* ,
          which
          will expire in December 2008 with an automatic renewal for successive one
          year
          terms unless written termination notice is given six months prior to the
          end of
          the term or any renewal term by either party. In addition, we have also
          entered
          into a supply agreement for the supply of *Selsun
          Blue* bottles
          with a minimum quantity to be purchased over the life of the agreement,
          which
          will expire on August 31, 2006. As of November 30, 2005, our remaining
          purchase
          commitment obligations based on the last price paid are approximately $1,495,
          $1,242 and $1,242 for our 2006, 2007 and 2008 fiscal years,
          respectively.
  **(14)** **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, 2005 arose in conjunction with Chattem’s issuance of
          the Revolving Credit Facility, the Floating Rate Senior Notes and 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,
          2005 is $182,500.
 77
  Note
          14
 **CHATTEM,
          INC. AND SUBSIDIARIES**
 **CONSOLIDATING
          BALANCE SHEETS**
 
 *NOVEMBER
          30, 2005*
 (In
          thousands)
 CHATTEM
                
                GUARANTOR
                    SUBSIDIARY    COMPANIES
                
                NON-GUARANTOR
                       SUBSIDIARY
                             COMPANIES
                
                ELIMINATIONS
                
                CONSOLIDATEDASSETSCURRENT
                    ASSETS:Cash and cash equivalents
                
                $
                36,647
                
                $
                1,982
                
                $
                8,698
                
                $
                —
                
                $
                47,327Accounts
                    receivable, less allowances of $2,338
                
                
                29,220
                
                
                11,181
                
                
                4,452
                
                
                (11,181
                )
                
                33,672Other
                    receivables
                
                
                9,600
                
                
                —
                
                
                —
                
                
                —
                
                
                9,600Interest
                    receivable
                
                
                17
                
                
                625
                
                
                —
                
                
                (642
                )
                
                —Inventories
                
                
                18,192
                
                
                2,429
                
                
                3,010
                
                
                —
                
                
                23,631Refundable
                    income taxes
                
                
                1,207
                
                
                —
                
                
                —
                
                
                —
                
                
                1,207Deferred
                    income taxes
                
                
                2,478
                
                
                —
                
                
                —
                
                
                —
                
                
                2,478Prepaid
                    expenses and other current assets
                
                
                4,241
                
                
                —
                
                
                1,285
                
                
                (420
                )
                
                5,106Total
                    current assets
                
                
                101,602
                
                
                16,217
                
                
                17,445
                
                
                (12,243
                )
                
                123,021PROPERTY,
                    PLANT AND EQUIPMENT, NET
                
                
                27,937
                
                
                775
                
                
                542
                
                
                —
                
                
                29,254OTHER
                    NONCURRENT ASSETS:Patents,
                    trademarks and other purchased product
                  rights,
                    net
                
                
                404
                
                
                268,273
                
                
                —
                
                
                (62,290
                )
                
                206,387Debt
                    issuance costs, net
                
                
                4,297
                
                
                —
                
                
                —
                
                
                —
                
                
                4,297Investment
                    in subsidiaries
                
                
                276,987
                
                
                33,000
                
                
                66,860
                
                
                (376,847
                )
                
                —Note
                    receivable
                
                
                —
                
                
                33,000
                
                
                —
                
                
                (33,000
                )
                
                —Other
                
                
                5,334
                
                
                —
                
                
                —
                
                
                —
                
                
                5,334Total
                    other noncurrent assets
                
                
                287,022
                
                
                334,273
                
                
                66,860
                
                
                (472,137
                )
                
                216,018TOTAL
                    ASSETS
                
                $
                416,561
                
                $
                351,265
                
                $
                84,847
                
                $
                (484,380
                )
                $
                368,293LIABILITIES
                    AND SHAREHOLDERS’ EQUITYCURRENT
                    LIABILITIES:Current
                    maturities of long-term debt
                
                $
                37,000
                
                $
                —
                
                $
                —
                
                $
                —
                
                $
                37,000Accounts
                    payable and other
                
                
                14,841
                
                
                —
                
                
                2,397
                
                
                —
                
                
                17,238Accrued
                    liabilities
                
                
                21,432
                
                
                969
                
                
                6,169
                
                
                (12,243
                )
                
                16,327Total
                    current liabilities
                
                
                73,273
                
                
                969
                
                
                8,566
                
                
                (12,243
                )
                
                70,565LONG-TERM
                    DEBT, less current maturities
                
                
                145,500
                
                
                —
                
                
                33,000
                
                
                (33,000
                )
                
                145,500DEFERRED
                    INCOME TAXES
                
                
                (795
                )
                
                28,531
                
                
                —
                
                
                —
                
                
                27,736OTHER
                    NONCURRENT LIABILITIES
                
                
                1,865
                
                
                —
                
                
                —
                
                
                —
                
                
                1,865INTERCOMPANY
                    ACCOUNTS
                
                
                74,088
                
                
                (75,941
                )
                
                1,853
                
                
                —
                
                
                —SHAREHOLDERS’
                    EQUITY:Preferred shares, without par value, authorized
                  1,000,
                    none issued
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —Common
                    shares, without par value, authorized
                  50,000,
                    issued 19,668
                
                
                63,876
                
                
                —
                
                
                —
                
                
                —
                
                
                63,876Share
                    capital of subsidiaries
                
                
                —
                
                
                329,705
                
                
                39,803
                
                
                (369,508
                )
                
                —Retained
                    earnings
                
                
                60,853
                
                
                68,001
                
                
                1,582
                
                
                (69,583
                )
                
                60,853Total
                
                
                124,729
                
                
                397,706
                
                
                41,385
                
                
                (439,091
                )
                
                124,729Unamortized
                    value of restricted common shares
                  issued
                
                
                (1,818
                )
                
                —
                
                
                —
                
                
                —
                
                
                (1,818
                )Cumulative
                    other comprehensive income, net of
                  taxes:Interest rate cap adjustment
                
                
                (83
                )
                
                —
                
                
                —
                
                
                —
                
                
                (83
                )Foreign
                    currency translation adjustment
                
                
                (198
                )
                
                —
                
                
                43
                
                
                (46
                )
                
                (201
                )Total
                    shareholders’ equity
                
                
                122,630
                
                
                397,706
                
                
                41,428
                
                
                (439,137
                )
                
                122,627TOTAL
                    LIABILITIES AND
                  SHAREHOLDERS’
                    EQUITY
                
                $
                416,561
                
                $
                351,265
                
                $
                84,847
                
                $
                (484,380
                )
                $
                368,293
 
 78
  Note
          14
 **CHATTEM,
          INC. AND SUBSIDIARIES**
 **CONSOLIDATING
          BALANCE SHEETS**
 
 *NOVEMBER
          30, 2004*
 (In
          thousands)
 CHATTEM
                
                GUARANTOR
                    SUBSIDIARY    COMPANIES
                
                NON-GUARANTOR
                       SUBSIDIARY
                             COMPANIES
                
                ELIMINATIONS
                
                CONSOLIDATEDASSETS
                
                as
                    adjusted(1)
                
                
                
                
                
                
                
                as
                    adjusted(1)CURRENT
                    ASSETS:Cash and cash equivalents
                
                $
                28,344
                
                $
                1,967
                
                $
                9,882
                
                $
                —
                
                $
                40,193Accounts
                    receivable, less allowances of $1,682
                
                
                26,727
                
                
                8,733
                
                
                5,376
                
                
                (8,738
                )
                
                32,098Interest
                    receivable
                
                
                —
                
                
                619
                
                
                —
                
                
                (619
                )
                
                —Inventories
                
                
                18,115
                
                
                3,020
                
                
                1,989
                
                
                —
                
                
                23,124Refundable
                    income taxes
                
                
                4,186
                
                
                —
                
                
                —
                
                
                —
                
                
                4,186Deferred
                    income taxes
                
                
                4,308
                
                
                —
                
                
                —
                
                
                —
                
                
                4,308Prepaid
                    expenses and other current assets
                
                
                3,489
                
                
                —
                
                
                194
                
                
                —
                
                
                3,683Total
                    current assets
                
                
                85,169
                
                
                14,339
                
                
                17,441
                
                
                (9,357
                )
                
                107,592PROPERTY,
                    PLANT AND EQUIPMENT, NET
                
                
                27,724
                
                
                775
                
                
                266
                
                
                —
                
                
                28,765OTHER
                    NONCURRENT ASSETS:Patents,
                    trademarks and other purchased product
                  rights,
                    net
                
                
                763
                
                
                287,087
                
                
                —
                
                
                (62,290
                )
                
                225,560Debt
                    issuance costs, net
                
                
                5,174
                
                
                —
                
                
                —
                
                
                —
                
                
                5,174Investment
                    in subsidiaries
                
                
                249,999
                
                
                33,000
                
                
                68,477
                
                
                (351,476
                )
                
                —Note
                    receivable
                
                
                —
                
                
                33,000
                
                
                —
                
                
                (33,000
                )
                
                —Other
                
                
                4,681
                
                
                —
                
                
                870
                
                
                —
                
                
                5,551Total
                    other noncurrent assets
                
                
                260,617
                
                
                353,087
                
                
                69,347
                
                
                (446,766
                )
                
                236,285TOTAL
                    ASSETS
                
                $
                373,510
                
                $
                368,201
                
                $
                87,054
                
                $
                (456,123
                )
                $
                372,642LIABILITIES
                    AND SHAREHOLDERS’ EQUITYCURRENT
                    LIABILITIES:Current
                    maturities of long-term debt
                
                $
                —
                
                $
                —
                
                $
                —
                
                $
                —
                
                $
                —Accounts
                    payable and other
                
                
                11,398
                
                
                —
                
                
                1,943
                
                
                —
                
                
                13,341Accrued
                    liabilities
                
                
                27,435
                
                
                1,107
                
                
                4,578
                
                
                (9,357
                )
                
                23,763Total
                    current liabilities
                
                
                38,833
                
                
                1,107
                
                
                6,521
                
                
                (9,357
                )
                
                37,104LONG-TERM
                    DEBT, less current maturities
                
                
                200,000
                
                
                —
                
                
                33,000
                
                
                (33,000
                )
                
                200,000DEFERRED
                    INCOME TAXES
                
                
                (511
                )
                
                26,243
                
                
                —
                
                
                —
                
                
                25,732OTHER
                    NONCURRENT LIABILITIES
                
                
                1,776
                
                
                —
                
                
                —
                
                
                —
                
                
                1,776INTERCOMPANY
                    ACCOUNTS
                
                
                25,382
                
                
                (25,484
                )
                
                102
                
                
                —
                
                
                —SHAREHOLDERS’
                    EQUITY:Preferred shares, without par value, authorized
                  1,000,
                    none issued
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —Common
                    shares, without par value, authorized
                  50,000,
                    issued 19,882
                
                
                85,949
                
                
                —
                
                
                —
                
                
                —
                
                
                85,949Share
                    capital of subsidiaries
                
                
                —
                
                
                329,705
                
                
                41,100
                
                
                (370,805
                )
                
                —Retained
                    earnings
                
                
                24,806
                
                
                36,630
                
                
                6,115
                
                
                (42,745
                )
                
                24,806Total
                
                
                110,755
                
                
                366,335
                
                
                47,215
                
                
                (413,550
                )
                
                110,755Unamortized
                    value of restricted common shares
                  issued
                
                
                (2,386
                )
                
                —
                
                
                —
                
                
                —
                
                
                (2,386
                )Cumulative
                    other comprehensive income, net of
                  taxes:Interest rate cap adjustment
                
                
                (316
                )
                
                —
                
                
                —
                
                
                —
                
                
                (316
                )Foreign
                    currency translation adjustment
                
                
                (23
                )
                
                —
                
                
                216
                
                
                (216
                )
                
                (23
                )Total
                    shareholders’ equity
                
                
                108,030
                
                
                366,335
                
                
                47,431
                
                
                (413,766
                )
                
                108,030TOTAL
                    LIABILITIES AND
                  SHAREHOLDERS’
                    EQUITY
                
                $
                373,510
                
                $
                368,201
                
                $
                87,054
                
                $
                (456,123
                )
                $
                372,642
 
 (1)
          The
          consolidating balance sheet for Chattem has been adjusted to reflect
          retroactively the change in method of valuing our domestic inventory from
          the
          LIFO to the FIFO method adopted in fiscal 2005.
 79
  Note
          14
 **CHATTEM,
          INC. AND SUBSIDIARIES**
 **CONSOLIDATING
          STATEMENTS OF INCOME**
 
 *FOR
          THE YEAR ENDED NOVEMBER 30, 2005*
 (In
          thousands)
 
 CHATTEM
                
                GUARANTOR
                    SUBSIDIARY    COMPANIES
                
                NON-GUARANTOR
                          SUBSIDIARY    
                        COMPANIES
                
                ELIMINATIONS
                
                CONSOLIDATEDTOTAL
                    REVENUES
                
                $
                225,874
                
                $
                76,405
                
                $
                22,120
                
                $
                (45,081
                )
                $
                279,318COSTS
                    AND EXPENSES:Cost
                    of sales
                
                
                63,312
                
                
                8,561
                
                
                10,693
                
                
                (2,682
                )
                
                79,884Advertising
                    and promotion
                
                
                61,411
                
                
                10,336
                
                
                5,016
                
                
                —
                
                
                76,763Selling,
                    general and administrative
                
                
                46,089
                
                
                (180
                )
                
                1,413
                
                
                —
                
                
                47,322Executive
                    severance charges
                
                
                2,269
                
                
                —
                
                
                —
                
                
                —
                
                
                2,269Litigation
                    settlement
                
                
                (4,262
                )
                
                —
                
                
                2,176
                
                
                —
                
                
                (2,086
                )Loss
                    on product divestures
                
                
                8,678
                
                
                —
                
                
                —
                
                
                —
                
                
                8,678Equity
                    in subsidiary income
                
                
                (26,838
                )
                
                —
                
                
                —
                
                
                26,838
                
                
                —Total
                    costs and expenses
                
                
                150,659
                
                
                18,717
                
                
                19,298
                
                
                24,156
                
                
                212,830INCOME
                    FROM OPERATIONS
                
                
                75,215
                
                
                57,688
                
                
                2,822
                
                
                (69,237
                )
                
                66,488OTHER
                    INCOME (EXPENSE):Interest
                    expense
                
                
                (13,814
                )
                
                —
                
                
                (2,499
                )
                
                2,499
                
                
                (13,814
                )Investment
                    and other income, net
                
                
                4,714
                
                
                6,334
                
                
                6,549
                
                
                (16,511
                )
                
                1,086Loss
                    on early extinguishment of debt
                
                
                (750
                )
                
                —
                
                
                —
                
                
                —
                
                
                (750
                )Royalties
                
                
                (34,774
                )
                
                (5,430
                )
                
                (2,195
                )
                
                42,399
                
                
                —Corporate
                    allocations
                
                
                3,196
                
                
                (3,127
                )
                
                (69
                )
                
                —
                
                
                —Total
                    other income (expense)
                
                
                (41,428
                )
                
                (2,223
                )
                
                1,786
                
                
                28,387
                
                
                (13,478
                )INCOME
                    (LOSS) BEFORE INCOME TAXES
                
                
                33,787
                
                
                55,465
                
                
                4,608
                
                
                (40,850
                )
                
                53,010(BENEFIT
                    FROM) PROVISION FOR INCOME TAXES
                
                
                (2,260
                )
                
                17,749
                
                
                1,474
                
                
                —
                
                
                16,963NET
                    INCOME
                
                $
                36,047
                
                $
                37,716
                
                $
                3,134
                
                $
                (40,850
                )
                $
                36,047
 
 
 
 80
 Note
          14
 **CHATTEM,
          INC. AND SUBSIDIARIES**
 **CONSOLIDATING
          STATEMENTS OF INCOME**
 
 *FOR
          THE YEAR ENDED NOVEMBER 30, 2004*
 (In
          thousands)
 
 CHATTEM
                
                GUARANTOR
                    SUBSIDIARY    COMPANIES
                
                NON-GUARANTOR
                          SUBSIDIARY    
                        COMPANIES
                
                ELIMINATIONS
                
                CONSOLIDATEDas
                    adjusted(1)
                
                
                
                
                
                
                
                as
                    adjusted(1)TOTAL
                    REVENUES
                
                $
                209,002
                
                $
                71,140
                
                $
                17,863
                
                $
                (39,850
                )
                $
                258,155COSTS
                    AND EXPENSES:Cost
                    of sales
                
                
                58,103
                
                
                9,843
                
                
                7,749
                
                
                (2,337
                )
                
                73,358Advertising
                    and promotion
                
                
                56,904
                
                
                13,593
                
                
                4,432
                
                
                —
                
                
                74,929Selling,
                    general and administrative
                
                
                42,889
                
                
                456
                
                
                824
                
                
                —
                
                
                44,169Impairment
                    of indefinite-lived intangible assets
                
                
                —
                
                
                20,000
                
                
                —
                
                
                —
                
                
                20,000Litigation settlement
                
                
                13,405
                
                
                —
                
                
                2,431
                
                
                —
                
                
                15,836Equity
                    in subsidiary income
                
                
                (13,507
                )
                
                —
                
                
                —
                
                
                13,507
                
                
                —Total
                    costs and expenses
                
                
                157,794
                
                
                43,892
                
                
                15,436
                
                
                11,170
                
                
                228,292INCOME
                    FROM OPERATIONS
                
                
                51,208
                
                
                27,248
                
                
                2,427
                
                
                (51,020
                )
                
                29,863OTHER
                    INCOME (EXPENSE):Interest
                    expense
                
                
                (15,049
                )
                
                —
                
                
                (2,480
                )
                
                2,480
                
                
                (15,049
                )Investment
                    and other income, net
                
                
                158
                
                
                2,483
                
                
                2,012
                
                
                (4,355
                )
                
                298Loss
                    on early extinguishment of debt
                
                
                (12,958
                )
                
                —
                
                
                —
                
                
                —
                
                
                (12,958
                )Royalties
                
                
                (31,985
                )
                
                (5,527
                )
                
                —
                
                
                37,512
                
                
                —Corporate
                    allocations
                
                
                3,204
                
                
                (3,088
                )
                
                (116
                )
                
                —
                
                
                —Total
                    other income (expense)
                
                
                (56,630
                )
                
                (6,132
                )
                
                (584
                )
                
                35,637
                
                
                (27,709
                )INCOME
                    (LOSS) BEFORE INCOME TAXES
                
                
                (5,422
                )
                
                21,116
                
                
                1,843
                
                
                (15,383
                )
                
                2,154(BENEFIT
                    FROM) PROVISION FOR INCOME TAXES
                
                
                (6,873
                )
                
                6,968
                
                
                608
                
                
                —
                
                
                703NET
                    INCOME
                
                $
                1,451
                
                $
                14,148
                
                $
                1,235
                
                $
                (15,383
                )
                $
                1,451
 
 (1)
          The
          consolidating statement of income for Chattem has been adjusted to reflect
          retroactively the change in method of valuing our domestic inventory from
          the
          LIFO to the FIFO method adopted in fiscal 2005.
 
 81
 Note
          14
 **CHATTEM,
          INC. AND SUBSIDIARIES**
 **CONSOLIDATING
          STATEMENTS OF INCOME**
 
 *FOR
          THE YEAR ENDED NOVEMBER 30, 2003*
 (In
          thousands)
 
 CHATTEM
                
                GUARANTOR
                    SUBSIDIARY    COMPANIES
                
                NON-GUARANTOR
                          SUBSIDIARY    
                        COMPANIES
                
                ELIMINATIONS
                
                CONSOLIDATEDas
                    adjusted(1)
                
                
                
                
                
                
                
                as
                    adjusted(1)TOTAL
                    REVENUES
                
                $
                177,155
                
                $
                72,293
                
                $
                17,952
                
                $
                (33,651
                )
                $
                233,749COSTS
                    AND EXPENSES:Cost
                    of sales
                
                
                49,144
                
                
                9,810
                
                
                7,470
                
                
                —
                
                
                66,424Advertising
                    and promotion
                
                
                54,652
                
                
                10,497
                
                
                5,473
                
                
                —
                
                
                70,622Selling,
                    general and administrative
                
                
                39,258
                
                
                254
                
                
                1,291
                
                
                —
                
                
                40,803Equity
                    in subsidiary income
                
                
                (29,980
                )
                
                —
                
                
                —
                
                
                29,980
                
                
                —Total
                    costs and expenses
                
                
                113,074
                
                
                20,561
                
                
                14,234
                
                
                29,980
                
                
                177,849INCOME
                    FROM OPERATIONS
                
                
                64,081
                
                
                51,732
                
                
                3,718
                
                
                (63,631
                )
                
                55,900OTHER
                    INCOME (EXPENSE):Interest
                    expense
                
                
                (20,431
                )
                
                —
                
                
                —
                
                
                —
                
                
                (20,431
                )Investment
                    and other income, net
                
                
                44
                
                
                3
                
                
                77
                
                
                —
                
                
                124Royalties
                
                
                (27,331
                )
                
                (5,952
                )
                
                (368
                )
                
                33,651
                
                
                —Corporate
                    allocations
                
                
                3,735
                
                
                (3,535
                )
                
                (200
                )
                
                —
                
                
                —Total
                    other income (expense)
                
                
                (43,983
                )
                
                (9,484
                )
                
                (491
                )
                
                33,651
                
                
                (20,307
                )INCOME
                    BEFORE INCOME TAXES
                
                
                20,098
                
                
                42,248
                
                
                3,227
                
                
                (29,980
                )
                
                35,593(BENEFIT
                    FROM) PROVISION FOR INCOME TAXES
                
                
                (3,249
                )
                
                14,765
                
                
                730
                
                
                —
                
                
                12,246NET
                    INCOME
                
                $
                23,347
                
                $
                27,483
                
                $
                2,497
                
                $
                (29,980
                )
                $
                23,347
 
 (1)
          The
          consolidating statement of income for Chattem has been adjusted to reflect
          retroactively the change in method of valuing our domestic inventory from
          the
          LIFO to the FIFO method adopted in fiscal 2005.
 
 82
 
 Note
          14
 **CHATTEM,
          INC. AND SUBSIDIARIES**
 **CONSOLIDATING
          STATEMENTS OF CASH FLOWS**
 
 FOR
          THE
          YEAR ENDED NOVEMBER 30, 2005
 (In
          thousands)
 CHATTEM
                  
                  GUARANTOR
                      SUBSIDIARY    COMPANIES
                  
                  NON-GUARANTOR
                            SUBSIDIARY    
                          COMPANIES
                  
                  ELIMINATIONS
                  
                  CONSOLIDATEDOPERATING
                      ACTIVITIES:Net
                      income
                  
                  $
                  36,047
                  
                  $
                  37,716
                  
                  $
                  3,134
                  
                  $
                  (40,850
                  )
                  $
                  36,047Adjustments
                      to reconcile net income to net cash
                    (used in) provided by operating activities:Depreciation
                      and amortization
                  
                  
                  6,115
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  6,115Deferred
                      income tax provision
                  
                  
                  1,606
                  
                  
                  2,288
                  
                  
                  —
                  
                  
                  —
                  
                  
                  3,894Loss
                      on early extinguishment of debt
                  
                  
                  750
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  750Loss
                      on product line divestures
                  
                  
                  8,678
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  8,678Tax
                      benefit realized from stock option plans
                  
                  
                  3,292
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  3,292Stock
                      option expense
                  
                  
                  1,360
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  1,360Other,
                      net
                  
                  
                  105
                  
                  
                  —
                  
                  
                  695
                  
                  
                  —
                  
                  
                  800Equity
                      in subsidiary income
                  
                  
                  (40,850
                  )
                  
                  —
                  
                  
                  —
                  
                  
                  40,850
                  
                  
                  —Changes
                      in operating assets and liabilities:Accounts
                      receivable
                  
                  
                  (3,142
                  )
                  
                  (2,448
                  )
                  
                  923
                  
                  
                  2,443
                  
                  
                  (2,224
                  )Interest
                      receivable
                  
                  
                  (17
                  )
                  
                  —
                  
                  
                  —
                  
                  
                  17
                  
                  
                  —Inventories
                  
                  
                  (1,028
                  )
                  
                  591
                  
                  
                  (1,020
                  )
                  
                  —
                  
                  
                  (1,457
                  )Refundable
                      income taxes
                  
                  
                  2,979
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  2,979Prepaid
                      expenses and other current assets
                  
                  
                  (759
                  )
                  
                  —
                  
                  
                  (387
                  )
                  
                  420
                  
                  
                  (726
                  )Accounts
                      payable and accrued liabilities
                  
                  
                  (3,520
                  )
                  
                  (137
                  )
                  
                  2,045
                  
                  
                  (2,880
                  )
                  
                  (4,492
                  )Net
                      cash (used in) provided by operating activities
                  
                  
                  11,616
                  
                  
                  38,010
                  
                  
                  5,390
                  
                  
                  —
                  
                  
                  55,016INVESTING
                      ACTIVITIES:Purchases
                      of property, plant and equipment
                  
                  
                  (3,668
                  )
                  
                  —
                  
                  
                  (275
                  )
                  
                  —
                  
                  
                  (3,943
                  )Sales
                      (purchases) of patents, trademarks and other
                    product
                      rights
                  
                  
                  3,199
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  3,199Decrease
                      in other assets, net
                  
                  
                  (135
                  )
                  
                  —
                  
                  
                  221
                  
                  
                  —
                  
                  
                  86Net
                      cash (used in) provided by investing
                    activities
                  
                  
                  (604
                  )
                  
                  —
                  
                  
                  (54
                  )
                  
                  —
                  
                  
                  (658
                  )FINANCING
                      ACTIVITIES:Repayment
                      of long-term debt
                  
                  
                  (17,500
                  )
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  (17,500
                  )Repayments
                      of policy loans
                  
                  
                  (1,031
                  )
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  (1,031
                  )Repurchase
                      of common shares
                  
                  
                  (34,084
                  )
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  (34,084
                  )Proceeds
                      from exercise of stock options
                  
                  
                  6,681
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  6,681Increase
                      in debt issuance costs
                  
                  
                  (313
                  )
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  (313
                  )Debt
                      retirement costs
                  
                  
                  (282
                  )
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  (282
                  )Changes
                      in intercompany accounts
                  
                  
                  39,974
                  
                  
                  (35,495
                  )
                  
                  (4,479
                  )
                  
                  —
                  
                  
                  —Dividends
                      paid
                  
                  
                  3,846
                  
                  
                  (2,500
                  )
                  
                  (1,346
                  )
                  
                  —
                  
                  
                  —Net
                      cash provided by (used in) financing
                    activities
                  
                  
                  (2,709
                  )
                  
                  (37,995
                  )
                  
                  (5,825
                  )
                  
                  —
                  
                  
                  (46,529
                  )EFFECT
                      OF EXCHANGE RATE CHANGES ON
                    CASH
                      AND CASH EQUIVALENTS
                  
                  
                  —
                  
                  
                  —
                  
                  
                  (695
                  )
                  
                  —
                  
                  
                  (695
                  )CASH
                      AND CASH EQUIVALENTS:Increase
                      (decrease) for the year
                  
                  
                  8,303
                  
                  
                  15
                  
                  
                  (1,184
                  )
                  
                  —
                  
                  
                  7,134At
                      beginning of year
                  
                  
                  28,344
                  
                  
                  1,967
                  
                  
                  9,882
                  
                  
                  —
                  
                  
                  40,193At
                      end of year
                  
                  $
                  36,647
                  
                  $
                  1,982
                  
                  $
                  8,698
                  
                  $
                  —
                  
                  $
                  47,327
  83
 Note
          14
 **CHATTEM,
          INC. AND SUBSIDIARIES**
 **CONSOLIDATING
          STATEMENTS OF CASH FLOWS**
 
 FOR
          THE
          YEAR ENDED NOVEMBER 30, 2004
 (In
          thousands)
 CHATTEM
                
                GUARANTOR
                    SUBSIDIARY    COMPANIES
                
                NON-GUARANTOR
                          SUBSIDIARY    
                        COMPANIES
                
                ELIMINATIONS
                
                CONSOLIDATEDas
                    adjusted(1)
                
                
                
                
                
                
                
                as
                    adjusted(1)OPERATING
                    ACTIVITIES:Net
                    income
                
                $
                1,451
                
                $
                14,148
                
                $
                1,235
                
                $
                (15,383
                )
                $
                1,451Adjustments
                    to reconcile net income to net cash
                  provided by operating activities:Depreciation
                    and amortization
                
                
                6,089
                
                
                —
                
                
                42
                
                
                —
                
                
                6,131Deferred
                    income tax provision
                
                
                (1,434
                )
                
                (545
                )
                
                48
                
                
                —
                
                
                (1,931
                )Loss
                    on early extinguishment of debt
                
                
                12,958
                
                
                —
                
                
                —
                
                
                —
                
                
                12,958Impairment
                    of indefinite-lived assets
                
                
                —
                
                
                20,000
                
                
                —
                
                
                —
                
                
                20,000Tax
                    benefit realized from stock option plans
                
                
                5,568
                
                
                —
                
                
                —
                
                
                —
                
                
                5,568Other,
                    net
                
                
                (53
                )
                
                —
                
                
                (196
                )
                
                —
                
                
                (249
                )Equity
                    in subsidiary income
                
                
                (15,383
                )
                
                —
                
                
                —
                
                
                15,383
                
                
                —Changes
                    in operating assets and liabilities:Accounts
                    receivable
                
                
                (4,998
                )
                
                (1,644
                )
                
                (1,627
                )
                
                1,649
                
                
                (6,620
                )Interest
                    receivable
                
                
                —
                
                
                (619
                )
                
                —
                
                
                619
                
                
                —Inventories
                
                
                (3,756
                )
                
                (980
                )
                
                860
                
                
                —
                
                
                (3,876
                )Refundable
                    income taxes
                
                
                (380
                )
                
                —
                
                
                17
                
                
                —
                
                
                (363
                )Prepaid
                    expenses and other current assets
                
                
                1,019
                
                
                —
                
                
                (52
                )
                
                (1,167
                )
                
                (200
                )Accounts
                    payable and accrued liabilities
                
                
                9,250
                
                
                479
                
                
                3,213
                
                
                (1,101
                )
                
                11,841Net
                    cash provided by operating activities
                
                
                10,331
                
                
                30,839
                
                
                3,540
                
                
                —
                
                
                44,710INVESTING
                    ACTIVITIES:Purchases
                    of property, plant and equipment
                
                
                (3,390
                )
                
                —
                
                
                151
                
                
                —
                
                
                (3,239
                )Purchases
                    of patents, trademarks and other
                  product
                    rights
                
                
                —
                
                
                (7
                )
                
                —
                
                
                —
                
                
                (7
                )Increase
                    in note receivable
                
                
                —
                
                
                (33,000
                )
                
                —
                
                
                33,000
                
                
                —Decrease
                    in other assets, net
                
                
                (2,345
                )
                
                —
                
                
                100
                
                
                —
                
                
                (2,245
                )Net
                    cash (used in) provided by investing
                  activities
                
                
                (5,735
                )
                
                (33,007
                )
                
                251
                
                
                33,000
                
                
                (5,491
                )FINANCING
                    ACTIVITIES:Repayment
                    of long-term debt
                
                
                (212,288
                )
                
                —
                
                
                —
                
                
                —
                
                
                (212,288
                )Proceeds
                    from long-term debt
                
                
                200,000
                
                
                —
                
                
                —
                
                
                —
                
                
                200,000Proceeds
                    from borrowing under revolver
                
                
                25,000
                
                
                —
                
                
                —
                
                
                —
                
                
                25,000Payments
                    under revolver
                
                
                (25,000
                )
                
                —
                
                
                —
                
                
                —
                
                
                (25,000
                )Repurchase
                    of common shares
                
                
                (5,034
                )
                
                —
                
                
                —
                
                
                —
                
                
                (5,034
                )Proceeds
                    from exercise of stock options
                
                
                6,148
                
                
                —
                
                
                —
                
                
                —
                
                
                6,148Increase
                    in debt issuance costs
                
                
                (5,743
                )
                
                —
                
                
                —
                
                
                —
                
                
                (5,743
                )Debt
                    retirement costs
                
                
                (7,861
                )
                
                —
                
                
                —
                
                
                —
                
                
                (7,861
                )Premium
                    on interest rate cap agreement
                
                
                (1,375
                )
                
                —
                
                
                —
                
                
                —
                
                
                (1,375
                )Changes
                    in intercompany accounts
                
                
                31,199
                
                
                4,046
                
                
                (35,245
                )
                
                —
                
                
                —Dividends
                    paid
                
                
                —
                
                
                (1,875
                )
                
                1,875
                
                
                —
                
                
                —Intercompany
                    debt proceeds (payments)
                
                
                —
                
                
                —
                
                
                33,000
                
                
                (33,000
                )
                
                —Net
                    cash provided by (used in) financing
                  activities
                
                
                5,046
                
                
                2,171
                
                
                (370
                )
                
                (33,000
                )
                
                (26,153
                )EFFECT
                    OF EXCHANGE RATE CHANGES ON
                  CASH
                    AND CASH EQUIVALENTS
                
                
                —
                
                
                —
                
                
                196
                
                
                —
                
                
                196CASH
                    AND CASH EQUIVALENTS:Increase
                    for the year
                
                
                9,642
                
                
                3
                
                
                3,617
                
                
                —
                
                
                13,262At
                    beginning of year
                
                
                18,702
                
                
                1,964
                
                
                6,265
                
                
                —
                
                
                26,931At
                    end of year
                
                $
                28,344
                
                $
                1,967
                
                $
                9,882
                
                $
                —
                
                $
                40,193
 
 (1)
          The
          consolidating statement of cash flows for Chattem has been adjusted to
          reflect
          retroactively the change in method of valuing our domestic inventory from
          the
          LIFO to the FIFO method adopted in fiscal 2005.
 
 84
 Note
          14
 **CHATTEM,
          INC. AND SUBSIDIARIES**
 **CONSOLIDATING
          STATEMENTS OF CASH FLOWS**
 
 FOR
          THE
          YEAR ENDED NOVEMBER 30, 2003
 (In
          thousands)
 CHATTEM
                
                GUARANTOR
                    SUBSIDIARY    COMPANIES
                
                NON-GUARANTOR
                          SUBSIDIARY    
                        COMPANIES
                
                ELIMINATIONS
                
                CONSOLIDATEDas
                    adjusted(1)
                
                
                
                
                
                
                
                as
                    adjusted(1)OPERATING
                    ACTIVITIES:Net
                    income
                
                $
                23,347
                
                $
                27,483
                
                $
                2,497
                
                $
                (29,980
                )
                $
                23,347Adjustments
                    to reconcile net income to net cash
                  (used
                    in) provided by operating activities:Depreciation
                    and amortization
                
                
                6,427
                
                
                —
                
                
                157
                
                
                —
                
                
                6,584Deferred
                    income tax provision
                
                
                1,650
                
                
                4,979
                
                
                (2
                )
                
                —
                
                
                6,627Tax
                    benefit realized from stock option plans
                
                
                1,259
                
                
                —
                
                
                —
                
                
                —
                
                
                1,259Other,
                    net
                
                
                (72
                )
                
                —
                
                
                6
                
                
                —
                
                
                (66
                )Equity
                    in subsidiary income
                
                
                (29,980
                )
                
                —
                
                
                —
                
                
                29,980
                
                
                —Changes
                    in operating assets and liabilities:Accounts
                    receivable
                
                
                (144
                )
                
                (4,792
                )
                
                339
                
                
                4,792
                
                
                195Inventories
                
                
                102
                
                
                1,099
                
                
                47
                
                
                —
                
                
                1,248Refundable
                    income taxes
                
                
                (523
                )
                
                —
                
                
                120
                
                
                —
                
                
                (403
                )Prepaid
                    expenses and other current assets
                
                
                (1,777
                )
                
                —
                
                
                (7
                )
                
                1,167
                
                
                (617
                )Accounts
                    payable and accrued liabilities
                
                
                (1,898
                )
                
                302
                
                
                832
                
                
                (5,959
                )
                
                (6,723
                )Net
                    cash (used in) provided by operating activities
                
                
                (1,609
                )
                
                29,071
                
                
                3,989
                
                
                —
                
                
                31,451INVESTING
                    ACTIVITIES:Purchases
                    of property, plant and equipment
                
                
                (5,359
                )
                
                —
                
                
                (168
                )
                
                —
                
                
                (5,527
                )Purchases
                    of patents, trademarks and other
                  product
                    rights
                
                
                —
                
                
                (400
                )
                
                —
                
                
                —
                
                
                (400
                )Decrease
                    in other assets, net
                
                
                1,055
                
                
                —
                
                
                424
                
                
                —
                
                
                1,479Net
                    cash (used in) provided by investing
                  activities
                
                
                (4,304
                )
                
                (400
                )
                
                256
                
                
                —
                
                
                (4,448
                )FINANCING
                    ACTIVITIES:Repayment
                    of long-term debt
                
                
                (12,250
                )
                
                —
                
                
                —
                
                
                —
                
                
                (12,250
                )Repurchase
                    of common shares
                
                
                (5,351
                )
                
                —
                
                
                —
                
                
                —
                
                
                (5,351
                )Proceeds
                    from exercise of stock options
                
                
                1,555
                
                
                —
                
                
                —
                
                
                —
                
                
                1,555Increase
                    in debt issuance costs
                
                
                (25
                )
                
                —
                
                
                —
                
                
                —
                
                
                (25
                )Changes
                    in intercompany accounts
                
                
                215,675
                
                
                (215,481
                )
                
                (194
                )
                
                —
                
                
                —Recapitalization
                    of affiliate loan
                
                
                (200,636
                )
                
                200,636
                
                
                —
                
                
                —
                
                
                —Redemption
                    of preferred stock of affiliate
                
                
                1,142
                
                
                —
                
                
                (1,142
                )
                
                —
                
                
                —Dividends
                    paid
                
                
                13,000
                
                
                (13,000
                )
                
                —
                
                
                —
                
                
                —Net
                    cash provided by (used in) financing
                  activities
                
                
                13,110
                
                
                (27,845
                )
                
                (1,336
                )
                
                —
                
                
                (16,071
                )EFFECT
                    OF EXCHANGE RATE CHANGES ON
                  CASH
                    AND CASH EQUIVALENTS
                
                
                —
                
                
                —
                
                
                75
                
                
                —
                
                
                75CASH
                    AND CASH EQUIVALENTS:Increase
                    for the year
                
                
                7,197
                
                
                826
                
                
                2,984
                
                
                —
                
                
                11,007At
                    beginning of year
                
                
                11,505
                
                
                1,138
                
                
                3,281
                
                
                —
                
                
                15,924At
                    end of year
                
                $
                18,702
                
                $
                1,964
                
                $
                6,265
                
                $
                —
                
                $
                26,931
 
 (1)
          The
          consolidating statement of cash flows for Chattem has been adjusted to
          reflect
          retroactively the change in method of valuing our domestic inventory from
          the
          LIFO to the FIFO method adopted in fiscal 2005.
  85
 
 **(15)** **QUARTERLY
          INFORMATION** ***(Unaudited
          and in thousands, except per share amounts)***
  ******Quarter
                    Ended****Total**
                
                **February
                    28/29**
                
                **May
                    31**
                
                **August
                    31**
                
                **November
                    30**FISCAL
                    2005:Total
                    revenues
                
                $
                279,318
                
                
                71,531
                
                
                75,687
                
                
                68,215
                
                
                63,885Gross
                    profit(1)
                
                $
                199,434
                
                
                51,271
                
                
                54,571
                
                
                49,640
                
                
                43,952Net
                    income (loss)(1)
                
                $
                36,047
                
                
                8,665
                
                
                15,507
                
                
                9,449
                
                
                2,426Net
                    income (loss) per share:Basic(1)(2)
                
                $
                1.83
                
                
                .44
                
                
                .79
                
                
                .48
                
                
                .12Diluted(1)(2)
                
                $
                1.77
                
                
                .42
                
                
                .76
                
                
                .46
                
                
                .12FISCAL
                    2004:Total
                    revenues
                
                $
                258,155
                
                
                61,237
                
                
                70,092
                
                
                66,135
                
                
                60,691Gross
                    profit(3)
                
                $
                184,797
                
                
                44,285
                
                
                49,536
                
                
                47,000
                
                
                43,976Net
                    income (loss)(3)
                    (4)
                
                $
                1,451
                
                
                (712
                )
                
                7,247
                
                
                8,734
                
                
                (13,818
                )Net
                    income (loss) per share:Basic(2)
                    (3) (4)
                
                $
                .07
                
                
                (.04
                )
                
                .38
                
                
                .45
                
                
                (.70
                )Diluted(2)
                    (3) (4)
                
                $
                .07
                
                
                (.04
                )
                
                .36
                
                
                .43
                
                
                (.68
                )
 
 (1) Through
          the performance of our annual inventory control process, we determined
          that we
          did not fully apply manufacturing overhead costs in the first three quarters
          of
          fiscal 2005. As a result cost of sales and promotional expenses were understated
          in these prior quarterly periods.  A
          pre-tax
          adjustment of $1,709 was recorded in the fourth quarter of fiscal 2005
          to
          reflect the proper application of manufacturing overhead during the first
          three
          quarters of fiscal 2005. The adjustment resulted in increases to cost of
          sales
          and promotional expense of $1,242 and $467, respectively, in the fourth
          quarter
          of fiscal 2005.  These
          unapplied overhead costs which totaled $506, $655 and $548 for the first,
          second
          and third quarters, respectively, were not material to these quarters.
 
 (2)
          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 *.*
 
 (3)
          Gross
          profit, net income and net income per diluted share for fiscal 2004 have
          been
          adjusted to reflect retroactively the change in method of valuing our domestic
          inventory from the LIFO to the FIFO method adopted in fiscal 2005.
 
 (4)
          During
          the fourth quarter of fiscal 2004, litigation settlement charges and impairment
          charges related to our *Dexatrim* product
          line of $11,345 and $20,000, respectively, were recorded.
 
 86
  REPORT
          OF
          INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 TO
          THE
          BOARD OF DIRECTORS AND SHAREHOLDERS
 CHATTEM,
          INC.
 
 We
          have
          audited management's assessment, included in the accompanying Management's
          Report on Internal Control Over Financial Reporting, that Chattem, Inc.
          (a
          Tennessee corporation) and subsidiaries did not maintain effective internal
          control over financial reporting as of November 30, 2005, because of the
          effect
          of the material weakness identified in management’s assessment *,* based
          on
          criteria established in Internal Control—Integrated Framework issued by the
          Committee of Sponsoring Organizations of the Treadway Commission (COSO).
          Chattem, Inc.'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. Our responsibility is to express
          an
          opinion on management's assessment and an opinion on the effectiveness
          of the
          company's 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, evaluating management's assessment, testing and evaluating
          the design and operating effectiveness of internal control, and performing
          such
          other procedures as we considered necessary in the circumstances. We believe
          that 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.
 
 A
          material
          weakness is a control deficiency, or combination of control deficiencies,
          that
          results in more than a remote likelihood that a material misstatement of
          the
          annual or interim financial statements will not be prevented or detected.
          The
          following material weakness has been identified and included in management's
          assessment: the Company did not maintain effective internal control over
          its
          quarterly accounting of manufacturing overhead costs.  This material
          weakness was considered in determining the nature, timing, and extent of
          audit
          tests applied in our audit of the 2005 financial statements, and this report
          does not affect our report dated February 17, 2006 on those financial
          statements.
 
 In
          our
          opinion, management's assessment that Chattem, Inc. did not maintain effective
          internal control over financial reporting as of November 30, 2005, is fairly
          stated, in all material respects, based on criteria established in Internal
          Control—Integrated Framework issued by the Committee of Sponsoring Organizations
          of the Treadway Commission (COSO) *.* Also
          in
          our opinion, because of the effect of the material weakness described above
          on
          the achievement of the objectives of the control criteria, the Company
          has not
          maintained effective internal control over financial reporting as of November
          30, 2005, based on criteria established in Internal Control—Integrated Framework
          issued by the Committee of Sponsoring Organizations of the Treadway Commission
          (COSO) *.*
 
 /s/
          GRANT
          THORNTON LLP
 
 
 Charlotte,
          North Carolina
 February
          17, 2006
 
 87
  ***Item
          9. Changes in and Disagreements with Accountants on Accounting and Financial
          Disclosure***
 
 On
          April 20, 2005, the Company, acting upon the recommendation and approval of
          the Audit Committee, dismissed Ernst & Young LLP as the Company’s
          independent registered public accounting firm and engaged
          Grant Thornton LLP to serve as the Company’s new independent
          registered public accounting firm to audit the Company’s financial statements
          for fiscal year 2005.
  The
          reports of Ernst & Young LLP on the Company’s financial statements
          for the two year fiscal period ended November 30, 2004 did not contain an
          adverse opinion or a disclaimer of opinion and were not qualified or modified
          as
          to uncertainty, audit scope or accounting principles. During the two year
          fiscal
          period ended November 30, 2004, there were no disagreements between the
          Company and Ernst & Young LLP on any matter of accounting
          principles or practices, financial statement disclosure or auditing scope
          or
          procedure, which, if not resolved to the satisfaction of
          Ernst & Young LLP, would have caused it to make reference to the
          matter of the disagreement in connection with its reports on the Company’s
          financial statements for such periods. None of the reportable events described
          under Item 304(a)(1)(v) of Regulation S-K occurred within the two year
          fiscal period ended November 30, 2004.
 
 ***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 principal financial officer, we have evaluated the
          effectiveness of our disclosure controls and procedures (as such terms
          are
          defined in Rules 13a-15(e) and 15d-15(e)) under the Securities Exchange
          Act of
          1934, as amended (the “Exchange Act”) as of November 30, 2005 (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. However, as described below under Management’s Report on
          Internal Control over Financial Reporting, we have identified a material
          weakness in our internal control over quarterly financial reporting which
          we
          believe has been remediated with the implementation of a new quarterly
          control
          process.
  On
          November 16, 2005, Richard D. Moss resigned his position as vice president
          and
          chief financial officer, effective December 16, 2005. Robert E. Bosworth,
          president and chief operating officer, who formerly served as our chief
          financial officer from 1985 to 1998, is serving as our principal financial
          officer on an interim basis. Management has assessed the effect of this
          change
          on our disclosure controls and procedures and the completion of our fiscal
          2005
          financial statements. All of the controls that Mr. Moss performed as chief
          financial officer will be performed by Mr. Bosworth. Management believes
          that
          the transition of financial responsibilities will not have any adverse
          effect on
          our disclosure controls and procedures.
  ***Management’s
          Report on Internal Control Over Financial Reporting***
  The
          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.
  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.
  A
          material
          weakness is
          a
          control deficiency, or combination of control deficiencies, that results
          in more
          than a remote likelihood that a material misstatement of the annual or
          interim
          financial statements will not be prevented or detected. The
  88
  Company’s
          management assessed the effectiveness of the Company’s internal control over
          financial reporting as of November 30, 2005 using the criteria set forth
          by the
          Committee of Sponsoring Organizations of the Treadway Commission (COSO)
          in *Internal
          Control-Integrated Framework* .
          Management has concluded that, as a result of the material weakness identified
          below, the Company did not maintain effective internal control over financial
          reporting as of November 30, 2005, based on the criteria in *Internal
          Control-Integrated Framework* issued by
          COSO.
  The
          Company did not maintain effective internal control over its quarterly
          accounting of manufacturing overhead costs. Through the performance of
          the
          Company's established annual inventory control process, management of the
          Company determined that the Company did not fully apply manufacturing overhead
          costs in the first three quarters of fiscal 2005. As a result, cost of
          sales and
          promotional expenses were understated in these prior quarterly periods.
          A
          pre-tax adjustment of $1.7 million was recorded in the fourth quarter of
          2005 to
          reflect the proper application of manufacturing overhead during the first
          three
          quarters of fiscal 2005, resulting in increases to cost of sales and promotional
          expense of $1.2 million and $0.5 million, respectively, in the fourth quarter
          of
          fiscal 2005. These costs were not material to any of the first three quarters
          of
          fiscal 2005. To augment its annual control process, the Company has now
          implemented a quarterly control process that management believes remediates
          this
          material weakness and will ensure that inventory balances will include
          the
          appropriate amounts of overhead costs each quarter.
  The
          Company’s independent registered public accounting firm has issued an
          attestation report on our assessment of the Company’s internal control over
          financial reporting. This report appears on page 87.
  ***Item
          9B. Other Information***
  None
  **PART
          III**
 
 ***Item
          10. Directors and Executive Officers of the
          Registrant***
 
 (a) Directors
 
 The
          information found in our 2006 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 February 17, 2006, their ages and their
          positions
          and offices with the Company:
 
 NAME
                AGE
                POSITION
                    WITH REGISTRANTZan
                    Guerry
                57
                Chairman
                    of the Board and
                  Chief
                    Executive Officer; DirectorRobert
                    E. Bosworth
                58
                President
                    and Chief Operating Officer;
                  DirectorAndrea
                    M. Crouch
                47
                Vice
                    President - Brand ManagementRon
                    Galante
                62
                Vice
                    President - New Business DevelopmentRichard
                    W. Kornhauser
                51
                Vice
                    President - MarketingB.
                    Derrill Pitts
                63
                Vice
                    President - OperationsDonald
                    K. Riker, Ph.D.
                60
                Vice
                    President - Research and Development and Chief Scientific OfficerCharles
                    M. Stafford
                55
                Vice
                    President - SalesTheodore
                    K. Whitfield, Jr.
                41
                Vice
                    President, General Counsel and
                    Secretary
 
 89
 
 *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.
 
 *Richard
          W. Kornhauser* .
          Mr.
          Kornhauser joined us in May 2000 as our vice president-brand management.
          In
          October 2005, he became our vice president-marketing. Prior to joining
          us, Mr.
          Kornhauser served as vice president group marketing director for Combe
          Incorporated, a consumer products company, from October 1990 until May
          2000.
          Previously, he served as a marketing director at Del Laboratories, a consumer
          products company.
 
 *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.
 
 *Donald
          K. Riker, Ph.D.* Dr.
          Riker
          joined us in November 2001 as our vice president-research and development
          and
          chief scientific officer. Prior to joining us, he was employed by
          Richardson-Vicks, Inc., a health and personal care products company, from
          1982
          to 1986 and the Procter & Gamble Co., a consumer products company, from 1986
          to 2001 in various research capacities, the last of which was as P&G
          Corporate Fellow, Personal Health Care.
  *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.
 
 *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 2006 Proxy Statement under the heading “Section 16(a)
          Beneficial Ownership Reporting Compliance” is hereby incorporated by reference.
  90
 
 (d)
                Audit
                    Committee; Audit Committee Financial
                    Expert
 
 The
          information found in our 2006 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.
 91
  ***Item
          11. Executive Compensation***
 
 The
          information found in our 2006 Proxy Statement under the heading “Executive
          Compensation and Other Information” is hereby incorporated by reference.
 
 ***Item
          12. Security Ownership of Certain Beneficial Owners and Management and
          Related
          Stockholder Matters***
 
 The
          information found in our 2006 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 and Related
          Transactions***
 
 The
          information found in our 2006 Proxy Statement under the heading “Executive
          Compensation and Other Information” is hereby incorporated by
          reference.
 
 ***Item
          14. Principal Accountant Fees and Services***
 
 The
          information found in our 2006 Proxy Statement under the headings “Audit
          Committee Pre-Approval of Services by the Independent Auditor” and “Audit and
          Non-Audit Fees” is hereby incorporated by reference.
 
 **PART
          IV**
 
 ***Item
          15. Exhibits, Financial Statement Schedules and Reports on Form
          8-K***
 
 (a)  1.
          Consolidated Financial Statements
 The
          following consolidated financial statements of Chattem, Inc. and Subsidiaries
          are set forth in Item 8 hereof:
 
 Reports
          of
          Independent Registered Public Accounting Firms
 Consolidated
          Balance Sheets as of November 30, 2005 and 2004
 Consolidated
          Statements of Income for the Years Ended November 30, 2005, 2004 and
          2003
 Consolidated
          Statements of Shareholders’ Equity for the Years Ended November 30, 2005, 2004
          and 2003
 Consolidated
          Statements of Cash Flows for the Years Ended November 30, 2005, 2004 and
          2003
 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.
  92
 
 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
                (18)3.2
                Amended
                    and Restated By-Laws of Chattem, Inc.
                (1)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
                     Floating Rate Senior Notes due 2010
                (3)4.3
                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)10.1
                Lease
                    Agreements as amended, datedFebruary
                    1, 1996 between TammyDevelopment
                    Company and Chattem,Inc.
                    for warehouse space at 3100Williams
                    Street, Chattanooga, Tennessee
                (4)
                    and (5)10.2
                First
                    Amended and Restated MasterTrademark
                    License Agreement betweenSignal
                    Investment & Management Co.and 
                    Chattem, Inc., effectiveJune
                    30, 1992
                (6)10.3
                Commercial
                    Lease dated April 1, 1998between
                    Chattem, Inc., lessee, and KencoGroup,
                    Inc., lessor, for warehouse space located
                    at 4309 Distribution Avenue,Chattanooga,
                    Tennessee
                (7)10.4
                Purchase
                    and Sale Agreement datedNovember
                    16, 1998 by and among Thompson  Medical Company, Inc.,  Chattem,
                    Inc. and Signal Investment &  Management Co. for  certain
                     products
                (8)10.5*
                Chattem,
                    Inc. Non-Statutory StockOption
                    Plan- 1998
                (6)10.6*
                1999
                    Stock Plan for Non-Employee Directors
                (25)10.7*
                Chattem,
                    Inc. Non-Statutory Stock Option  Plan -  2000
                (9)
 
 93
  
 Exhibit
                    Number
                  Description
                      of Exhibit
                  References10.8*
                  Chattem,
                      Inc. Stock Incentive Plan - 2003
                  (13)10.9*
                  Chattem,
                      Inc. Stock Incentive Plan - 2005
                  (19)10.10*
                  Form
                      of Stock Option Grant Agreement under  Chattem, Inc. Stock Incentive
                      Plan - 2005
                  (19)10.11*
                  Form
                      of Restricted Stock Agreement under  Chattem, Inc. Stock Incentive
                      Plan - 2005
                  (19)10.12*
                  Form
                      of Amendment to Grant Agreement under  2005 Stock Incentive Plan
                      pertaining only to  officers
                  (22)10.13*
                  Form
                      of Amendment to Grant Agreement under  2005 Stock Incentive Plan
                      pertaining to all  optionees other than officers
                  (22)10.14*
                  Form
                      of Employment Agreements -
                    Zan
                      Guerry
                    A.
                      Alexander Taylor II
                  (10)10.15*
                  Form
                      of Amended and Restated Severance   Agreements-
                    Zan
                      Guerry
                    A.
                      Alexander Taylor II
                  (10)10.16*
                  Form
                      of Amended and Restated Non-Competitionand
                      Severance Agreements-
                    Andrea
                      M. Crouch
                    Ron
                      Galante
                    Richard
                      W. Kornhauser
                    B.
                      Derrill Pitts
                    Don
                      K. Riker
                    Charles
                      M. Stafford
                  (10)10.17*
                  Non-Competition
                      and Severance Agreementdated
                      June 1, 2004 by and between Chattem,Inc.
                      and Theodore K. Whitfield, Jr.
                  (17)10.18*
                  Non-Competition
                      and Severance Agreementdated
                      October 28, 2005 by and betweenChattem,
                      Inc. and Robert E. Bosworth
                  (21)10.19*
                  Form
                      of Restricted Stock Agreements -
                    Zan
                      Guerry
                    A.
                      Alexander Taylor II
                  (11)
  94
  Exhibit
                    Number
                  Description
                      of Exhibit
                  References10.20*
                  Separation
                      Agreement dated August 24, 2005  between Chattem, Inc. and A.
                      Alexander  Taylor II
                  (24)10.21
                  Asset
                      Purchase Agreement dated March 5,  2002  by and between Abbott
                      Laboratories and  Chattem, Inc. for the*Selsun
                      Blue*product line
                  (12)10.22
                  Asset
                      Purchase and Sale Agreement dated  November 30, 2005 by and between
                      Chattem,  Inc., Signal Investment & Management Co., The
                       Mentholatum Company, Inc. and the  Mentholatum Company of
                      Canada Ltd.
                  (23)10.23
                  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)10.24
                  New
                      Commitment Agreement dated March 9, 2004 between Chattem, Inc. and
                      Bank of  America, N.A., as administrative agent
                  (15)10.25
                  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
                  (20)10.26
                  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
                  (20)10.27
                  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
                  (22)10.28
                  Rate
                      Cap Transaction Agreement dated March  8, 2004 betweenChattem,
                      Inc. and JP Morgan  Chase Bank
                  (15)
 
 10.29
                First
                    Amendment to the Second Amended and  Restated Master Trademark
                    License  Agreement between Signal Investment &  Management
                    Co. and Chattem, Inc. effective  May 31, 2003
                (14)10.30
                First
                    Amendment to Master Trademark License  Agreement between Signal
                    Investment &  Management Co. and SunDex, LLC, effective  May
                    31, 2003
                (14)
 
 95
 
 Exhibit
                    Number
                  Description
                      of Exhibit
                  References10.31
                  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
                  (13)10.32
                  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
                  (15)10.33
                  Initial
                      Settlement Trust Agreement dated April  12, 2004 between Chattem,
                      Inc. and Amsouth  Bank
                  (15)10.34
                  Final
                      Settlement Trust Agreement between Chattem, Inc. and AmSouth
                      Bank dated
                      March 16, 2005
                  (20)10.35
                  Settlement
                      Agreement dated April 26, 2004  between Chattem, Inc. and General
                      Star  Indemnity Company
                  (15)10.36
                  Memorandum
                      of Understanding dated  December 13, 2003 between and among
                       Chattem, Inc. and Kemper Indemnity Insurance
                       Company
                  (15)10.37
                  Settlement
                      Agreement dated December 30,  2003 between Chattem, Inc. and Admiral
                       Insurance Company
                  (15)10.38
                  Settlement
                      Agreement dated July 14, 2004  between Chattem, Inc. and Sidmak
                       Laboratories
                  (16)10.39
                  *Dexatrim*Case Scoring System and Matrix for  the Chattem*Dexatrim*Class Action Settlement
                  (16)10.40
                  Settlement
                      and Coverage-In-Place Agreement  between Interstate Fire &
                      Casualty Company  and Chattem, Inc. effective March 18,
                      2005
                  (20)10.41
                  Settlement
                      Agreement dated as of June 30,  2005 by and between Chattem, Inc. and
                      The  DELACO Company
                  (19)10.42*
                  Summary
                      Description of Incentive  Compensation Plan18
                  Preferability
                      Letter from the Company’s Independent Registered Public Accounting
                      Firm21
                  Subsidiaries
                      of the Company
  96
  Exhibit
                    Number
                  Description
                      of Exhibit
                  References23.1
                  Consent
                      of Independent Registered Public  Accounting Firm23.2
                  Consent
                      of Ernst & Young LLP
 31.1
                Certification
                    required by Rule 13a-14(a) under  the Securities Exchange
                    Act31.2
                Certification
                    required by Rule 13a-14(a) under the Securities Exchange
                    Act
 
 32
                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
                        10-K for the year ended November 30,
                        1995.
  (5)
                    Form
                        10-K for the year ended November 30,
                        1996.
  (6)
                    Form
                        10-K for the year ended November 30,
                        1997.
  (7)
                    Form
                        10-K for the year ended November 30,
                        1998.
  (8)
                    Form
                        8-K filed December 28,
                        1998.
  (9)
                    Form
                        10-K for the year ended November 30,
                        1999.
  (10)
                Form
                    10-K for the year ended November 30,
                    2000.
  (11)
                Form
                    10-K for the year ended November 30,
                    2001.
  (12)
                Form
                    8-K filed April 10, 2002, as
                    amended.
  (13)
                Form
                    10-K for the year ended November 30, 2003.
  (14)
                Form
                    10-Q filed for the quarter ended May 31,
                    2003.
  (15)
                Form
                    10-Q filed for the quarter ended May 31,
                    2004.
  97
  (16)
                Form
                    10-Q filed for the quarter ended August 31,
                    2004.
  (17)
                Form
                    10-K for the year ended November 30,
                    2004.
  (18)
                Schedule
                    14A filed March 4, 2005.
  (19)
                Form
                    10-Q filed for the quarter ended May 31,
                    2005.
  (20)
                Form
                    10-Q filed for the quarter ended February 28,
                    2005.
  (21)
                Form
                    8-K filed November 3, 2005.
  (22)
                Form
                    8-K filed December 2, 2005.
  (23)
                Form
                    8-K filed December 5, 2005.
  (24)
                Form
                    8-K/A filed August 31, 2005.
  (25)
                Schedule
                    14A filed March 8, 1999.
 
 (b)
          The
          following reports on Form 8-K were filed with the Securities and Exchange
          Commission during the three months ended November 30, 2005:
  Form
                    8-K, filed September 13, 2005, announcing our expected financial
                    results
                    for the third quarter ended August 31,
                    2005.
  Form
                    8-K, filed September 19, 2005, announcing our financial results
                    for the
                    third quarter ended August 31,
                    2005.
  Form
                    8-K, filed on November 3, 2005, announcing our entry into and
                    the terms of
                    a non-competition and severance agreement dated October 28, 2005
                    with
                    Robert E. Bosworth.
  Form
                    8-K, filed on November 10, 2005, announcing that Ruth W. Brinkley
                    has
                    joined our board of directors.
  Form
                    8-K, filed on November 22, 2005, announcing the resignation of
                    Richard D.
                    Moss as our vice president and chief financial officer effective
                    December
                    16, 2005.
 
 98
 
 **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:
                  February 17, 2006
                By:
                /s/ Zan
                  GuerryZan
                  GuerryChairman
                  and Chief Executive Officer
 By:
                /s/ Robert
                  E.
                  BosworthRobert
                  E. BosworthPresident
                  and
                  Chief Operating 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
                Zan
                  Guerry
              Chairman
                  of the Board
                and
                  Director
                (Chief
                  Executive Officer)
              2-17-06/s/
                  Robert E. Bosworth
                Robert
                  E. Bosworth
              President
                  and Director
                (Chief
                  Operating Officer)
              2-17-06/s/
                  Samuel E. Allen
                Samuel
                  E. Allen
              Director
              2-17-06/s/
                  Ruth W. Brinkley
                Ruth
                  W. Brinkley
              Director
              2-17-06/s/
                  Richard E. Cheney
                Richard
                  E. Cheney
              Director
              2-17-06/s/
                  Bill W. Stacy
                Bill
                  W. Stacy
              Director
              2-17-06/s/
                  Philip H. Sanford
                Philip
                  H. Sanford
              Director
              2-17-06
  99
  
 
 **CHATTEM,
        INC. AND SUBSIDIARIES**
 **EXHIBIT
        INDEX**
 
 
 **EXHIBIT**
                **NUMBER**
              **DESCRIPTION
                  OF EXHIBIT**10.42
              Summary
                  Description of Incentive Compensation Plan18
              Preferability
                  Letter from the Company’s Independent Registered Public Accounting
                  Firm21
              Subsidiaries
                  of the Company23.1
              Consent
                  of Independent Registered Public Accounting Firm23.2
              Consent
                  of Ernst & Young LLP31.1
              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
  100