**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, 2006**
 
 **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
            þ**     **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
þ**
  **Indicate
            by check mark whether the registrant (1) has filed all reports required
            to be
            filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
            the
            preceding 12 months, and (2) has been subject to such filing requirements
            for
            the past 90 days.** **YES
            þ**  **NO** 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.þ**
 
 **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  þ**
                  **Accelerated
                      filer**o
                  **Non-accelerated
                      filer**o
 ********
 **Indicate
            by check mark whether the registrant is a shell company (as defined in
            rule
            12b-2 of the Act).** **YES** o  **NO 
            þ** ****
  **As
              of May 31, 2006, the aggregate market value of voting and non-voting
              shares held
              by non-affiliates was $656,381,284. 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 1, 2007, 18,670,612 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 11, 2007 (the “2007 Proxy Statement”) are
            incorporated by reference in Part III of this Form 10-K.**
  
 1
 **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, 2004, November 30, 2005 and
              November
              30, 2006 are referred to as fiscal 2004, fiscal 2005 and fiscal 2006,
              respectively, and our fiscal year ending on November 30, 2007 is referred
              to as
              fiscal 2007. Brand names that are italicized in this Form 10-K refer
              to
              trademarks that we own or license.
 
 ***General***
 
 Founded
              in 1879, we are a leading marketer and manufacturer of a broad portfolio
              of
              branded over-the-counter (“OTC”) healthcare products, toiletries and dietary
              supplements, in such categories as topical pain care, medicated skin
              care
              products, medicated dandruff shampoos, dietary supplements and other
              OTC and
              toiletry products. Our portfolio of products includes well-recognized
              brands
              such as:
 
 •
                    *Icy
                        Hot,**Aspercreme*and*Capzasin*-
                        topical pain care;
  •
                    *Gold
                        Bond -*medicated skin care products;
 
 •
                    *Selsun
                        Blue*and*Selsun
                        Salon -*medicated dandruff shampoos;
 
 •
                    *Dexatrim,
                        Garlique*and*New
                        Phase -*dietary
                        supplements;
 
 •
                    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 sunscreens;*UltraSwim,*a
                        chlorine-removing shampoo;*Sun-In*,
                        a
                        hair lightener.
 
 Our
              products target niche markets that are often outside the focus of larger
              companies where we believe we can achieve and sustain significant market
              share
              through innovation and strong advertising and promotion support. Many
              of our
              products are among the U.S. market leaders in their respective categories.
              For
              example, our portfolio of topical pain care 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 32%
              of our total
              revenues in fiscal 2006. 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 *Bullfrog
              Mosquito Coast, Gold Bond Ultimate* Softening Lotion and *Icy
              Hot*  *Pro-Therapy* knee and
              back support with therapeutic pain relieving inserts. On January 2,
              2007, we
              acquired the U.S. rights to five consumer and OTC brands for $410 million
              from
              Johnson & Johnson (“J&J Acquisition”). The acquired brands are: *ACT* ,
              an
              anti-cavity mouthwash/mouth rinse; *Unisom* ,
              an OTC
              sleep-aid; *Cortizone* ,
              a
              hydrocortisone anti-itch product; *Kaopectate* ,
              an
              anti-diarrhea product; and *Balmex* ,
              a
              diaper rash product. We will continue to seek opportunities to acquire
              attractive brands in niche markets. 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 27 brands in a variety
              of
              different product categories, including topical pain care, medicated
              dandruff
              shampoos, medicated skin care products, toiletries and dietary supplements.
              Our
              products are marketed under well-recognized brand names, such as our
              portfolio
              of topical pain care brands *lcy
              Hot, Aspercreme, Flexall* , *Sportscreme* , *Capzasin* and *Arthritis
              Hot* ,
              as well
              as *Gold
              Bond* , *Selsun
              Blue, Dexatrim* and *Garlique* .
              The
              brand names added to our portfolio from the J&J Acquisition are *ACT* , *Unisom,
              Cortizone, Kaopectate* and *Balmex* .
              Our
              presence in diverse product categories reduces our exposure to changing
              consumer
              demand or weakness in any single category.
 
 ***Significant
              presence in niche markets.*** We
              acquire and develop brands that compete in small to medium sized niche
              markets
              where we believe we can achieve significant market presence and build
              brand
              equity. Our products often face less
  2
 competitive
              pressures because we focus on these markets that are frequently outside
              the core
              product areas of larger consumer products and pharmaceutical companies.
              This
              focus provides us with the opportunity to develop strong brand equity,
              identify
              and respond to consumer trends and leverage our strong selling and
              distribution
              capabilities in these markets.
 
 ***High
              margins and efficient operating structure.*** We are
              able to achieve high gross margins as a result of our ability to build
              and
              maintain brand equity, our significant market presence in niche markets
              and
              efficiencies in purchasing, manufacturing and distribution. In addition,
              we seek
              to tightly control our expenses, which strengthens our operating margins.
              Our
              high margins and resulting strong cash flow allow us to withstand temporary
              fluctuations in our product markets that could have adverse effects
              on our
              business.
 
 ***Proven
              advertising and promotion strategy.*** We
              aggressively build awareness and consumer loyalty of our brands through
              extensive and cost-effective advertising strategies that emphasize
              the
              competitive strengths of our products. We rely principally on television
              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 through control of our production
              costs. We also maintain the flexibility to allocate purchased media
              time among
              our key brands to respond quickly to changing consumer trends and to
              support our
              growing brands. We believe our well-developed advertising and promotion
              platform
              allows us to quickly and efficiently launch and support newly acquired
              brands
              and product line extensions as well as increase market penetration
              of existing
              brands. Advertising and promotion expenditures represented approximately
              32% of
              our total revenues in fiscal 2006. 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 2006, sales to our top ten customers
              constituted approximately 73% 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 2006 sales to Wal-Mart Stores, Inc. accounted for
              approximately 36% of our total revenues. Through targeted sales and
              utilization
              of our established network, including our approximately 43 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 2006, our
              product
              development expenditures were $4.2 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
              product
              line extensions include *Bullfrog Mosquito Coast* , *Gold
              Bond Ultimate* Softening Lotion and *Icy
              Hot*  *Pro-Therapy* .
              In
              fiscal 2006, we introduced eight new product line extensions and have
              eight new
              product launches scheduled for fiscal 2007.
 
 ***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 seek
              to increase market share for our major brands through focused marketing
              of our
              existing products and product line extensions while maintaining market
              share for
              our smaller brands. Our marketing strategy is to position our products
              to meet
              consumer preferences identified through extensive use of market and
              consumer
              research. We intend to channel advertising and promotion resources
              to those
              brands that we feel exhibit the most potential for growth. We also
              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 construction of a research and product development facility
              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. On January 2, 2007, we completed
              the
              J&J Acquisition and acquired the U.S. rights to the following
  3
 five
              OTC
              brands: *ACT* ,
              an
              anti-cavity mouthwash/mouth rinse; *Unisom* ,
              an OTC
              sleep-aid; *Cortizone* ,
              a
              hydrocortisone anti-itch product; *Kaopectate* ,
              an
              anti-diarrhea product; and *Balmex* ,
              a
              diaper rash product. We will continue to seek opportunities to acquire
              attractive brands in niche markets.
 
 ***Developments
              During Fiscal 2006***
 
 In
              the
              first quarter of fiscal 2006, we introduced or completed the introduction
              of the
              following product line extensions: *Icy
              Hot Pro-Therapy* , *Selsun
              Salon,*  *Bullfrog*  *Mosquito
              Coast* , *Garlique
              CardioAssist* , *Capzasin* Back
& Body Patch and *Pamprin* Max. In
              the second quarter of fiscal 2006, we introduced *Dexatrim* Max 2 O. *Gold
              Bond Ultimate* Softening
              Lotion was introduced in the fourth quarter of 2006.
 
 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 repayment at 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 (see Note 5 of the notes to consolidated financial statements
              in
              Item 8 “Financial
              Statements and Supplementary Data”).
              As a result of
              the redemption, a loss on early extinguishment of debt of $2.8 million
              was
              recorded in the first quarter of fiscal 2006.
 
 Over
              the
              past two years, we have resolved all of the claims submitted in the *Dexatrim* PPA
              settlement. A total of $70.9 million was previously funded into a settlement
              trust by our insurers and Sidmak Laboratories, Inc., the manufacturer
              of *Dexatrim* products
              containing PPA, for the purpose of paying claims in the settlement.
              All claims
              in the settlement and expenses of the trust have now been paid. On
              June 14,
              2006, we filed a motion to dissolve the settlement trust. The court
              granted this
              motion on July 14, 2006. On August 31, 2006, the settlement trust paid
              us $10.7
              million which is included as a component of litigation settlement in
              our
              condensed consolidated statement of income. The settlement trust currently
              has a
              balance of approximately $2.8 million. We expect to use those funds
              to resolve
              the one pending *Dexatrim* PPA case
              which opted out of the settlement. Any funds remaining after we resolve
              the
              opt-out case will be returned to one of our insurance carriers. We
              currently do
              not expect to record any additional charges relative to the settlement
              of the
              PPA litigation, except for legal expenses that will be recorded in
              the period
              incurred.
 
 During
              the 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”). The DELACO Agreement was
              approved by the DELACO bankruptcy court on July 28, 2005. Pursuant
              to the DELACO
              Agreement, we agreed to assume responsibility for all claims against
              DELACO and
              its predecessor, Thompson Medical Company, Inc., or us relating to *Dexatrim* products
              involving an injury date after December 21, 1998 and hold the DELACO
              bankruptcy
              estate harmless from any such claims. In exchange, a settlement trust
              to be
              established under DELACO’s bankruptcy plan agreed to pay us $8.8 million and
              assume responsibility for all claims related to *Dexatrim* products
              alleging injury dates on or before December 21, 1998. On February 17,
              2006, the
              DELACO bankruptcy court entered an order confirming the DELACO bankruptcy
              plan
              which incorporated the terms of the DELACO Agreement. In accordance
              with the
              DELACO bankruptcy plan, the settlement trust established under the
              plan paid us
              $8.75 million on March 17, 2006, which is included as a component of
              litigation
              settlement in our consolidated statement of income. In addition, this
              order
              allowed us to dismiss all cases against us with injury dates prior
              to December
              21, 1998. The confirmation of the DELACO bankruptcy plan effectively
              released us
              from liability for all PPA products liability cases with injury dates
              prior to
              December 21, 1998.
 
 On
              July
              25, 2006, we successfully completed a consent solicitation from the
              holders of
              our 7% Subordinated Notes to an amendment to the indenture to increase
              our
              capacity to make restricted payments by an additional $85.0 million,
              including
              payments for the repurchase of our common stock, and adjust the fixed
              charge
              coverage ratio as defined in the indenture. In connection with the
              consent
              solicitation, our Board of Directors authorized the repurchase of up
              to an
              additional $100.0 million of our common stock under the terms of our
              existing
              stock repurchase program. As of February 1, 2007, the current amount
              available
              under the repurchase authorization from our Board of Directors was
              $88.1
              million.
 
 On
              November 22, 2006, we completed a private offering of $125.0 million
              of 2.0%
              Convertible Senior Notes due 2013 (“Convertible Notes”), the proceeds of which
              were used to fund a convertible note hedge transaction designed to
              offset our
              exposure to dilution upon conversion of the Convertible Notes, repay
              existing
              indebtedness and fund in part the J&J Acquisition. The Convertible Notes
              bear interest at an annual rate of 2.0%, payable semi-annually on May
              15 and
              November 15 of each year, with the first interest payment due on May
              15, 2007.
              Concurrently with the sale of the Convertible Notes, we purchased a
              note hedge
              for $32.0 million and issued warrants for proceeds of $18.6 million
              with an
              affiliate of Merrill Lynch (the “Counterparty”). The note hedge and warrants are
              separate and legally distinct instruments that bind us and the Counterparty
              and
              have no binding effect on the holders of the Convertible Notes.
 
 4
 Based
              on *Icy
              Hot Pro-Therapy* performing below expectations, a review of point of sales data throughout
              fiscal
              2006, an estimate of inventory on hand at customers and a review of
              our on hand
              inventory and purchase commitments outstanding as of November 30, 2006,
              during
              the fourth fiscal quarter we provided for an estimate of returns of
              $3.3 million
              and an estimate of obsolete inventory of $2.0 million, which reduced
              net sales
              and increased cost of sales, respectively, in our consolidated financial
              statements as of November 30, 2006.
 
 During
              fiscal 2006, we repurchased 1.2 million shares of our common stock
              under our
              stock repurchase program for $39.3 million at an average price per
              share of
              $33.57.
 
 On
              January 2, 2007, we completed the J&J Acquisition, which added the following
              five brands: *ACT* ,
              an
              anti-cavity mouthwash/mouth rinse; *Unisom* ,
              an OTC
              sleep aid; *Cortizone* ,
              a
              hydrocortisone anti-itch product; *Kaopectate,* an
              anti-diarrhea product; and *Balmex* ,
              a
              diaper rash product. On January 2, 2007, we also completed an amended
              credit
              facility providing for up to a $100.0 million revolving credit facility
              and a
              $300.0 million term loan (the “Credit
              Facility”).
              The proceeds from the term loan under the Credit Facility were used
              to finance
              in part the J&J Acquisition.
  ***Products***
 
 We
              currently market a diverse and broad portfolio of branded OTC healthcare
              products, toiletries and dietary supplements in such categories as
              topical pain
              care, 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
                        Pain Care****Icy
                        Hot*
                    Dual
                        action muscular and arthritis pain reliever*Icy
                        Hot Pro-Therapy*
                    Elastic
                        support braces and pain relieving inserts*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*Cortizone*
                    Hydrocortisone
                        anti-itch*Balmex*
                    Diaper
                        rash***Medicated
                        Dandruff Shampoos****Selsun
                        Blue*
                    Medicated
                        dandruff shampoos*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
                        sunscreens*Sun-In*
                    Spray-on
                        hair lightener*UltraSwim*
                    Chlorine-removing
                        shampoo and conditioner
  5
 ***Oral
                        Care****ACT*
                    Anti-cavity
                        mouthwash/mouth rinse*Herpecin-L*
                    Cold
                        sore lip treatment*Benzodent*
                    Denture
                        pain relief cream***Other****Unisom*
                    OTC
                        sleep-aid*Kaopectate*
                    Anti-diarrhea*Mudd*
                    Facial
                        masque
 
 ***Topical
              Pain Care***
 
 Our
              topical pain care portfolio features six distinctly positioned brands.
              Our
              flagship brand, *Icy
              Hot* ,
              is a
              leader in the external analgesic category and receives heavy media
              support and
              strong advertising featuring NBA super-star Shaquille O’Neal.
              In fiscal
              2006, we introduced *Icy
              Hot Pro-Therapy* ,
              a
              product line which combines strong knee or back support with therapeutic
              pain
              relieving inserts. In the first quarter of fiscal 2007, we extended
              the *Icy
              Hot* brand
              into the air activated portable heat category with *Icy
              Hot* Heat
              Therapy. *Icy
              Hot* will
              also be introducing new patch and cream line extensions in fiscal 2007
              that are
              intended to capitalize on consumer trends.
 
 *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 for arthritis sufferers. In the first
              quarter
              of 2007, we will launch a new no-mess applicator under the *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 competes against private label products at a
              value
              price.
 
 ***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 the fourth quarter of fiscal 2006, we introduced *Gold
              Bond Ultimate* Softening Lotion. The new Ultimate Softening lotion is specially formulated
              to
              soften rough dry skin.
 
 As
              part
              of the J&J Acquisition on January 2, 2007, we have added two new brands to
              the medicated skin care category: *Cortizone-10,* a hydrocortisone anti-itch product, and *Balmex,*a diaper
              rash product.
 
 ***Medicated
              Dandruff Shampoos***
 
 *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 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. **
 
 6
 ***Dietary
              Supplements***
 
 *Dexatrim* is a
              leading brand in the diet pill category. *Dexatrim* experienced
              strong growth in fiscal 2006 behind *Dexatrim
              Max* and the
              newly ** introduced *Dexatrim
              Max* *2* *O* . *Dexatrim
              Max* was
              introduced in fiscal 2005 and contains Vitamin B complex, ginseng,
              chromium and
              ECGC from green tea. In fiscal 2007, we plan to launch *Dexatrim
              Max* Evening
              Appetite Control, a caffeine-free diet pill intended for night time
              use. *Dexatrim* Natural,
              a drug free, all-natural dietary supplement, is available in green
              tea,
              caffeine-free and extra energy versions. In fiscal 2006, we launched
              a unique
              new diet product, *Dexatrim* Max 2 O. *Dexatrim* Max 2 O,
              an
              effervescent tablet that dissolves in water, contains a Vitamin B complex
              and
              ECGC from green tea and is now available in four flavors.
  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 launched 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. *Pamprin* is
              available in three formulas: Multi-Symptom, Cramp and All Day. In fiscal
              2006, *Pamprin*  *Max* was
              added to the line. *Pamprin*  *Max* is
              formulated with three active ingredients to provide maximum relief
              from
              menstrual symptoms.
 
 *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 targeted to outdoor
              active
              children and adults. In fiscal 2006, we launched *Bullfrog* *Mosquito
              Coast*, which combines SPF 30 sunblock with a DEET-free insect repellent
              in
              a convenient spray form. In the first quarter of fiscal 2007, we will
              launch *Bullfrog* Marathon
              Mist. This new product available in an adult and children’s version combines
              quick-drying SPF 30 sunblock in a continuous spray format.
 
 *Sun-In* ,
              a hair
              lightener, is available in two varieties of spray-on and a highlighting
              gel. In
              2007, *Sun-In* will
              introduce an updated package design for its spray-on products. *UltraSwim* is our
              niche line of swimmers’ shampoos and conditioner.
 
 *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. *Herpecin-L* is
              available in a stick and a jar format. With the J&J Acquisition completed
              January 2, 2007, we have added *ACT* ,
              a line
              of anti-cavity mouthwash and mouth rinses.
 
 *Other*
 
 Our
              other
              brands include *Mudd,* a
              line of
              specialty masque products, and a variety of other smaller brands. In
              connection
              with the J&J Acquisition on January 2, 2007, we also added the *Unisom* and *Kaopectate* brands *.
              Unisom* is the
              leading single ingredient brand in the OTC sleep aid category. *Kaopectate* is a
              well established anti-diarrheal remedy.
 
 7
 ***International
              Business***
 
 Our
              international business, which represented approximately 8% of our total
              revenues
              in fiscal 2006, 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
              distributors and receive a royalty based on a percentage of distributor
              sales.
              We have entered into distributor agreements with third party distributors
              for *Selsun* in
              various international markets other than Canada and the U.K., where
              we engage
              national brokers.
 
 ***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, Icy Hot, Aspercreme, Capzasin* and *Sportscreme* into
              these markets.
 
 
 ***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 32% of total revenues in fiscal 2006.
 
 We
              seek
              to increase market share for our major brands through focused marketing
              of our
              existing products and product line extensions while maintaining market
              share for
              our smaller brands. Our marketing strategy is to position our products
              to meet
              consumer preferences identified through extensive use of market and
              consumer
              research. We intend to channel advertising and promotion resources
              to those
              brands that we feel exhibit the most potential for growth. We rely
              principally
              on television 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
  8
 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 food retailers such as The Kroger
              Co. In
              fiscal 2006, our ten largest customers represented approximately 73%
              of total
              revenues, and our 20 largest customers represented approximately 84%
              of total
              revenues, which allows us to target our selling efforts to our key
              customers and
              customize programs to meet their needs. Our fiscal 2006 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 2006. 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
              43 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
              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 third
              party
              common carriers to transport our products. We do not generally experience
              wide
              variances in the amount of inventory we maintain. At present, we have
              no
              significant backlog of customer orders and are promptly meeting customer
              requirements.
 
 ***Manufacturing
              and Quality Control***
 
 During
              fiscal 2006, we manufactured 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, *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.
 
 
 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*
  9
 products
              represented approximately 4% of our consolidated total revenues in
              fiscal 2006.
              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
              emphasis on new product development as evidenced by our increased research
              and
              development spending, the expansion of our product development staff
              and our
              10,000 square foot research and product development facility. We currently
              employ approximately 28 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
              $4.2 million in fiscal 2006 and $3.6 million in fiscal 2005.
 
 ***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.
 
 
 ***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 2006, 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,* and the
              newly acquired brands *ACT,*  *Unisom* and *Cortizone* .
 
 Our
              principal brand names are registered trademarks in the United States
              and certain
              foreign countries. We maintain or have applied for patent and copyright
              protection in the United States relating to certain of our existing
              and proposed
              products and processes. We also license from third parties other intellectual
              property that is used in certain of our products. The sale of these
              products
              relies on our ability to maintain and extend our supply and licensing
              agreements
              with these third parties.
  ***Government
              Regulation***
  The
              U.S.
              manufacturing, distribution, processing, formulation, packaging, labeling
              and
              advertising of our products are subject to regulation by federal agencies,
              including, but not limited to:
  **·**
                    the
                        Food & Drug Administration (the
“FDA”);
 **·**
                    the
                        Federal Trade Commission (the
“FTC”);
 **·**
                    the
                        Drug Enforcement Administration (the
“DEA”);
 **·**
                    the
                        Consumer Product Safety Commission (the
“CPSC”);
 **·**
                    the
                        United States Postal Service;
 **·**
                    the
                        Environmental Protection Agency (“EPA”);
                        and
 **·**
                    the
                        Occupational Safety and Health Administration
                        (“OSHA”).
  10
 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.
              In
              foreign countries these same activities may be regulated by Ministries
              of
              Health, or other local regulatory agencies; the manner in which they
              are
              registered, or how they are formulated, or what claims may be permitted
              may
              differ from similar products and practices in the U.S.
 
 Under
              the
              Federal Food, Drug, and Cosmetic Act (“FDC Act”) all “new drugs”, including OTC
              products, are subject to pre-market approval by the FDA under the new
              drug
              application (“NDA”) process. The FDC Act defines a “new drug” as a drug that is
              not generally recognized among scientifically qualified experts as
              safe and
              effective for use under the conditions stated in its labeling. A drug
              might also
              be considered new if it has not been used, outside of clinical investigations,
              to a material extent or for a material time under conditions described
              for a
              product. A drug that is generally regarded as safe and effective is
              not a “new
              drug” and therefore does not require pre-market approval.
  The
              FDA
              has adopted an administrative process, the OTC Drug Review, to determine
              which
              active ingredients and indications are safe and effective for use in
              OTC
              products. With the aid of independent expert advisory review panels,
              the FDA
              develops rules, referred to as “monographs”, 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
              monographs in that they establish conditions under which OTC drugs
              can be
              marketed for certain uses without FDA pre-marketing approval. The FDA
              generally
              does not take enforcement action against an OTC drug subject to a tentative
              final monograph unless there is a safety problem or a substantial effectiveness
              question.
  The
              majority of our OTC drug products are regulated pursuant to the FDA
              monograph
              system with the exception of *Pamprin* All Day,
              the subject of an abbreviated NDA held by The Perrigo Company and the
              newly
              acquired *Unisom* SleepTabs, the subject of an approved NDA now held by Chattem. 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 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
              (“Perrigo”) 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 **
  11
 *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, we have 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 4% of our consolidated total revenues in
              fiscal
              2006.
  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 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 began shipping in February,
              2006.
 
 We
              are
              also aware of the FDA’s concern about the potential toxicity due to concomitant
              use of OTC and prescription products that contain the analgesic ingredient
              acetaminophen, an ingredient also found in *Pamprin* and ** *Prēmsyn* *PMS* . We are
              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 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 8% of our consolidated total revenues in
              fiscal
              2006.
  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-2008 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*
  12
 *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 12% of our consolidated total revenues
              in
              fiscal 2006.
  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* Heat
              Therapy *,
              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, and *Icy
              Hot Heat Therapy* are
              subject to regulations which exempt them from the 510(k) pre-market
              notification
              requirements. 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
  13
 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 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
              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 the 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 the FDA in its sunscreen monograph, but the insect repellent,
              IR-3535, and its labeling, require pre-market safety and
  14
 efficacy
              testing and approval by the EPA and all 50 states (and U.S.
              Territories). *Bullfrog*  *Mosquito
              Coast* received
              approval from all states and the EPA prior to launch. Further, the
              FDA 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 the FDA might grandfather existing products
              or otherwise
              allow time for their compliance.
  Our
              business is also regulated by the California Safe Drinking Water and
              Toxic
              Enforcement Act of 1986, known as Proposition 65. Proposition 65 prohibits
              businesses from exposing consumers to chemicals that the state has
              determined
              cause cancer or reproduction toxicity without first giving fair and
              reasonable
              warning unless the level of exposure to the carcinogen or reproductive
              toxicant
              falls below prescribed levels. From time to time, one or more ingredients
              in our
              products could become subject to an inquiry under Proposition 65. If
              an
              ingredient is on the state’s list as a carcinogen, it is possible that a claim
              could be brought, in which case we would be required to demonstrate
              that
              exposure is below a “no significant risk” level for consumers. Any such claims
              may cause us to incur significant expense, and we may face monetary
              penalties or
              injunctive relief, or both, or be required to reformulate our product
              to
              acceptable levels. The State of California under Proposition 65 is
              also
              considering the inclusion of titanium dioxide on the state’s list of suspected
              carcinogens. Titanium dioxide has a long history of widespread use
              as an
              excipient in prescription and OTC pharmaceuticals, cosmetics, dietary
              supplements and skin care products and is an active ingredient in
              our *Bullfrog* Superblock products. We have participated in an industry-wide submission
              to the
              State of California, facilitated through CHPA, presenting evidence
              that titanium
              dioxide presents “no significant risk” to consumers.
  Finally,
              the FDA regulates the quality of all finished drug, medical device,
              and food
              products under GMP’s. As part of its regulatory authority, the FDA may
              periodically conduct audits of the physical facilities, machinery,
              processes and
              procedures that we, or our suppliers, use to manufacture products.
              The FDA may
              perform these audits at any time without advanced notice. In February
              2006, we
              registered as a medical device manufacturer with the FDA in connection
              with our
              sale of *Pro-Therapy* products. 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 GMP’s 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 EPA has primary
              jurisdiction
              over insect repellants and combination insect repellant products containing
              sunscreens, such as *BullFrog
              Mosquito Coast* .
              Both
              products and manufacturing establishments must be registered with EPA.
              The FDA
              has published notice that a monograph regulating combination insect
              repellants
              and sunscreens will be issued during 2007. This new monograph may change
              the
              regulatory enforcement jurisdiction from the EPA to the FDA.
 
 15
 The
              handling, disposal, and environmental exposure of the insect repellent,
              IR-3535,
              is strictly regulated by the EPA under the Clean Waters Act. Any failure
              to
              comply with applicable regulations with respect to the use of IR-3535
              might
              result in EPA action against us, including fines or injunctive
              action.
  ***Employees***
 
 We
              employ
              approximately 423 persons on a full-time basis and eight persons on
              a part-time
              basis in the United States. In addition, we employ approximately 24 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.
 
 ***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 not be able to successfully integrate the five brands acquired
              in the
              J&J Acquisition into our portfolio of consumer brands or achieve other
              synergies associated with the acquisition.**
  In
              connection with the completion of the J&J Acquisition, we acquired the U.S.
              rights to the following five brands: *ACT* , *Unisom,
              Cortizone, Kaopectate* and *Balmex.* The
              integration of these acquired brands into our existing business involves
              a
              number of risks and presents significant financial, operational and
              managerial
              challenges. Failure to successfully integrate the new brands into our
              business
              may have a material adverse effect on our business, results of operation,
              financial condition, cash flow or the trading price for our common
              stock or the
              trading price and liquidity of the Convertible Notes.
 
 **We
              have a significant amount of debt that could adversely affect our business
              and
              growth prospects.**
 
 As
              of
              November 30, 2006, our total long-term debt was $232.5 million. Additionally,
              on
              January 2, 2007, we completed an amended credit facility providing
              for up to a
              $100.0 million revolving credit facility and a $300.0 million term
              loan. The
              proceeds from the term loan were used to finance in part the J&J
              Acquisition. 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.
 
 16
 **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.
  **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
              manufacture 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 $25.0 million of coverage through
              our captive
              insurance subsidiary, of which approximately $6.6 million is funded
              as of
              February 1, 2007. We also have an additional $20.0 million of excess
              coverage
              through a third party reinsurance policy, which excludes coverage for
              any future
              claims involving *Dexatrim* products
              containing ephedrine. 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 (including the five brands acquired in
              the J&J
              Acquisition) 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
              a third party reinsurance policy that provides coverage for product
              liability
              claims. Our product liability insurance coverage for all of our products,
              including *Dexatrim* products
              containing ephedrine, consists of $25.0 million of coverage through
              our captive
              insurance subsidiary, of which approximately $6.6 million is funded
              as of
              February 1, 2007, and an additional $20.0 million of excess coverage
              through a
              third party reinsurance policy, which excludes coverage for any future
              claims
              involving *Dexatrim* products
              containing ephedrine.
 
 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
  17
 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. Also,
              the
              addition of five new brands to our consumer products portfolio following
              the
              completion of the J&J Acquisition may result in increased insurance
              costs.
 
 **Our
              acquisition strategy is subject to risk and may not be
              successful.**
 
 A
              component of our growth strategy depends on our ability to successfully
              execute
              acquisitions, which involves numerous risks including:
 
 •
                    not
                        accurately identifying suitable products or brands for
                        acquisition;
 
 •
                    difficulties
                        in integrating the operations, technologies and manufacturing
                        processes of
                        the acquired products;
 
 •
                    the
                        diversion of management’s attention from other business concerns;
                        and
 
 •
                    incurring
                        substantial additional
                        indebtedness.
  Any
              future acquisitions, or potential acquisitions, may result in substantial
              costs,
              disrupt our operations or materially adversely affect our operating
              results.
 
 **Our
              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 preferences.**
 
 Our
              success depends on our products’ appeal to a broad range of consumers whose
              preferences cannot be predicted with certainty and are subject to change.
              If our
              current products do not conform to consumer preferences, our sales
              may decline.
              In addition, our growth depends upon our ability to develop new products
              through
              product line extensions and product modifications, which involve numerous
              risks.
              We may not be able to accurately identify consumer preferences and
              translate our
              knowledge into customer-accepted products or successfully integrate
              these
              products with our existing product platform or operations. We may also
              experience increased expenses incurred in connection with product development,
              marketing and advertising that are not subsequently supported by a
              sufficient
              level of sales, which would negatively affect our margins. Furthermore,
              product
              development may divert management’s attention from other business concerns,
              which could cause sales of our existing products to suffer. We cannot
              assure you
              that newly developed products will contribute favorably to our operating
              results.
 
 **We
              rely on a few large customers, particularly Wal-Mart Stores, Inc.,
              for a
              significant portion of our sales.**
 
 In
              fiscal
              2006, Wal-Mart Stores, Inc. represented approximately 36% of our total
              revenues,
              our ten largest customers represented approximately 73% of our total
              revenues
              and our 20 largest customers represented approximately 84% 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.
 
 18
 **We
              may be adversely affected by fluctuations in buying decisions of mass
              merchandiser, drug and food trade buyers and the trend toward retail
              trade
              consolidation.**
 
 We
              sell
              our products to mass merchandiser and food and drug retailers in the
              United
              States. Consequently, our total revenues are affected by fluctuations
              in the
              buying patterns of these customers. These fluctuations may result from
              wholesale
              buying decisions, economic conditions and other factors. In addition,
              with the
              growing trend towards retail consolidation, we are increasingly dependent
              upon a
              few leading retailers, such as Wal-Mart Stores, Inc., whose bargaining
              strength
              continues to grow due to their size. Such retailers have demanded,
              and may
              continue to demand, increased service and order accommodations as well
              as price
              and incremental promotional investment concessions. As a result, we
              may face
              downward pressure on our prices and increased promotional expenses
              to meet these
              demands, which would reduce our margins. We also may be negatively
              affected by
              changes in the policies of our retail trade customers such as inventory
              destocking, limitations on access to shelf space and other
              conditions.
 
 **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 and the brands acquired in the J&J Acquisition.**
 
 We
              use
              third party manufacturers to make products representing approximately
              40% of our
              fiscal 2006 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.  Pfizer Inc. will manufacture the
*Cortizone*, *Unisom* and *Kaopectate*
              products for us during a transition period of up to 18 months.  In the
              near term, we will also rely on third party manufacturers to manufacture
              the
*Act* and *Balmex* product
              lines. In many cases, third party manufacturers are not bound by fixed
              term
              commitments in our contracts with them, and they may discontinue production
              with
              little or no advance notice. Manufacturers also may experience problems
              with
              product quality or timeliness of product delivery. We rely on these
              manufacturers to comply with applicable current GMPs. The loss of a
              contract
              manufacturer may force us to shift production to in-house facilities
              and
              possibly cause manufacturing delays, disrupt our ability to fill orders
              or
              require us to suspend production until we find another third party
              manufacturer.
              We are not able to control the manufacturing efforts of these third
              party
              manufacturers as closely as we control our business. Should any of
              these
              manufacturers fail to meet our standards, we may face regulatory sanctions,
              additional product liability claims or customer complaints, any of
              which could
              harm our reputation and our business.
 
 **Our
              dietary supplement business could suffer as a result of injuries caused
              by
              dietary supplements in general, unfavorable scientific studies or negative
              press.**
 
 Our
              dietary supplements consist of *Dexatrim* and our *Sunsource* product
              line. We are highly dependent upon consumers’ perceptions of the benefit and
              integrity of the dietary supplements business as well as the safety
              and quality
              of products in that industry. Injuries caused by dietary supplements
              or
              unfavorable scientific studies or news relating to products in this
              category,
              such as the December 30, 2003 consumer alert on the safety of dietary
              supplements containing ephedrine alkaloids issued by the FDA and the
              subsequent
              FDA rule banning the sale of supplements containing ephedrine alkaloids
              that
              became effective on April 11, 2004, may negatively affect consumers’ overall
              perceptions of products in this category, including our products, which
              could
              harm the goodwill of these brands and cause our sales to decline.
 
 **Our
              business could be adversely affected if we are unable to successfully
              protect
              our intellectual property.**
 
 Our
              trademarks are of material importance to our business and are among
              our most
              important assets. In fiscal 2006, 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* as
              well
              as the brands acquired in the J&J Acquisition in January 2007. 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.
              Also, we did not acquire any material intellectual property or trademark
              rights
              outside of the United States for the five brands acquired in the J&J
              Acquisition. 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.
 
 19
 In
              addition, our product line extensions are often based on new or unique
              delivery
              methods for those products like our *Icy
              Hot* patches
              and sleeves. These delivery methods may not be protected by intellectual
              property rights that we own or license on an exclusive basis or by
              exclusive
              manufacturing agreements. As a result, we may be unable to prevent
              any
              competitor or customer from duplicating our delivery methods to compete
              directly
              with these product line extensions, which could cause sales to
              suffer.
 
 We
              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 2006 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. We cannot
              assure you
              that we will be able to continue to purchase adequate quantities of
              these active
              ingredients at acceptable prices in the future.
 
 **We
              are subject to the risk of doing business internationally.**
 
 In
              fiscal
              2006, approximately 8% of our total revenues were attributable to our
              international business. Our acquisition of *Selsun
              Blue* in
              2002
              expanded our international business. We operate in regions and countries
              where
              we have little or no
  20
 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.
 
 **The
              terms of our outstanding debt obligations limit certain of our
              activities.**
 
 The
              terms
              of the indenture under which our 7.0% Subordinated Notes are issued
              and
              our Credit Facility impose operating and financial restrictions on us
              including restrictions on:
 
 •
                    incurrence
                        of additional indebtedness;
 
 •
                    dividends
                        and restricted payments;
 
 •
                    investments;
 
 •
                    loans
                        and guarantees;
 
 •
                    creation
                        of liens;
 
 •
                    transactions
                        with affiliates;
 
 •
                    use
                        of proceeds from sales of assets and subsidiary stock;
                        and
 
 •
                    certain
                        mergers, consolidations and transfers of
                        assets.
 
 The
              terms
              of our Credit Facility also require us to comply with financial maintenance
              covenants. In the future, we may have other indebtedness with similar
              or even
              more restrictive covenants. These restrictions may impair our ability
              to respond
              to changing business and economic conditions or to grow our business.
              In the
              event that we fail to comply with these covenants, there could be an
              event of
              default under the applicable debt instrument, which in turn could cause
              a cross
              default to other debt instruments. As a result, all amounts outstanding
              under
              our various debt instruments may become immediately due and
              payable.
 
 **Our
              operations are subject to significant environmental laws and
              regulations.**
 
 Our
              manufacturing sites use chemicals and other potentially hazardous materials
              and
              generate both hazardous and non-hazardous waste, the transportation,
              treatment,
              storage and disposal of which are regulated by various governmental
              agencies and
              federal, state and local laws and regulations. Under these laws and
              regulations,
              we are exposed to liability primarily as an owner or operator of real
              property,
              and as such, we may be responsible for the clean-up or other remediation
              of
  21
 contaminated
              property. Environmental laws and regulations can change rapidly, and
              we may
              become subject to more stringent environmental laws and regulations
              in the
              future, which may be retroactively applied to earlier events. Product
              line
              extensions, such as *Bullfrog
              Mosquito Coast* ,
              or
              acquisitions of new products, such as those acquired in the J&J Acquisition,
              may also subject our business to new or additional environmental laws
              and
              regulations. In addition, compliance with new or more stringent environmental
              laws and regulations could involve significant costs.
 
 **We
              are dependent on certain key executives, the loss of whom could have
              a material
              adverse effect on our business.**
 
 Our
              future performance depends significantly upon the efforts and abilities
              of
              certain members of senior management, in particular those of Zan Guerry,
              our
              chairman and chief executive officer, and Robert E. Bosworth, our president
              and
              chief operating officer. If we were to lose any key senior executive,
              our
              business could be materially adversely affected.
 
 **Our
              shareholder rights plan and 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 (including
              holders of the Convertible Notes which may convert into common stock)
              of their
              ability to receive a premium on their common stock.
 
 Generally,
              if any person attempts to acquire 15% or more of our common stock then
              outstanding without the approval of our independent directors, pursuant
              to our
              shareholder rights plan, our shareholders may purchase a significant
              amount of
              additional shares of our common stock at 50% of the then applicable
              market
              price. This threat of substantial dilution will discourage takeover
              attempts not
              approved by our board despite significant potential benefits to our
              shareholders.
 
 Our
              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 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 potential product liability litigation and stock market
              conditions generally.
 
 22
 **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
              1B. Unresolved Staff Comments**
 
 None
 
 **Item
              2. Properties**
 
 Our
              headquarters and administrative offices are located at 1715 West 38th
              Street,
              Chattanooga, Tennessee. Our primary production facilities are in close
              proximity
              to our headquarters on land owned by us. We lease our primary warehouse
              and
              distribution centers in Chattanooga, Tennessee for our domestic consumer
              products. The following table describes in detail the principal properties
              owned
              and leased by us:
 
 **Total
                        Area**
                      **(Acres)**
                    
                    **Total
                        Buildings**
                      **(Square
                        Feet)**
                    
                    **Use**
                    
                    **Square**
                      **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
                    
                    
                    5.1
                    
                    
                    139,000
                    
                    
                    Warehousing
                      Warehousing
                        & Manufacturing
                    
                    
                    103,800
                      35,200Chattanooga,
                        Tennessee
                    
                    
                    10.0
                    
                    
                    100,000
                    
                    
                    Warehousing
                      Office
                    
                    
                    99,300
                      700Mississauga,
                        Ontario, Canada
                    
                    
                    0.3
                    
                    
                    15,069
                    
                    
                    Warehousing
                      Office
                        & Administration
                      Packaging
                    
                    
                    10,569
                      3,000
                      1,500Basingstoke,
                        Hampshire, England
                    
                    
                    0.5
                    
                    
                    12,332
                    
                    
                    Warehousing
                      Office
                        & Administration
                    
                    
                    9,332
                      3,000Limerick,
                        Ireland
                    
                    
                    —
                    
                    
                    2,100
                    
                    
                    Office
                        & Administration
                    
                    
                    2,100
  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.
 23
 **Item
              3. Legal Proceedings**
 
 See
              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
 
 **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 Global Select Market under the
              symbol
“CHTT”. The table below sets forth the high and low closing sales prices
              of our
              common stock as reported on the Nasdaq Global Select Market for the
              periods
              indicated.
 
 Fiscal
                        2006:
                    
                    **High**
                    
                    **Low**First
                        Quarter
                    
                    $
                    42.00
                    
                    $
                    33.58Second
                        Quarter
                    
                    
                    39.90
                    
                    
                    33.43Third
                        Quarter
                    
                    
                    35.49
                    
                    
                    29.09Fourth
                        Quarter
                    
                    
                    49.60
                    
                    
                    33.37Fiscal
                        2005:
                    
                    
                    **High**
                    
                    
                    **Low**First
                        Quarter
                    
                    $
                    38.08
                    
                    $
                    32.01Second
                        Quarter
                    
                    
                    45.65
                    
                    
                    36.30Third
                        Quarter
                    
                    
                    46.08
                    
                    
                    38.05Fourth
                        Quarter
                    
                    
                    39.68
                    
                    
                    31.77
 
 ***Holders***
 
 As
              of
              February 1, 2007, there were approximately 243 holders of record of our
              common stock. The number of record holders does not include beneficial
              owners
              whose shares are held in the names of banks, brokers, nominees or other
              fiduciaries.
 
 ***Dividends***
 
 We
              have
              not paid dividends on our common stock during the past two fiscal years.
              We are
              restricted from paying dividends by the terms of the indenture under
              which our
              7.0% Subordinated Notes were issued and by the terms of our Credit
              Facility.
 24
 
 ***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)9/1/06-9/30/06
                    
                    
                    —
                    
                    $
                    —
                    
                    
                    —
                    
                    $
                    88,147,22410/1/06-10/31/06
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    88,147,22411/1/06-11/30/06
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    88,147,224Total
                        Fourth Quarter
                    
                    
                    —
                    
                    $
                    —
                    
                    
                    —
                    
                    
                    88,147,224
 
 
 (1)
                    Average
                        price paid per share includes broker
                        commissions
 
 (2)
                    In
                        January 2005, our board of directors increased the total
                        authorization to
                        repurchase our common stock under our stock buyback program
                        to $30.0
                        million. A total of $17.3 million remained available under
                        the stock
                        buyback authority prior to July 29, 2005, when our board
                        of directors
                        increased the total buyback authorization back to $30.0 million.
                        Subsequent to share purchases made in the fourth quarter
                        of fiscal 2005,
                        our board of directors again increased the total buyback
                        authorization
                        back to $30.0 million, effective November 29, 2005. On June
                        26, 2006, our
                        board of directors authorized the repurchase of up to an
                        additional $100.0
                        million of our common stock under our existing stock repurchase
                        program.
                        There is no expiration date specified for our stock buyback
                        program.
  25
 ***Item
              6. Selected Financial Data***
 
 This
              selected financial data should be read in conjunction with item 7 “Management’s
              Discussion and Analysis of Financial Condition and Results of Operations” and
              our consolidated financial statements and notes thereto included elsewhere
              in
              this Annual Report on Form 10-K.
  **Year
                        Ended November 30,****2006**
                    
                    **2005**
                    
                    **2004**
                    
                    **2003**
                    
                    **2002****(dollars
                        in thousands, except per share
                        amounts)**INCOME
                        STATEMENT DATA:Total
                        revenues
                    
                    $
                    300,548
                    
                    $
                    279,318
                    
                    $
                    258,155
                    
                    $
                    233,749
                    
                    $
                    223,116Operating
                        costs and expenses
                    
                    
                    217,804
                    
                    
                    212,830
                    
                    
                    228,292
                    
                    
                    177,849
                    
                    
                    171,540Income
                        from operations
                    
                    
                    82,744
                    
                    
                    66,488
                    
                    
                    29,863
                    
                    
                    55,900
                    
                    
                    51,576Other
                        expense, net
                    
                    
                    (13,454
                    )
                    
                    (13,478
                    )
                    
                    (27,709
                    )
                    
                    (20,307
                    )
                    
                    (21,406
                    )Income
                        before income taxes and change in accounting principle
                    
                    
                    69,290
                    
                    
                    53,010
                    
                    
                    2,154
                    
                    
                    35,593
                    
                    
                    30,170Provision
                        for income taxes
                    
                    
                    24,178
                    
                    
                    16,963
                    
                    
                    703
                    
                    
                    12,246
                    
                    
                    11,470Income
                        before change in accounting principle
                    
                    
                    45,112
                    
                    
                    36,047
                    
                    
                    1,451
                    
                    
                    23,347
                    
                    
                    18,700Cumulative
                        effect of change in accounting principle, net of income tax
                        benefit(1)
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    (8,877
                    )Net
                        income
                    
                    $
                    45,112
                    
                    $
                    36,047
                    
                    $
                    1,451
                    
                    $
                    23,347
                    
                    $
                    9,823PER
                        SHARE DATA:Income
                        per diluted share before change in accounting principle
                    
                    $
                    2.34
                    
                    $
                    1.77
                    
                    $
                    .07
                    
                    $
                    1.19
                    
                    $
                    .97Change
                        in accounting principle
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    (.46
                    )Total
                        diluted
                    
                    $
                    2.34
                    
                    $
                    1.77
                    
                    $
                    .07
                    
                    $
                    1.19
                    
                    $
                    .51BALANCE
                        SHEET DATA:
                      (At
                        end of year)Total
                        assets
                    
                    $
                    415,313
                    
                    $
                    367,214
                    
                    $
                    372,642
                    
                    $
                    364,466
                    
                    $
                    354,574Long-term
                        debt, less current maturities
                    
                    $
                    232,500
                    
                    $
                    145,500
                    
                    $
                    200,000
                    
                    $
                    204,676
                    
                    $
                    217,458
 
 (1)
                    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***
 
 Founded
              in 1879, we are a leading marketer and manufacturer of a broad portfolio
              of
              branded OTC healthcare products, toiletries and dietary supplements
              in such
              categories as topical pain care, medicated skin care products, medicated
              dandruff shampoos, dietary supplements, and other OTC and toiletry
              products. Our
              portfolio of products includes well-recognized brands such as:
 
 •
                    *Icy
                        Hot,**Aspercreme*and*Capzasin*-
                        topical pain care;
 
 •
                    *Gold
                        Bond -*medicated skin care products;
 
 •
                    *Selsun
                        Blue*and*Selsun
                        Salon -*medicated dandruff shampoos;
 
 •
                    *Dexatrim,
                        Garlique*and*New
                        Phase -*dietary supplements;
 
 26
 •
                    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 sunscreens;*UltraSwim,*a
                        chlorine-removing shampoo;*Sun-In*,
                        a
                        hair lightener.
 
 Our
              products target niche markets that are often outside the focus of larger
              companies where we believe we can achieve and sustain significant market
              share
              through innovation and strong advertising and promotion support. Many
              of our
              products are among the U.S. market leaders in their respective categories.
              For
              example, our portfolio of topical pain care 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 32%
              of our total
              revenues in fiscal 2006. We sell our products nationally through mass
              merchandiser, drug and food channels, principally utilizing our own
              sales
              force.
 
 ***Developments
              During Fiscal 2006***
 
 ***Products***
 
 In
              the
              first quarter of fiscal 2006, we introduced or completed the introduction
              of the
              following product line extensions: *Icy
              Hot Pro-Therapy* , *Selsun
              Salon,*  *Bullfrog*  *Mosquito
              Coast* , *Garlique
              CardioAssist* , *Capzasin* Back
& Body Patch and *Pamprin* Max. In
              the second quarter of fiscal 2006, we introduced *Dexatrim* Max 2 O. *Gold
              Bond Ultimate* Softening
              Lotion was introduced in the fourth quarter of 2006.
 
 Based
              on *Icy
              Hot Pro-Therapy* performing below expectations, a review of point of sales data throughout
              fiscal
              2006, an estimate of inventory on hand at customers and a review of
              our on hand
              inventory and purchase commitments outstanding as of November 30, 2006,
              we have
              provided for an estimate of returns of $3.3 million and an estimate
              of obsolete
              inventory of $2.0 million, which reduced net sales and increased cost
              of sales,
              respectively, in our consolidated financial statements as of November
              30,
              2006.
 
 ***Debt***
 
 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 repayment at 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 $2.8 million was recorded in the first quarter of fiscal
              2006.
 
 On
              November 22, 2006, we completed a private offering of $125.0 million of the
              Convertible Notes, the proceeds of which were used to fund in part the
              J&J Acquisition. The Convertible Notes bear interest at an annual rate
              of
              2.0%, payable semi-annually on May 15 and November 15 of each year,
              with the
              first interest payment due on May 15, 2007. Concurrently with the sale
              of the
              Convertible Notes, we purchased a note hedge for $32.0 million and
              issued
              warrants for proceeds of $18.6 million with an affiliate of Merrill
              Lynch (the
“Counterparty”). The note hedge and warrants are separate and legally distinct
              instruments that bind us and the Counterparty and have no binding effect
              on the
              holders of the Convertible Notes.
 
 On
              January 2, 2007, we completed an amended credit facility providing for up
              to a $100.0 million revolving credit facility and a $300.0 million
              term loan
              (the “Credit
              Facility”),
              led by Bank of America. The proceeds from the term loan under the Credit
              Facility were used to finance in part the J&J Acquisition. The term loan
              bears interest at LIBOR plus 1.75% or a base rate (the higher of the
              federal
              funds rate plus 0.5% or the prime rate) plus 0.75% at our discretion.
              Maturities
              of the term loan are $3.0 million annually with any remaining balance
              due
              January 2, 2013.
 
 ***Stock
              Repurchase***
 
 During
              fiscal 2006, we repurchased 1.2 million shares of our common stock
              under our
              stock repurchase program for $39.3 million at an average price per
              share of
              $33.57.
 
 On
              July
              25, 2006, we successfully completed a consent solicitation from the
              holders of
              the 7.0% Subordinated Notes to an amendment to the indenture to increase
              our
              capacity to make restricted payments by an additional $85.0 million,
              including
              payments for the repurchase of our common stock and adjust the fixed
              charge
              coverage ratio as defined in the indenture. In connection with the
              consent
              solicitation, our Board of Directors authorized the repurchase of up
              to an
              additional $100.0 million of our common stock under the terms of our
              existing
              stock repurchase program. As of February 1, 2007, the current amount
              available
              under the authorization from the Board of Directors was $88.1
              million.
 
 27
 ***Litigation***
 
 Over
              the
              past two years, we have resolved all of the claims submitted in the *Dexatrim* PPA
              settlement. A total of $70.9 million was previously funded into a settlement
              trust by our insurers and Sidmak Laboratories, Inc., the manufacturer
              of *Dexatrim* products
              containing PPA, for the purpose of paying claims in the settlement.
              All claims
              in the settlement and expenses of the trust have now been paid. On
              June 14,
              2006, we filed a motion to dissolve the settlement trust. The court
              granted this
              motion on July 14, 2006. On August 31, 2006, the settlement trust paid
              us $10.7
              million which is included as a component of litigation settlement in
              our
              condensed consolidated statement of income. The settlement trust currently
              has a
              balance of approximately $2.8 million. We expect to use those funds
              to resolve
              the one pending *Dexatrim* PPA case
              which opted out of the settlement. Any funds remaining after we resolve
              the
              opt-out case will be returned to one of our insurance carriers. We
              currently do
              not expect to record any additional charges relative to the settlement
              of the
              PPA litigation, except for legal expenses that will be recorded in
              the period
              incurred.
  During
              the 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”). The DELACO Agreement was
              approved by the DELACO bankruptcy court on July 28, 2005. Pursuant
              to the DELACO
              Agreement, we agreed to assume responsibility for all claims against
              DELACO and
              its predecessor, Thompson Medical Company, Inc., or us relating to *Dexatrim* products
              involving an injury date after December 21, 1998 and hold the DELACO
              bankruptcy
              estate harmless from any such claims. In exchange, a settlement trust
              to be
              established under DELACO’s bankruptcy plan agreed to pay us $8.75 million and
              assume responsibility for all claims related to *Dexatrim* products
              alleging injury dates on or before December 21, 1998. On February 17,
              2006, the
              DELACO bankruptcy court entered an order confirming the DELACO bankruptcy
              plan
              which incorporated the terms of the DELACO Agreement. In accordance
              with the
              DELACO bankruptcy plan, the settlement trust established under the
              plan paid us
              $8.75 million on March 17, 2006, which is included in our condensed
              consolidated
              statements of income, net of legal expenses. In addition, this order
              allows us
              to dismiss all cases against us with injury dates prior to December
              21, 1998,
              and channel these cases to the DELACO settlement trust 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. The confirmation
              of the
              DELACO bankruptcy plan effectively releases us from liability for all
              PPA
              products liability cases with injury dates prior to December 21, 1998.
 
 ***Acquisition***
 
 On
              January 2, 2007,
              we
              completed the J&J Acquisition for $410.0 million. The acquisition was
              funded with the proceeds received from the Convertible Notes, borrowings
              under our revolving credit facility and funds provided from the term
              loan under
              our Credit Facility.
 
 28
 ***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,****2006**
                    
                    **2005**
                    
                    **2004**TOTAL
                        REVENUES
                    
                    
                    100.0
                    %
                    
                    100.0
                    %
                    
                    100.0
                    %COSTS
                        AND EXPENSES:Cost
                        of sales
                    
                    
                    31.3
                    
                    
                    28.6
                    
                    
                    28.4Advertising
                        and promotion
                    
                    
                    32.0
                    
                    
                    27.5
                    
                    
                    29.0Selling,
                        general and administrative
                    
                    
                    15.6
                    
                    
                    16.9
                    
                    
                    17.1Executive
                        severance charges
                    
                    
                    —
                    
                    
                    0.8
                    
                    
                    —Impairment
                        of indefinite-lived intangible assets
                    
                    
                    —
                    
                    
                    —
                    
                    
                    7.8Loss
                        on product divestures
                    
                    
                    —
                    
                    
                    3.1
                    
                    
                    —Litigation
                        settlement
                    
                    
                    (6.4
                    )
                    
                    (0.7
                    )
                    
                    6.1Total
                        costs and expenses
                    
                    
                    72.5
                    
                    
                    76.2
                    
                    
                    88.4INCOME
                        FROM OPERATIONS
                    
                    
                    27.5
                    
                    
                    23.8
                    
                    
                    11.6OTHER
                        INCOME (EXPENSE):Interest
                        expense
                    
                    
                    (3.9
                    )
                    
                    (4.9
                    )
                    
                    (5.9
                    )Investment
                        and other income, net
                    
                    
                    0.4
                    
                    
                    0.4
                    
                    
                    0.1Loss
                        on early extinguishment of debt
                    
                    
                    (0.9
                    )
                    
                    (0.3
                    )
                    
                    (5.0
                    )Total
                        other income (expense)
                    
                    
                    (4.4
                    )
                    
                    (4.8
                    )
                    
                    (10.8
                    )INCOME
                        BEFORE INCOME TAXES
                    
                    
                    23.1
                    
                    
                    19.0
                    
                    
                    0.8PROVISION
                        FOR INCOME TAXES
                    
                    
                    8.1
                    
                    
                    6.1
                    
                    
                    0.2NET
                        INCOME
                    
                    
                    15.0
                    %
                    
                    12.9
                    %
                    
                    0.6
                    %
 
 
 29
 ***Critical
              Accounting Estimates***
 
 The
              preparation of financial statements in accordance with U.S. generally
              accepted
              accounting principles requires management to use estimates. Several
              different
              estimates or methods can be used by management that might yield different
              results. The following are the significant estimates used by management
              in the
              preparation of the November 30, 2006 consolidated financial
              statements:
 
 ***Allowance
              for Doubtful Accounts***
 
 As
              of
              November 30, 2006, 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, 2006, we performed a detailed assessment
              of
              the collectibility of trade accounts receivable and did not make any
              significant
              adjustments to our estimate of allowance for doubtful accounts. The
              balance of allowance for doubtful accounts was $0.3 million, $0.3 million
              and
              $0.8 million at November 30, 2006, 2005 and 2004, respectively.
 
 ***Revenue
              Recognition***
 
 Revenue
              is recognized when our products are shipped and title transfers to
              our
              customers. It is generally our policy across all classes of customers
              that all
              sales are final. As is common in the consumer products industry, customers
              return products for a variety of reasons including products damaged
              in transit,
              discontinuance of a particular size or form of product and shipping
              errors. As
              sales are recorded, we accrue an estimated amount for product returns,
              as a
              reduction of these sales, based upon our historical experience and
              consideration
              of discontinued products, product divestitures, estimated inventory
              levels held
              by our customers and retail point of sale data on existing and newly
              introduced
              products. The level of returns may fluctuate from our estimates due
              to several
              factors including weather conditions, customer inventory levels and
              competitive
              conditions. We charge the allowance account for product returns when
              the
              customer provides appropriate supporting documentation that the product
              is
              properly destroyed or upon receipt of the product.
 
 We
              separate returns into the two categories of seasonal and non-seasonal
              products.
              We use the historical return detail of seasonal and non-seasonal products
              for at
              least the most recent three fiscal years on generally all products,
              which is
              normalized for any specific occurrence that is not reasonably likely
              to recur,
              to determine the amount of product returned as a percentage of sales,
              and
              estimate an allowance for potential returns based on product sold in
              the current
              period. To consider product sold in current and prior periods, an estimate
              of
              inventory held by our retail customers is calculated based on customer
              inventory
              detail. This estimate of inventory held by our customers, along with
              historical
              returns as a percentage of sales, is used to determine an estimate
              of potential
              product returns. This estimate of the allowance for seasonal and non-seasonal
              returns is further analyzed by considering retail customer point of
              sale data.
              We also consider specific events, such as discontinued product or product
              divestitures, when determining the adequacy of the allowance. Our estimate
              of
              product returns for seasonal and non-seasonal products as of November
              30, 2006
              was $1.2 million and $1.3 million, respectively, $0.2 million and $0.6
              million,
              respectively, as of November 30, 2005 and $0.5 million and $0.1 million,
              respectively, as of November 30, 2004. As of November 30, 2006 and
              November 30,
              2005, estimated returns of pHisoderm product was $0.3 million and $0.7
              million,
              respectively, due to our November 30, 2005 divestiture of this brand.
              Based on
              consideration of the sales of *Icy
              Hot Pro-Therapy* performing below expectations, review of retail point of sales data
              throughout
              fiscal 2006 and an estimate of inventory on hand at customers, we have
              estimated
              returns as of November 30, 2006 of $3.3 million, which decreased net
              sales on
              our consolidated financial statements. As a result of higher sales
              volumes in
              fiscal 2006, we increased our estimate of returns for seasonal products
              by
              approximately $1.0 million, which resulted in a decrease to net sales
              in our
              consolidated financial statements. For fiscal 2005 and 2004, we decreased
              our
              estimate of seasonal returns by approximately $0.2 million and $0.9
              million,
              respectively, which resulted in an increase to net sales in our consolidated
              financial statements. During the fiscal years ended November 30, 2006
              and 2005,
              as a result of our estimate of customer inventory levels, historical
              non-seasonal product returns and retail point of sale data, we increased
              our
              estimate of non-seasonal returns by approximately $0.7 million and
              $0.6 million,
              respectively, which resulted in a decrease to net sales in our consolidated
              financial statements. During fiscal 2004, we decreased our estimate
              of
              non-seasonal returns by approximately $0.8 million, which resulted
              in an
              increase to net sales in our consolidated financial statements. Each
              percentage
              point change in the seasonal return rate would impact net sales by
              approximately
              $0.2 million. Each percentage point change in the non-seasonal return
              rate would
              impact net sales by approximately $0.4 million.
 
 30
 We
              routinely enter into agreements with customers to participate in promotional
              programs. The cost of these programs is recorded as either advertising
              and
              promotion expense or as a reduction of sales as prescribed by Emerging
              Issues
              Task Force 01-9, “Accounting for Consideration Given by a Vendor to a Customer
              (Including a Reseller of the Vendor’s Products)”. A significant portion of the
              programs are recorded as a reduction of sales and generally take the
              form of
              coupons and vendor allowances, which are normally taken via temporary
              price
              reductions, scan downs, display activity and participations in in-store
              programs
              provided uniquely by the customer. We also enter into cooperative advertising
              programs with certain customers, the cost of which is recorded as advertising
              and promotion expense. In order for retailers to receive reimbursement
              under
              such programs, the retailer must meet specified advertising guidelines
              and
              provide appropriate documentation of the advertisement being run. During
              fiscal
              2006, 2005 and 2004, our cooperative advertising reimbursements did
              not exceed
              the fair value of the benefits received under those programs.
 
 We
              analyze promotional programs in two primary categories -- coupons and
              vendor
              allowances. Customers normally utilize vendor allowances in the form
              of
              temporary price reductions, scan downs, display activity and participations
              in
              in-store programs provided uniquely by the customer. We estimate the
              accrual for
              outstanding coupons by utilizing a third-party clearinghouse to track
              coupons
              issued, coupon value, distribution and expiration dates, quantity distributed
              and estimated redemption rates that are provided by us. We estimate
              the
              redemption rates based on internal analysis of historical coupon redemption
              rates and expected future retail sales by considering recent point
              of sale data.
              The estimate for vendor allowances is based on estimated unit sales
              of a product
              under a program and amounts committed for such programs in each fiscal
              year.
              Estimated unit sales are determined by considering customer forecasted
              sales,
              point of sale data and the nature of the program being offered. The
              three most
              recent years of expected program payments versus actual payments made
              and
              current year retail point of sale trends are analyzed to determine
              future
              expected payments. Customer delays in requesting promotional program
              payments
              due to their audit of program participation and resulting request for
              reimbursement is also considered to evaluate the accrual for vendor
              allowances.
              The costs of these programs is often variable based on the number of
              units
              actually sold. As of November 30, 2006, the coupon accrual and reserve
              for
              vendor allowances were $1.2 million and $3.7 million, respectively, $0.6
              million and $1.1 million, respectively, as of November 30, 2005 and
              $1.3 million
              and $1.9 million, respectively, as of November 30, 2004. Each percentage
              point
              change in promotional program participation would impact net sales
              by $0.2
              million and advertising and promotion expense by an insignificant
              amount.
 
 ***Income
              Taxes***
 
 We
              account for income taxes using the asset and liability approach as
              prescribed by
              SFAS No. 109, “Accounting for Income Taxes”. This approach requires recognition
              of deferred tax assets and liabilities for the expected future tax
              consequences
              of events that have been included in the consolidated financial statements
              or
              tax returns. Using the enacted tax rates in effect for the year in
              which the
              differences are expected to reverse, deferred tax assets and liabilities
              are
              determined based on the differences between the financial reporting
              and the tax
              basis of an asset or liability. We record income tax expense in our
              consolidated
              financial statements based on an estimated annual effective income
              tax rate. Our
              estimated annual effective income tax rate during fiscal 2006 was 35%,
              as
              compared to 32% in fiscal 2005 and 33% in fiscal 2004, as a result
              of lower
              deductions for charitable contributions and greater apportionment in
              states with
              higher statutory tax rates.
 
 For
              additional information regarding our significant accounting policies,
              see note 2
              of notes to consolidated financial statements.
 
 31
 ***Fiscal
              2006 Compared to Fiscal 2005***
 
 To
              facilitate discussion of our operating results for the years ended
              November 30,
              2006 and 2005, we have included the following selected data from our
              consolidated statements of income:
 
 **For
                        the Year Ended November 30,****Increase
                        ( Decrease)****2006**
                    
                    **2005**
                    
                    **Amount**
                    
                    **Percentage****(dollars
                        in thousands)**Domestic
                        net sales
                    
                    $
                    276,397
                    
                    $
                    252,436
                    
                    $
                    23,961
                    
                    
                    9.5
                    %International
                        revenues (including royalties)
                    
                    
                    24,151
                    
                    
                    26,882
                    
                    
                    (2,731
                    )
                    
                    (10.2
                    )Total
                        revenues
                    
                    
                    300,548
                    
                    
                    279,318
                    
                    
                    21,230
                    
                    
                    7.6Cost
                        of sales
                    
                    
                    94,036
                    
                    
                    79,884
                    
                    
                    14,152
                    
                    
                    17.7Advertising
                        and promotion expense
                    
                    
                    96,071
                    
                    
                    76,763
                    
                    
                    19,308
                    
                    
                    25.2Selling,
                        general and administrative expense
                    
                    
                    46,989
                    
                    
                    47,322
                    
                    
                    (333
                    )
                    
                    (0.7
                    )Executive
                        severance charges
                    
                    
                    —
                    
                    
                    2,269
                    
                    
                    (2,269
                    )
                    
                    (100.0
                    )Loss
                        on product divestures
                    
                    
                    —
                    
                    
                    8,678
                    
                    
                    (8,678
                    )
                    
                    (100.0
                    )Litigation
                        settlement charges
                    
                    
                    (19,292
                    )
                    
                    (2,086
                    )
                    
                    (17,206
                    )
                    
                    (824.8
                    )Interest
                        expense
                    
                    
                    11,725
                    
                    
                    13,814
                    
                    
                    (2,089
                    )
                    
                    (15.1
                    )Loss
                        on early extinguishment of debt
                    
                    
                    2,805
                    
                    
                    750
                    
                    
                    2,055
                    
                    
                    274.0Net
                        income
                    
                    
                    45,112
                    
                    
                    36,047
                    
                    
                    9,065
                    
                    
                    25.1
  ***Domestic
              Net Sales***
 
 Domestic
              net sales for fiscal 2006 increased $24.0 million, or 9.5%, to $276.4
              million
              from $252.4 million in fiscal 2005. 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)****2006**
                    
                    **2005**
                    
                    **Amount**
                    
                    **Percentage****(dollars
                        in thousands)**Topical
                        pain care products
                    
                    $
                    101,396
                    
                    $
                    89,539
                    
                    $
                    11,857
                    
                    
                    13.2
                    %Medicated
                        skin care products
                    
                    
                    67,238
                    
                    
                    62,458
                    
                    
                    4,780
                    
                    
                    7.7Dietary
                        supplements
                    
                    
                    35,081
                    
                    
                    33,828
                    
                    
                    1,253
                    
                    
                    3.7Medicated
                        dandruff shampoos and conditioner
                    
                    
                    37,742
                    
                    
                    34,880
                    
                    
                    2,862
                    
                    
                    8.2Other
                        OTC and toiletry products
                    
                    
                    34,940
                    
                    
                    31,731
                    
                    
                    3,209
                    
                    
                    10.1Total
                    
                    $
                    276,397
                    
                    $
                    252,436
                    
                    $
                    23,961
                    
                    
                    9.5
 
 Net
              sales
              growth in the topical pain care category was led by the launch of the
              new *Icy
              Hot*  *Pro-Therapy* line of
              elastic support braces and pain relieving insert product and a 18%
              increase in
              sales of *Capzasin,* led
              by
              the new *Capzasin* Back
& Body Patch. Excluding sales of *Icy
              Hot Pro-Therapy* ,
              the
              category declined 3% compared to fiscal 2005, led by decreased sales
              of *Icy
              Hot* and *Flexall* .
              Based
              on *Icy
              Hot Pro-Therapy* performing below expectations, a review of retail point of sales data
              throughout
              fiscal 2006 and an estimate of inventory on hand at customers, we have
              provided
              for an estimate of returns as of November 30, 2006 of $3.3 million,
              which
              reduced net sales in our consolidated financial statements.
 
 Net
              sales
              growth in the medicated skin care products category resulted from a
              24% increase
              in the *Gold
              Bond* franchise. *Gold
              Bond* sales
              growth was attributable to 62%, 5% and 10% increases from the lotion,
              powder 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 and the introduction of *Gold
              Bond Ultimate* Softening Lotion in fiscal 2006. The increase in net sales of *Gold
              Bond* powder
              was due to continued growth of the medicated powder line. The overall
              sales
              growth in this category was offset by the 16% decline in sales resulting
              from
              the sale of pHisoderm effective November 30, 2005.
 
 32
 Net
              sales
              for the dietary supplements category improved primarily due to a 28%
              increase in *Dexatrim* led
              by
              the introduction of *Dexatrim* Max 2 O
              in
              fiscal 2006, which was partially offset by lost sales of the discontinued
              All-in-One Bar. Net sales of *New
              Phase* decreased due to the introduction in fiscal 2005 of *New
              Phase* Extra
              Strength.
  Domestic
              net sales of our medicated dandruff shampoos increased 8% due to a
              full years
              sales of *Selsun
              Salon* ,
              which
              was launched in the fourth quarter of fiscal 2005. This sales growth
              was
              partially offset by a slight reduction in sales of *Selsun
              Blue* .
 
 The
              increase in net sales for the other OTC and toiletry products category
              was due
              primarily to sales increases of *Pamprin* and *Bullfrog* of 16%
              and 17%, respectively, led by the introduction of *Pamprin* MAX and *Bullfrog*  *Mosquito
              Coast* ,
              respectively. The sales growth was partially offset by sales decreases
              of *Mudd* , *Prēmsyn* 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 2006, international revenues decreased $2.7 million, or 10.2%, to
              $24.2 million from $26.9 million in fiscal 2005. The decrease was primarily
              due
              to the reduction of sales as a result of the divestiture of pHisoderm
              at the end
              of fiscal 2005 and the suspension of distribution in a single European
              market in
              2005, partially offset by a full year sales of *Icy
              Hot* in
              Canada in 2006.
 
 ***Cost
              of Sales***
 
 Cost
              of
              sales in fiscal 2006 increased $14.2 million, or 17.7%, to $94.0 million
              from
              $79.9 million in fiscal 2005. Cost of sales as a percentage of total
              revenues
              was 31.3% for fiscal 2006 as compared to 28.6% for fiscal 2005. The
              increase in
              cost of sales as a percentage of total revenues was primarily due to
              the launch
              of *Icy
              Hot Pro-Therapy* which
              has
              higher product costs than our other products *.* Based
              on *Icy
              Hot*  *Pro-Therapy* performing below expectations and a review of our on hand inventory
              and purchase
              commitments outstanding as of November 30, 2006, we have recorded an
              estimate
              for obsolete inventory of $2.0 million, which increased cost of sales
              in our
              consolidated financial statements.
 
 ***Advertising
              and Promotion Expense***
 
 Advertising
              and promotion expenses in fiscal 2006 increased $19.3 million, or 25.2%, to
              $96.1 million from $76.8 million in fiscal 2005 and were 32.0% of total
              revenues
              for fiscal 2006 compared to 27.5% for the comparable period of fiscal
              2005.
              Support for new product introductions resulted in an increase in advertising
              and
              promotion expenditures in fiscal 2006 for *Icy
              Hot*  *Pro-Therapy* , *Selsun
              Salon* and *Bullfrog
              Mosquito Coast* .
 
 ***Selling,
              General and Administrative Expense***
 
 Selling,
              general and administrative expenses decreased $0.3 million, or 0.7%,
              to $47.0
              million from $47.3 million in fiscal 2005. Selling, general and administrative
              expenses were 15.6% and 16.9% of total revenues for fiscal 2006 and
              fiscal 2005,
              respectively. The decrease was attributable to lower compensation expense
              in the
              current year related to payments associated with restricted stock grants
              in the
              prior year and an executive severance charge in fiscal 2005, offset
              in part by
              share-based compensation expense under SFAS 123R in fiscal 2006.
 
 ***Litigation
              Settlement Charges***
  Litigation
              settlement for fiscal 2006 reflected the $8.8 million recovery from
              the DELACO
              settlement trust in the first quarter of 2006, the $10.7 million recovery
              from
              the settlement trust in the third quarter of 2006 in the *Dexatrim* litigation settlement and net legal expenses related to the *Dexatrim* litigation
              of $0.2 million, compared to the reversal of a charge of $6.0 million
              related to
              the *Dexatrim* litigation, $0.5 million reimbursement from the settlement trust for
              previously
              incurred administrative costs for the same period of fiscal 2005, offset
              by
              legal expenses and ephedrine-related claims of $4.4 million related
              to the
              settlement of *Dexatrim* litigation.
 
 33
 ***Interest
              Expense***
 
 Interest
              expense in fiscal 2006 decreased $2.1 million, or 15.1%, to $11.7 million
              from $13.8 million in fiscal 2005. The decrease was largely the result
              of
              reductions in outstanding debt as a result of the redemption of our
              $75.0
              million Floating Rate Senior Notes on December 30, 2005. Until our
              indebtedness
              is reduced substantially, interest expense will continue to represent
              a
              significant percentage of our total revenues.
 
 ***Loss
              on Early Extinguishment of Debt***
 
 Our
              $75.0
              million of Floating Rate Senior Notes were fully redeemed in the first
              quarter
              of fiscal 2006, which resulted in a loss on early extinguishment of
              debt of $2.8
              million. During fiscal 2005, we repurchased $17.5 million of our 7.0%
              Subordinated Notes, which resulted in a loss on early extinguishment
              of debt of
              $0.7 million.
 
          34
 ***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****(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
  ***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
                        pain care products
                    
                    $
                    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 pain care 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 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.
 
 35
 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 fiscal 2005 compared to 29.0% for 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.
 
 ***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*
  36
 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 in fiscal 2005 decreased $1.2 million, or 8.2%, 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 $2.8
              million was recorded ****** in
              the
              first quarter of fiscal 2006.
 
 ***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
              $54.4 million and $55.0 million was provided by operations in fiscal
              2006 and
              2005, respectively. Increased net income and reduced accounts receivable,
              due
              mainly to the receipt of cash from the sale of pHisoderm in 2005, was
              offset by
              increased inventory, due primarily to inventory related to *Icy
              Ho* t *Pro-Therapy* ,
              and a
              decrease in accounts payable and accrued liabilities.
 
 Investing
              activities used cash of $6.8 million and $0.7 million in fiscal 2006
              and 2005,
              respectively. The increase 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 $4.1 million and $46.5 million in fiscal 2006
              and 2005,
              respectively. The decrease in cash used primarily was attributable
              to the sale
              of the $125.0 million Convertible Notes in fiscal 2006 and the sale
              of warrants
              for $18.6 million, which offset the payoff of the $75.0 million Floating
              Rate
              Senior Notes, the repurchase of $39.3 million of common stock and the
              purchase
              of the Convertible Note hedge for $32.0 million.
 
 As
              of
              November 30, 2006, our total debt was $232.5 million, consisting of
              our 7.0%
              Subordinated Notes of $107.5 million and our Convertible Notes of $125.0
              million. As of November 30, 2006, we had no borrowings outstanding
              under our
              Amended Revolving Credit Facility with available borrowings of up to
              $100.0
              million. As of February 1, 2007, our total debt was $570.5 million,
              consisting
              of borrowings outstanding under our revolving credit facility under
              our Credit
              Facility totaling $38.0 million, $107.5 million of our 7.0% Subordinated
              Notes, $125.0 million of our Convertible Notes and a $300.0 million
              term loan
              under our Credit Facility. Borrowings under our revolving credit facility
              under the Credit Facility bear interest at LIBOR plus applicable percentages
              of
              1.00% to 2.00% or a base
  37
 rate
              (the
              higher of the federal funds rate plus 0.5% or the prime rate) plus
              applicable
              percentages of 0.0% to 0.5% (8.25% as of November 30, 2006). The applicable
              percentages are calculated based on our leverage ratio. Borrowings
              under the
              term loan under our Credit Facility bear interest at LIBOR plus 1.75%
              or a base
              rate (the higher of the federal funds rate plus 0.5% or the prime rate)
              plus
              0.75%. 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. On November 22, 2006, we entered into
              an
              interest rate cap (the “forward starting cap”) and an interest rate swap (the
“forward starting swap”), both with a future effective date of January 15, 2007.
              The forward starting cap has decreasing notional principal amounts
              beginning
              October 15, 2007 and a cap rate of 5.0% over the life of the agreement.
              The
              forward starting swap has decreasing notional principal amounts beginning
              October 15, 2007 and a swap rate of 4.98% over the life of the agreement.
 
 On
              July
              25, 2006, we successfully completed a consent solicitation from the
              holders of
              the 7.0% Subordinated Notes to an amendment to the indenture governing
              such
              notes to increase our capacity to make restricted payments by an additional
              $85.0 million, including payments for the repurchase of our common
              stock and
              adjust the fixed charge coverage ratio as defined in the indenture.
              In
              connection with the consent solicitation, our Board of Directors authorized
              the
              repurchase of up to an additional $100.0 million of our common stock
              under the
              terms of our existing stock repurchase program. During fiscal 2006,
              we
              repurchased 1,171,663 shares of our common stock for $39.3 million.
 
 We
              believe that cash provided by operating activities, our cash and cash
              equivalents balance and funds available under our Credit Facility will
              be
              sufficient to fund our capital expenditures, debt service and working
              capital
              requirements for the foreseeable future as our business is currently
              conducted.
              It is likely that any acquisitions we make in the future will require
              us to
              obtain additional financing.
  
 ***Contractual
              Obligations***
 
 The
              following data summarizes our contractual obligations as of November
              30, 2006.
              We had no commercial obligations as of November 30, 2006:
 
 **Payments
                        due by****Contractual
                        Obligations:**
                    
                    **Total**
                    
                    **Within
                        1 year**
                    
                    **2-3
                        years**
                    
                    **4-5
                        years**
                    
                    **After
                        5 years****(dollars
                        in thousands)**Long-term
                        debt
                    
                    $
                    232,500
                    
                    $
                    —
                    
                    $
                    —
                    
                    $
                    —
                    
                    $
                    232,500Operating
                        leases
                    
                    
                    3,301
                    
                    
                    1,488
                    
                    
                    1,038
                    
                    
                    363
                    
                    
                    412Purchase
                        commitments
                    
                    
                    3,136
                    
                    
                    1,894
                    
                    
                    1,242
                    
                    
                    —
                    
                    
                    —Endorsements
                    
                    
                    4,025
                    
                    
                    1,675
                    
                    
                    2,350
                    
                    
                    —
                    
                    
                    —Total
                    
                    $
                    242,962
                    
                    $
                    5,057
                    
                    $
                    4,630
                    
                    $
                    363
                    
                    $
                    232,912
 
 Purchase
              orders or contracts for the purchase of inventory and other goods and
              services
              are not included in the table above. We are not able to determine the
              aggregate
              amount of such purchase orders that represent contractual obligations,
              as
              purchase orders may represent authorizations to purchase rather than
              binding
              agreements. Our purchase orders are based on our current distribution
              needs and
              are fulfilled by our vendors within short time horizons. Other than
              as presented
              in the table above, we do not have significant agreements for the purchase
              of
              inventory or other goods specifying minimum quantities or 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 2006 and 2005, these subsidiaries accounted for 8%
              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* ,
              our
              international business operations have expanded significantly, which
              has
              increased our exposure to fluctuations in foreign exchange rates. During
              fiscal
              2006, a portion of these foreign sales was reflected as royalties,
              which have
              been paid to us in
  38
 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.
              An insignificant loss for the year ended November 30, 2006 and a gain
              of $0.2
              million for the year ended November 30, 2005 resulted from foreign
              currency
              transactions and are included in selling, general and administrative
              expenses in
              the consolidated statements of income. ****
 
 ***Recent
              Accounting Pronouncements***
 
 See
              note
              2 of notes to consolidated financial statements included in Item 8
“Financial
              Statements and Supplementary Data.”
 
 ***Forward
              Looking Statements***
  We
              may
              from time to time make written and oral forward-looking statements.
              Written
              forward-looking statements may appear in documents filed with the Securities
              and
              Exchange Commission, in press releases and in reports to shareholders
              or be made
              orally in publicly accessible conferences or conference calls. The
              Private
              Securities Litigation Reform Act of 1995 contains a safe harbor for
              forward-looking statements. We rely on this safe harbor in making such
              disclosures. These forward-looking statements generally can be identified
              by use
              of phrases such as “believe,” “plan,” “expect,” “anticipate,” “intend,”
“forecast” or other similar words or phrases. These forward-looking statements
              relate to, among other things, our strategic and business initiatives
              and plans
              for growth or operating changes; our financial condition and results
              of
              operation; future events, developments or performance; and management’s
              expectations, beliefs, plans, estimates and projections. The forward-looking
              statements are based on management’s current beliefs and assumptions about
              expectations, estimates, strategies and projections. These statements
              are not
              guarantees of future performance and involve risks, uncertainties and
              assumptions that are difficult to predict. Therefore, actual outcomes
              and
              results may differ materially from what is expressed or forecasted
              in such
              forward-looking statements. We undertake no obligation to update publicly
              any
              forward-looking statements whether as a result of new information,
              future events
              or otherwise. Factors that could cause our actual results to differ
              materially
              from those anticipated in the forward-looking statements in this Form
              10-K and
              the documents incorporated herein by reference include the
              following:
 ·
                    the
                        inability to successfully integrate the new brands into our
                        portfolio of
                        consumer brands or achieve other synergies associated with
                        the
                        acquisition; ·
                    we
                        have a significant amount of debt that could adversely affect
                        our business
                        and growth prospects; ·
                    we
                        face significant competition in the OTC healthcare, toiletries
                        and dietary
                        supplements markets; ·
                    the
                        possibility of product liability claims, including lawsuits
                        alleging
                        injury from the use of*Dexatrim*products containing ephedrine, which we discontinued manufacturing
                        and
                        shipping in September 2002, or from other products that we
                        currently
                        produce or may produce in the future; ·
                    our
                        product liability insurance coverage may be insufficient
                        to cover existing
                        or future liability claims; ·
                    our
                        acquisition strategy is subject to risk and may not be
                        successful; ·
                    our
                        business is regulated by numerous federal, state and foreign
                        governmental
                        authorities, which subjects us to elevated compliance costs
                        and risks of
                        non-compliance; ·
                    our
                        success depends on our ability to anticipate and respond
                        in a timely
                        manner to changing consumer demands; ·
                    we
                        rely on a few large customers, particularly Wal-Mart Stores,
                        Inc., for a
                        significant portion of our sales; ·
                    we
                        may be adversely affected by fluctuations in buying decisions
                        of mass
                        merchandise, drug and food trade buyers and the trend toward
                        retail trade
                        consolidation; ·
                    we
                        rely on third party manufacturers for a portion of our product
                        portfolio,
                        including products under our*Gold
                        Bond, Icy Hot, Selsun,**Dexatrim,
                        ACT, Unisom*and
                        *Cortizone* brands; ·
                    our
                        dietary supplement business could suffer as a result of injuries
                        caused by
                        dietary supplements in general, unfavorable scientific studies
                        or negative
                        press; ·
                    our
                        business could be adversely affected if we are unable to
                        successfully
                        protect our intellectual property; ·
                    because
                        most of our operations are located in Chattanooga, Tennessee,
                        we are
                        subject to regional and local risks; ·
                    we
                        depend on sole or limited source suppliers for ingredients
                        in certain of
                        our products, and our inability to buy these ingredients
                        would prevent us
                        from manufacturing these products; ·
                    we
                        are subject to the risk of doing business
                        internationally; ·
                    the
                        terms of our outstanding debt obligations limit certain of
                        our
                        activities; ·
                    our
                        operations are subject to significant environmental laws
                        and
                        regulations; ·
                    we
                        are dependent on certain key executives, the loss of whom
                        could have a
                        material adverse effect on our business; ·
                    our
                        shareholder rights plan and restated charter contain provisions
                        that may
                        delay or prevent a merger, tender offer or other change of
                        control of us; ·
                    the
                        trading price of our common stock may be volatile;
                        and ·
                    other
                        risks described in our Securities and Exchange Commission
                        filings.
  39
 ***Item
              7A. Quantitative and Qualitative Disclosures about Market
              Risk***
 
 We
              are
              exposed to market risk from changes in interest rates and foreign currency
              exchange rates, which may adversely affect our results of operations
              and
              financial condition. We seek to minimize the risks from these interest
              rates and
              foreign currency exchange rate fluctuations through our regular operating
              and
              financing activities.
 
 Our
              exposure to interest rate risk currently relates to amounts outstanding
              under
              our Amended Revolving Credit Facility. 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 up to 0.5%. The applicable percentages
              are
              calculated based on our leverage ratio. As of November 30, 2006, no
              amounts were
              outstanding under the Amended Revolving Credit Facility. The 7.0% Subordinated
              Notes and the 2.0% Convertible Senior Notes are fixed interest rate
              obligations.
              On March 8, 2004, we entered into an interest rate cap agreement effective
              June
              1, 2004 with decreasing annual notional principal amounts of $15.0
              million
              beginning March 1, 2006 and cap rates ranging from 4.0% to 5.0% over
              the life of
              the agreement. The amortized value of the premium on the interest rate
              cap was
              compared to its fair value as of November 30, 2006 resulting in a loss
              of $0.3
              million, reflected in the income statement as interest expense. As
              of November
              30, 2006, the interest rate cap was deemed to be an ineffective cash
              flow hedge
              resulting in de-designation of the hedge. The interest rate cap agreement
              terminates on March 1, 2010. On November 22, 2006, we entered into
              a forward
              starting cap agreement effective January 15, 2007. The forward starting
              cap has
              decreasing notional principal amounts beginning October 15, 2007 and
              a cap rate
              of 5.0% over the life of the agreement. During the year ended November
              30, 2006,
              the value of the premium on the forward starting cap was compared to
              the fair
              value of the forward starting cap and the change in the market value
              of the
              premium of $0.1 million, net of tax, was recorded to other comprehensive
              income.
              The forward starting cap agreement terminates on January 15, 2010.
              On November
              22, 2006, we entered into a forward starting swap agreement effective
              January
              15, 2007. The forward starting swap has decreasing notional principal
              amounts
              beginning October 15, 2007 and a swap rate of 4.98% over the life of
              the
              agreement. During the year ended November 30, 2006, the change in fair
              value of
              $0.5 million, net of tax, was recorded to other comprehensive income.
              The
              forward starting swap agreement terminates on January 15, 2010. The
              impact on
              our results of operations of a one-point rate change on the February
              1, 2007
              outstanding revolving credit facility balance of $38.0 million and
              $300.0
              million term loan balance of our Credit Facility for the next twelve months
              would be approximately $2.2 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 $0.8 million as of
              November 30, 2006.
 
 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.
 
 40
  ***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 sheets of Chattem,
              Inc. (a
              Tennessee corporation) and subsidiaries (the “Company”) as of November 30, 2006
              and 2005, and the related consolidated statements of income, shareholders’
equity, and cash flows for the years then ended. These consolidated
              financial
              statements are the responsibility of the Company’s management. Our
              responsibility is to express an opinion on these consolidated 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 audits to obtain reasonable assurance about whether
              the
              financial statements are free of material misstatement. An audit includes
              examining, on a test basis, evidence supporting the amounts and disclosures
              in
              the financial statements. An audit also includes assessing the accounting
              principles used and significant estimates made by management, as well
              as
              evaluating the overall financial statement presentation. We believe
              that our
              audits provide a reasonable basis for our opinion.
 
 In
              our
              opinion, the consolidated financial statements referred to above present
              fairly,
              in all material respects, the consolidated financial position of Chattem,
              Inc.
              and subsidiaries as of November 30, 2006 and 2005, and the consolidated
              results
              of its operations and its consolidated cash flows for the years then
              ended in
              conformity with accounting principles generally accepted in the United
              States of
              America.
 
 Our
              audits were conducted for the purpose of forming an opinion on the
              basic
              consolidated 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 consolidated
              financial statements. This schedule has been subjected to the auditing
              procedures applied in the audit of the basic consolidated financial
              statements
              and, in our opinion, is fairly stated in all material respects in relation
              to
              the basic consolidated 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, 2006,
              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 8, 2007 expressed an unqualified opinion
              on
              management’s assessment of, and the effectiveness of, internal control over
              financial reporting.
 
 As
              discussed in Note 2 of the consolidated financial statements, the Company
              has
              adopted Financial Accounting Standards Board Statement No. 123(R),
              Share-Based
              Payments, in 2006.
 
 
 /s/
              GRANT
              THORNTON LLP
 
 
 Charlotte,
              North Carolina
 February
              8, 2007
  41
 ***Report
              of Independent Registered Public Accounting Firm***
 
 *To
              the Board of Directors and Shareholders*
 *Chattem,
              Inc. and subsidiaries*
 
 We
              have
              audited the accompanying consolidated statements of income, shareholders’ equity
              and cash flows of Chattem, Inc. and subsidiaries for the year 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 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 financial statements referred to above present fairly,
              in all
              material respects, the consolidated results of operations and cash
              flows of
              Chattem, Inc. and subsidiaries for the year ended November 30, 2004,
              in
              conformity with U.S. generally accepted accounting principles.
 
 
  
 
 /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
 
 
 
 
  
 42
 **Consolidated
              Balance Sheets**
 *November
              30, 2006 and 2005*
 *(In
              thousands)*
 
 
 ASSETS
                    
                    2006
                    
                    2005CURRENT
                        ASSETS:
                      Cash
                        and cash equivalents
                    
                    $
                    90,527
                    
                    $
                    47,327Accounts
                        receivable, less allowances of $10,907  in 2006and
                        $3,417 in 2005
                    
                    
                    29,595
                    
                    
                    32,593Other
                        receivables
                    
                    
                    257
                    
                    
                    9,600Inventories
                    
                    
                    31,389
                    
                    
                    23,631Refundable
                        income taxes
                    
                    
                    —
                    
                    
                    1,207Deferred
                        income taxes
                    
                    
                    4,341
                    
                    
                    2,478Prepaid
                        expenses and other current assets
                    
                    
                    5,857
                    
                    
                    5,106Total
                        current assets
                    
                    
                    161,966
                    
                    
                    121,942PROPERTY,
                        PLANT AND EQUIPMENT, NET
                    
                    
                    30,353
                    
                    
                    29,884OTHER
                        NONCURRENT ASSETS:Patents,
                        trademarks and other purchasedproduct
                        rights, net
                    
                    
                    206,149
                    
                    
                    206,387Debt
                        issuance costs, net
                    
                    
                    11,399
                    
                    
                    4,297Other
                    
                    
                    5,446
                    
                    
                    4,704Total
                        other noncurrent assets
                    
                    
                    222,994
                    
                    
                    215,388TOTAL
                        ASSETS
                    
                    $
                    415,313
                    
                    $
                    367,214
 
 
 *The
              accompanying notes are an integral part of these consolidated financial
              statements.*
  
 43
 **Consolidated
              Balance Sheets**
 *November
              30, 2006 and 2005*
 *(In
              thousands)*
 
 
 LIABILITIES
                        AND SHAREHOLDERS’ EQUITY
                    
                    2006
                    
                    2005CURRENT
                        LIABILITIES:Current
                        maturities of long-term debt
                    
                    $
                    —
                    
                    $
                    37,000Accounts
                        payable and other
                    
                    
                    9,948
                    
                    
                    17,238Bank
                        overdrafts
                    
                    
                    5,824
                    
                    
                    —Accrued
                        liabilities
                    
                    
                    11,805
                    
                    
                    15,248Total
                        current liabilities
                    
                    
                    27,577
                    
                    
                    69,486LONG-TERM
                        DEBT, less current maturities
                    
                    
                    232,500
                    
                    
                    145,500DEFERRED
                        INCOME TAXES
                    
                    
                    17,668
                    
                    
                    27,736OTHER
                        NONCURRENT LIABILITIES
                    
                    
                    1,987
                    
                    
                    1,865COMMITMENTS
                        AND CONTINGENCIES (Note 13)SHAREHOLDERS’
                        EQUITY:Preferred
                        shares, without par value, authorized 1,000, none issued
                    
                    
                    —
                    
                    
                    —Common
                        shares, without par value, authorized 100,000, issued 18,669
                        in 2006 and 19,668 in 2005
                    
                    
                    30,452
                    
                    
                    63,876Retained
                        earnings
                    
                    
                    105,965
                    
                    
                    60,853136,417
                    
                    
                    124,729Unamortized
                        value of restricted common shares issued
                    
                    
                    —
                    
                    
                    (1,818
                    )Cumulative
                        other comprehensive income, net of taxes:Interest
                        rate cap adjustment
                    
                    
                    (597
                    )
                    
                    (83
                    )Foreign
                        currency translation adjustment
                    
                    
                    (239
                    )
                    
                    (201
                    )Total
                        shareholders’ equity
                    
                    
                    135,581
                    
                    
                    122,627TOTAL
                        LIABILITIES AND SHAREHOLDERS’ EQUITY
                    
                    $
                    415,313
                    
                    $
                    367,214
 
 *The
              accompanying notes are an integral part of these consolidated financial
              statements.*
 
 44
 **Consolidated
              Statements of Income**
 *For
              the Years Ended November 30, 2006, 2005 and 2004*
 *(In
              thousands, except per share amounts)*
 
 **2006**
                    
                    **2005**
                    
                    **2004**TOTAL
                        REVENUES:Net
                        sales
                    
                    $
                    300,320
                    
                    $
                    279,140
                    
                    $
                    257,534Royalties
                    
                    
                    228
                    
                    
                    178
                    
                    
                    621Total
                        revenues
                    
                    
                    300,548
                    
                    
                    279,318
                    
                    
                    258,155COSTS
                        AND EXPENSES:Cost
                        of sales
                    
                    
                    94,036
                    
                    
                    79,884
                    
                    
                    73,358Advertising
                        and promotion
                    
                    
                    96,071
                    
                    
                    76,763
                    
                    
                    74,929Selling,
                        general and administrative
                    
                    
                    46,989
                    
                    
                    47,322
                    
                    
                    44,169Executive
                        severance charges
                    
                    
                    —
                    
                    
                    2,269
                    
                    
                    —Impairment
                        of indefinite-lived intangible assets
                    
                    
                    —
                    
                    
                    —
                    
                    
                    20,000Loss
                        on product divestures
                    
                    
                    —
                    
                    
                    8,678
                    
                    
                    —Litigation
                        settlement
                    
                    
                    (19,292
                    )
                    
                    (2,086
                    )
                    
                    15,836Total
                        costs and expenses
                    
                    
                    217,804
                    
                    
                    212,830
                    
                    
                    228,292INCOME
                        FROM OPERATIONS
                    
                    
                    82,744
                    
                    
                    66,488
                    
                    
                    29,863OTHER
                        INCOME (EXPENSE):Interest
                        expense
                    
                    
                    (11,725
                    )
                    
                    (13,814
                    )
                    
                    (15,049
                    )Investment
                        and other income, net
                    
                    
                    1,076
                    
                    
                    1,086
                    
                    
                    298Loss
                        on early extinguishment of debt
                    
                    
                    (2,805
                    )
                    
                    (750
                    )
                    
                    (12,958
                    )Total
                        other income (expense)
                    
                    
                    (13,454
                    )
                    
                    (13,478
                    )
                    
                    (27,709
                    )INCOME
                        BEFORE INCOME TAXES
                    
                    
                    69,290
                    
                    
                    53,010
                    
                    
                    2,154PROVISION
                        FOR INCOME TAXES
                    
                    
                    24,178
                    
                    
                    16,963
                    
                    
                    703NET
                        INCOME
                    
                    $
                    45,112
                    
                    $
                    36,047
                    
                    $
                    1,451NUMBER
                        OF COMMON SHARES:Weighted
                        average outstanding, basic
                    
                    
                    19,036
                    
                    
                    19,652
                    
                    
                    19,379Weighted
                        average and potential dilutive outstanding
                    
                    
                    19,262
                    
                    
                    20,366
                    
                    
                    20,225NET
                        INCOME PER COMMON SHARE:Basic
                    
                    $
                    2.37
                    
                    $
                    1.83
                    
                    $
                    .07Diluted
                    
                    $
                    2.34
                    
                    $
                    1.77
                    
                    $
                    .07
 
 
 *The
              accompanying notes are an integral part of these consolidated financial
              statements.*
 
 45
 **Consolidated
              Statements of Shareholders’ Equity**
 *For
              the Years Ended November 30, 2006, 2005 and 2004*
 *(In
              thousands, except per share amounts)*
  Common
                      Shares
                    
                    Retained
                      Earnings
                    
                    Unamortized
                      Value
                        of
                      Restricted
                           Common
                      Shares
                        Issued
                    
                    Interest
                        Rate
                      Cap
                      Adjustment
                    
                    Foreign
                      Currency
                      Translation
                      Adjustment
                    
                    Minimum
                      PensionLiability
                      Adjustment,
                      Net
                    
                    TotalBalance,
                        November 30, 2003
                    
                    $
                    77,815
                    
                    $
                    23,355
                    
                    $
                    (2,058
                    )
                    $
                    —
                    
                    $
                    (820
                    )
                    $
                    (1,640
                    )
                    $
                    96,652Comprehensive
                        income (loss):Net
                        income
                    
                    
                    —
                    
                    
                    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
                    
                    
                    85,949
                    
                    
                    24,806
                    
                    
                    (2,386
                    )
                    
                    (316
                    )
                    
                    (23
                    )
                    
                    —
                    
                    
                    108,030Comprehensive
                        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
 
 46
  Common
                      Shares
                    
                    Retained
                      Earnings
                    
                    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
                    
                    —
                    
                    45,112
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    45,112Interest
                        rate cap adjustment
                    
                    —
                    
                    —
                    
                    —
                    
                    (514)
                    
                    —
                    
                    —
                    
                    (514)Foreign
                        currency translation adjustment
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    (38)
                    
                    —
                    
                    (38)Total
                        comprehensive income
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    44,560Stock-based
                        compensation expense
                    
                    5,594
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    4,882Stock
                        options exercised
                    
                    2,480
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    2,480Tax
                        benefit realized from stock option plans
                    
                    982
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    982Stock
                        repurchases
                    
                    (39,332)
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    (39,332)Payment
                        for purchase of note hedge, net of tax benefit
                    
                    (19,994)
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    (19,994)Proceeds
                        from issuance of warrant
                    
                    18,581
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    18,581Issuance
                        of 2.5 common shares for non-employee directors’
                        compensation
                    
                    83
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    —
                    
                    83Adjustment
                        from unamortized value of restricted common shares issued
                        to common
                        shares
                    
                    (1,818)
                    
                    —
                    
                    1,818
                    
                    —
                    
                    —
                    
                    —
                    
                    —Balance,
                        November 30, 2006
                    
                    $
                    30,452
                    
                    $
                    105,965
                    
                    $
                    —
                    
                    $
                    (597
                    )
                    $
                    (239
                    )
                    
                    —
                    
                    $
                    135,581
 
 *The
              accompanying notes are an integral part of these consolidated financial
              statements.*
 
 47
 **Consolidated
              Statements of Cash Flows**
 *For
              the Years Ended November 30, 2006, 2005 and 2004*
 *(In
              thousands, except per share amounts)*
 **2006**
                    
                    **2005**
                    
                    **2004**Net
                        income
                    
                    $
                    45,112
                    
                    $
                    36,047
                    
                    $
                    1,451Adjustments
                        to reconcile net income to net cash provided by operating
                        activities:Depreciation
                        and amortization
                    
                    
                    5,835
                    
                    
                    6,115
                    
                    
                    6,131Deferred
                        income taxes
                    
                    
                    413
                    
                    
                    3,894
                    
                    
                    (1,931
                    )Stock-based
                        compensation expense
                    
                    
                    4,745
                    
                    
                    —
                    
                    
                    —Loss
                        on early extinguishment of debt
                    
                    
                    2,805
                    
                    
                    750
                    
                    
                    12,958Impairment
                        of indefinite-lived assets
                    
                    
                    —
                    
                    
                    —
                    
                    
                    20,000Loss
                        on product line divestures
                    
                    
                    —
                    
                    
                    8,678
                    
                    
                    —Tax
                        benefit realized from stock options
                    
                    
                    (1,627
                    )
                    
                    3,292
                    
                    
                    5,568Restricted
                        stock modification expense
                    
                    
                    —
                    
                    
                    1,360
                    
                    
                    —Other,
                        net
                    
                    
                    384
                    
                    
                    800
                    
                    
                    (249
                    )Changes
                        in operating assets and liabilities, net of acquisitions:Accounts
                        receivable
                    
                    
                    12,341
                    
                    
                    (3,069
                    )
                    
                    (8,426
                    )Inventories
                    
                    
                    (7,621
                    )
                    
                    (1,457
                    )
                    
                    (3,876
                    )Refundable
                        income taxes
                    
                    
                    2,834
                    
                    
                    2,979
                    
                    
                    (363
                    )Prepaid
                        expenses and other current assets
                    
                    
                    579
                    
                    
                    (726
                    )
                    
                    (200
                    )Accounts
                        payable and accrued liabilities
                    
                    
                    (11,378
                    )
                    
                    (3,647
                    )
                    
                    13,647Net
                        cash provided by operating activities
                    
                    
                    54,422
                    
                    
                    55,016
                    
                    
                    44,710INVESTING
                        ACTIVITIES:Purchases
                        of property, plant and equipment
                    
                    
                    (4,705
                    )
                    
                    (4,302
                    )
                    
                    (3,671
                    )Sales
                        (purchases) of patents, trademarks and other product
                        rights
                    
                    
                    —
                    
                    
                    3,199
                    
                    
                    (7
                    )(Increase)
                        decrease in other assets
                    
                    
                    (2,111
                    )
                    
                    445
                    
                    
                    (1,813
                    )Net
                        cash used in investing activities
                    
                    
                    (6,816
                    )
                    
                    (658
                    )
                    
                    (5,491
                    )FINANCING
                        ACTIVITIES:Repayment
                        of long-term debt
                    
                    
                    (75,000
                    )
                    
                    (17,500
                    )
                    
                    (212,288
                    )Proceeds
                        from long-term debt
                    
                    
                    125,000
                    
                    
                    —
                    
                    
                    200,000Proceeds
                        from borrowings under revolving credit facility
                    
                    
                    75,500
                    
                    
                    —
                    
                    
                    25,000Repayments
                        of revolving credit facility
                    
                    
                    (75,500
                    )
                    
                    —
                    
                    
                    (25,000
                    )Repayments
                        of policy loans
                    
                    
                    —
                    
                    
                    (1,031
                    )
                    
                    —Bank
                        overdraft
                    
                    
                    5,824
                    
                    
                    —
                    
                    
                    —Repurchase
                        of common shares
                    
                    
                    (39,332
                    )
                    
                    (34,084
                    )
                    
                    (5,034
                    )Proceeds
                        from exercise of stock options
                    
                    
                    2,480
                    
                    
                    6,681
                    
                    
                    6,148Payment
                        for purchase of note hedge
                    
                    
                    (32,042
                    )
                    
                    —
                    
                    
                    —Proceeds
                        from issuance of warrant
                    
                    
                    18,581
                    
                    
                    —
                    
                    
                    —Increase
                        in debt issuance costs
                    
                    
                    (9,099
                    )
                    
                    (313
                    )
                    
                    (5,743
                    )Debt
                        retirement costs
                    
                    
                    (1,501
                    )
                    
                    (282
                    )
                    
                    (7,861
                    )Premium
                        on interest rate cap agreement
                    
                    
                    (687
                    )
                    
                    —
                    
                    
                    (1,375
                    )Tax
                        benefit realized from stock options
                    
                    
                    1,627
                    
                    
                    —
                    
                    
                    —Net
                        cash used in financing activities
                    
                    
                    (4,149
                    )
                    
                    (46,529
                    )
                    
                    (26,153
                    )EFFECT
                        OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
                    
                    
                    (257
                    )
                    
                    (695
                    )
                    
                    196CASH
                        AND CASH EQUIVALENTS:Increase
                        for the year
                    
                    
                    43,200
                    
                    
                    7,134
                    
                    
                    13,262At
                        beginning of year
                    
                    
                    47,327
                    
                    
                    40,193
                    
                    
                    26,931At
                        end of year
                    
                    $
                    90,527
                    
                    $
                    47,327
                    
                    $
                    40,193SCHEDULE
                        OF NON-CASH INVESTING AND FINANCING ACTIVITIES:Issuance
                        of 50 shares at a value of $35.37 per share in 2005 and 70
                        shares at a
                        value of $19.98 per share in 2004
                    
                    $
                    —
                    
                    $
                    1,769
                    
                    $
                    1,399
 
 *The
              accompanying notes are an integral part of these consolidated financial
              statements* .
 48
 **Notes
              to Consolidated Financial Statements**
 
 *All
              monetary and share amounts are expressed in thousands. Our fiscal years
              ended
              November 30, 2004, November 30, 2005 and November 30, 2006 are referred
              to
              herein as fiscal 2004, fiscal 2005 and fiscal 2006,
              respectively.*
 
 **(1)** **NATURE
              OF OPERATIONS**
 
  Chattem,
              Inc. and its wholly-owned subsidiaries (“we”, “us”, “our” or “Chattem”) market
              and manufacture branded over-the-counter (“OTC”) health care products. The
              products are sold primarily through mass merchandisers, independent
              and chain
              drug stores, drug wholesalers and food stores in the United States
              (“U.S.”) and
              in various markets in approximately 80 countries throughout the
              world.
 
 **(2)** **SUMMARY
              OF SIGNIFICANT ACCOUNTING POLICIES**
 
 
 **BASIS
              OF CONSOLIDATION**
  The
              accompanying consolidated financial statements include the accounts
              of Chattem and its wholly-owned subsidiaries. All significant intercompany
              transactions and balances have been eliminated.
 
 **CASH
              AND CASH EQUIVALENTS**
 
 We
              consider all short-term deposits and investments with original maturities
              of three months or less to be cash equivalents. Short-term cash investments
              are
              placed with high credit-quality financial institutions or in low risk,
              liquid
              instruments.
  **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.
              During the quarter ended November 30, 2005, our domestic operations
              changed the
              method of accounting for the cost of inventories from the last-in,
              first-out
              (LIFO) method to FIFO. We estimate reserves for inventory obsolescence
              based on
              our judgment of future realization. Based on consideration of *Icy
              Hot*  *Pro-Therapy* performing below expectations and reviewing our on-hand inventory and
              purchase
              commitments outstanding as of November 30, 2006, we provided for an
              estimate for
              obsolete inventory of $1,983, which is included as a component of cost
              of sales
              in the accompanying consolidated financial statements.
  **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 2006, fiscal 2005 and fiscal
              2004 was
              $4,191, $3,961 and $3,941 respectively.
 
 **PATENTS,
              TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS**
 
 The
              costs
              of acquired patents and other purchased product rights are capitalized and
              amortized over their respective useful lives, generally 5 years.
 
 The
              provisions of Statement of Financial Accounting Standards (“SFAS”) No. 142,
“Goodwill and Other Intangible Assets” (“SFAS 142”), require certain
              fair-value-based tests of the carrying value of indefinite-lived intangible
              assets at least annually.
 
 Under
              SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets”, we
              evaluate whether events and circumstances have occurred that indicate
              the
              remaining useful life of finite-lived assets might warrant revision
              or that the
              remaining balance may not be recoverable. When factors indicated that
              finite-lived assets should have been evaluated for
  49
 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 $693, $727 and $843 in fiscal
              2006,
              fiscal 2005 and fiscal 2004, respectively. Accumulated amortization
              of these
              costs was $1,356 and $689 at November 30, 2006 and 2005, respectively.
              Due to
              the redemption of our $75,000 of Floating Rate Senior Notes on December
              30,
              2005, we recorded a loss on early extinguishment of debt of $2,805.
              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
              accompanying consolidated statements of income. In addition, during
              fiscal 2004
              new debt issuance costs of $5,743 were capitalized. In connection with
              our
              refinancing transactions (described in Note 5) in fiscal 2005, a loss
              on early
              extinguishment of debt was recorded to the consolidated statements
              of income of
              $750. On July 25, 2006, we successfully completed the consent solicitation
              from
              the holders of the 7.0% Subordinated Notes resulting in a consent fee
              of $5,619,
              which is being amortized as additional interest expense through 2014,
              the
              remaining term of the 7.0% Subordinated Notes. On November 22, 2006,
              we
              completed a private offering of $125,000 of Convertible Senior Notes
              due 2013
              resulting in the capitalization of additional debt issuance costs of
              $3,465,
              which is being amortized as additional interest expense through
              2013.
  **BANK
              OVERDRAFT**
 
 Bank
              overdraft represents outstanding checks in excess of current cash levels.
              We
              fund bank overdrafts from our short-term investments and our operating
              cash
              flows.
 
 **PRODUCT
              DEVELOPMENT**
 
 Product
              development costs relate primarily to the development of new products and
              are expensed as incurred. Such expenses were $4,241, $3,618 and $3,051
              in fiscal
              2006, 2005 and 2004, 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
              2006, 2005 and 2004 was $64,411, $53,096 and $54,263, respectively.
              At November
              30, 2006 and 2005, we reported $2,096 and $2,087, respectively, of
              advertising paid for in fiscal 2006 and fiscal 2005, which will run
              or did run
              in the next fiscal year. These amounts are included in prepaid expenses
              and
              other current assets in the accompanying 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 (losses) which result from foreign currency transactions
              amounted
              to ($21), $189 and $194 in fiscal 2006, 2005 and 2004, respectively,
              and are
              included in the accompanying consolidated statements of income as investment
              and
              other income, net of expense.
 
 **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 2006, 2005 and 2004.
  50
 **Allowance
              For Doubtful Accounts**
 
 As
              of
              November 30, 2006, 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, 2006, we performed a detailed assessment
              of
              the collectibility of trade accounts receivable and increased our estimate
              of
              allowance for doubtful accounts by approximately $43, which resulted
              in an
              increase to selling, general and administrative expense in the accompanying
              consolidated statement of income. The balance of allowance for doubtful
              accounts
              was $346, $303 and $750 at November 30, 2006, 2005 and 2004,
              respectively.
 
 **Revenue
              Recognition**
 
 Revenue
              is recognized when our products are shipped and title transfers to
              our
              customers. It is generally our policy across all classes of customers
              that all
              sales are final. As is common in the consumer products industry, customers
              return products for a variety of reasons including products damaged
              in transit,
              discontinuance of a particular size or form of product and shipping
              errors. As
              sales are recorded, we accrue an estimated amount for product returns,
              as a
              reduction of these sales, based upon our historical experience and
              consideration
              of discontinued products, product divestitures, estimated inventory
              levels held
              by our customers and retail point of sale data on existing and newly
              introduced
              products. The level of returns may fluctuate from our estimates due
              to several
              factors including weather conditions, customer inventory levels and
              competitive
              conditions. We charge the allowance account for product returns when
              the
              customer provides appropriate supporting documentation that the product
              is
              properly destroyed or upon receipt of the product.
 
 We
              separate returns into the two categories of seasonal and non-seasonal
              products.
              We use the historical return detail of seasonal and non-seasonal products
              for at
              least the most recent three fiscal years on generally all products,
              which is
              normalized for any specific occurrence that is not reasonably likely
              to recur,
              to determine the amount of product returned as a percentage of sales,
              and
              estimate an allowance for potential returns based on product sold in
              the current
              period. To consider product sold in current and prior periods, an estimate
              of
              inventory held by our retail customers is calculated based on customer
              inventory
              detail. This estimate of inventory held by our customers, along with
              historical
              returns as a percentage of sales, is used to determine an estimate
              of potential
              product returns. This estimate of the allowance for seasonal and non-seasonal
              returns is further analyzed by considering retail customer point of
              sale data.
              We also consider specific events, such as discontinued product or product
              divestitures, when determining the adequacy of the allowance. Our estimate
              of
              product returns for seasonal and non-seasonal products as of November
              30, 2006
              was $1,204 and $1,321, respectively, $248 and $647, respectively, as
              of November
              30, 2005 and $450 and $65, respectively, as of November 30, 2004. As
              of November
              30, 2006 and November 30, 2005, estimated returns of pHisoderm product
              was $287
              and $650, respectively, due to our November 30, 2005 divestiture of
              this brand.
              Based on consideration of the sales of *Icy
              Hot*  *Pro-Therapy* performing below expectations, review of retail point of sales data
              throughout
              fiscal 2006 and an estimate of inventory on-hand at customers, we have
              estimated
              returns as of November 30, 2006 of $3,339, which decreased net sales
              in the
              accompanying consolidated statements of income. As a result of higher
              sales
              volumes in fiscal 2006, we increased our estimate of seasonal returns
              by $956,
              which resulted in a decrease to net sales in the accompanying consolidated
              statements of income. For fiscal 2005 and 2004, we decreased our estimate
              of
              seasonal returns by approximately $202 and $934, respectively, which
              resulted in
              an increase to net sales in the accompanying consolidated statements
              of income.
              During the fiscal years ended November 30, 2006 and 2005, as a result
              of our
              estimate of customer inventory levels, historical non-seasonal product
              returns
              and retail point of sale data, we increased our estimate of non-seasonal
              returns
              by approximately $674 and $582, respectively, which resulted in a decrease
              to
              net sales in the accompanying consolidated statements of income. During
              fiscal
              2004, we decreased our estimate of non-seasonal returns by approximately
              $765,
              which resulted in an increase to net sales in the accompanying consolidated
              statements of income. Each percentage point change in the seasonal
              return rate
              would impact net sales by approximately $195. Each percentage point
              change in
              the non-seasonal return rate would impact net sales by approximately
              $437.
 
  We
              routinely enter into agreements with customers to participate in promotional
              programs. The cost of these programs is recorded as either advertising
              and
              promotion expense or as a reduction of sales as prescribed by Emerging
              Issues
              Task Force 01-9, “Accounting for Consideration Given by a Vendor to a Customer
              (Including a Reseller of the Vendor’s Products)”. A significant portion of the
              programs are recorded as a reduction of sales and generally take the
              form of
              coupons and vendor allowances, which are normally taken via temporary
              price
              reductions, scan downs, display activity and
  51
 participations
              in in-store programs provided uniquely by the customer. We also enter
              into
              cooperative advertising programs with certain customers, the cost of
              which is
              recorded as advertising and promotion expense. In order for retailers
              to receive
              reimbursement under such programs, the retailer must meet specified
              advertising
              guidelines and provide appropriate documentation of the advertisement
              being run.
              During fiscal 2006 and 2005, our cooperative advertising reimbursements
              did not
              exceed the fair value of the benefits received under those
              programs.
  We
              analyze promotional programs in two primary categories -- coupons and
              vendor
              allowances. Customers normally utilize vendor allowances in the form
              of
              temporary price reductions, scan downs, display activity and participations
              in
              in-store programs provided uniquely by the customer. We estimate the
              accrual for
              outstanding coupons by utilizing a third-party clearinghouse to track
              coupons
              issued, coupon value, distribution and expiration dates, quantity distributed
              and estimated redemption rates that are provided by us. We estimate
              the
              redemption rates based on internal analysis of historical coupon redemption
              rates and expected future retail sales by considering recent point
              of sale data.
              The estimate for vendor allowances is based on estimated unit sales
              of a product
              under a program and amounts committed for such programs in each fiscal
              year.
              Estimated unit sales are determined by considering customer forecasted
              sales,
              point of sale data and the nature of the program being offered. The
              three most
              recent years of expected program payments versus actual payments made
              and
              current year retail point of sale trends are analyzed to determine
              future
              expected payments. Customer delays in requesting promotional program
              payments
              due to their audit of program participation and resulting request for
              reimbursement is also considered to evaluate the accrual for vendor
              allowances.
              The costs of these programs is often variable based on the number of
              units
              actually sold. As of November 30, 2006, the coupon and vendor allowances
              accruals were $1,236 and $3,718, respectively, $566 and $1,079, respectively,
              as
              of November 30, 2005 and $1,264 and $1,924, respectively, as of November
              30,
              2004. Each percentage point change in promotional program participation
              would
              impact net sales by approximately $157 and advertising and promotion
              expense by
              an insignificant amount.
 
 **Income
              Taxes**
 
 We
              account for income taxes using the asset and liability approach as
              prescribed by
              SFAS No. 109, “Accounting for Income Taxes”. This approach requires recognition
              of deferred tax assets and liabilities for the expected future tax
              consequences
              of events that have been included in the consolidated financial statements
              or
              tax returns. Using the enacted tax rates in effect for the year in
              which the
              differences are expected to reverse, deferred tax assets and liabilities
              are
              determined based on the differences between the financial reporting
              and the tax
              basis of an asset or liability. We record income tax expense in our
              consolidated
              financial statements based on an estimated annual effective income
              tax rate. Our
              estimated annual effective income tax rate during fiscal 2006 was 35%,
              as
              compared to 32% in fiscal 2005 and 33% in fiscal 2004, as a result
              of lower
              deductions for charitable contributions and greater apportionment in
              states with
              higher statutory tax rates.
 
 52
 **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. In
              accordance
              with SFAS 133, Accounting for Derivative Instruments and Hedging Activities,
              as
              of November 30, 2006, the interest rate cap was deemed to be an ineffective
              cash
              flow hedge due to the reduction of variable rate debt resulting in
              a loss of
              $257, net of tax, reflected in the income statement as interest
              expense.
 
 On
              November 10, 2006, we entered into a forward starting interest rate
              cap
              agreement effective January 15, 2007 as a means of managing our interest
              rate
              exposure and not for trading purposes. We paid a $687 premium to enter
              into the
              forward starting cap agreement, which will be amortized over the life
              of the
              agreement. In accordance with SFAS 133, as of November 30, 2006, the
              forward
              starting cap was deemed to be an effective cash flow hedge and the
              value of the
              premium on the forward starting cap was compared to the fair value
              of the
              forward starting cap and the change in the market value of the premium
              of $104,
              net of tax, was recorded to other comprehensive income.
 
 On
              November 10, 2006, we entered into a forward starting interest rate
              swap
              agreement effective January 15, 2007 as a means of managing our interest
              rate
              exposure and not for trading purposes. In accordance with SFAS 133,
              as of
              November 30, 2006, the forward starting swap was deemed to be an effective
              cash
              flow hedge and the change in fair value of $493, net of tax, was recorded
              to
              other comprehensive income.
  **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%, 36% and 34% of consolidated sales in fiscal 2006, 2005 and 2004,
              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 73% of total revenues during fiscal 2006, and
              approximately 71% of our total accounts receivable at November 30,
              2006.
 
 **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 2006 represented approximately $12,788 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 $8,947, $7,998, and $7,482 for fiscal 2006, 2005
              and 2004,
              respectively, are included in selling expenses in our consolidated
              statements of
              income.
 
 **STOCK-BASED
              COMPENSATION**
 
 We
              currently provide stock-based compensation under five stock incentive
              plans that
              have been approved by our shareholders. Our 1998 Non-Statutory Stock
              Option Plan
              provides for the issuance of up to 1,400 shares of common stock to
              key employees
              while the 1999 Non-Statutory Stock Option Plan for Non-Employee Directors
              allows
              for the issuance of up to 200 shares of common stock. The 2000 Non-Statutory
              Stock Option Plan provides for the issuance of up to 1,500 shares of
              common
              stock. The 2003 and 2005 Stock Incentive Plans both provide for the
              issuance of
              up to 1,500 shares of common stock. Stock options granted under all
              of these
              plans generally vest over four years from the date of grant as specified
              in the
              plans or by the compensation committee of our board of directors and
              are
              exercisable for a period of up to ten years from the date of grant.
 
 53
 Effective
              December 1, 2005, we adopted SFAS 123R, using the modified prospective
              method.
              SFAS 123R requires the recognition of the cost of employee services
              received in
              exchange for an award of equity instruments in the financial statements
              and is
              measured based on the grant date fair value of the award. SFAS 123R
              also
              requires the stock option compensation expense to be recognized over
              the period
              during which an employee is required to provide service in exchange
              for the
              award (the vesting period). Prior to our adopting SFAS 123R, we accounted
              for
              our stock-based compensation plans under APB 25 and adopted the disclosure-only
              provision of SFAS 123. 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 date of grant.
 
 For
              fiscal 2006, we recorded compensation expense related to stock options
              that
              reduced income from operations by $4,745, provision for income taxes
              by $1,656,
              net income by $3,089 and basic and diluted income per share by $0.16.
              The stock
              option compensation expense was included partly in cost of sales, advertising
              and promotion expenses and selling, general and administrative expenses
              in the
              accompanying consolidated statements of income. We capitalized $137
              of stock
              options compensation cost as a component of the carrying cost of inventory
              on-hand as of November 30, 2006.
 
 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
              $6,603, $4,292 net of tax, over the next three fiscal years.
 
 For
              options granted subsequent to our SFAS 123R adoption date of December
              1, 2005,
              the fair value of each stock option grant was estimated on the date
              of grant
              using a Flex Lattice Model. For options granted prior to our adoption
              date of
              SFAS 123R, we used the Black-Scholes option pricing model. The following
              assuptions were used to determine the fair value of stock option
              grants:
 
 For
                        the Year Ended November 30,2006
                    
                    2005
                    
                    2004Risk-free
                        interest rate
                    
                    
                    4.48
                    %
                    
                    4.49
                    %
                    
                    4.35
                    %Expected
                        dividend yield
                    
                    
                    0
                    %
                    
                    0
                    %
                    
                    0
                    %Expected
                        volatility
                    
                    
                    43
                    %
                    
                    55
                    %
                    
                    58
                    %Expected
                        life (years)
                    
                    
                    6
                    
                    
                    6
                    
                    
                    5
 
 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 and 2004 as indicated
              below:
 
 2005
                    
                    2004Net
                        income (loss):As
                        reported
                    
                    $
                    36,047
                    
                    $
                    1,451Recognized
                        stock-based compensation costs, net
                    
                    
                    —
                    
                    
                    —Fair
                        value method compensation costs, net
                    
                    
                    (10,005
                    )
                    
                    (4,465
                    )Pro
                        forma
                    
                    $
                    26,042
                    
                    $
                    (3,014
                    )Net
                        income (loss) per share, basic:As
                        reported
                    
                    $
                    1.83
                    
                    $
                    .07Pro
                        forma
                    
                    $
                    1.33
                    
                    $
                    (.16
                    )Net
                        income (loss) per share, diluted:As
                        reported
                    
                    $
                    1.77
                    
                    $
                    .07Pro
                        forma
                    
                    $
                    1.28
                    
                    $
                    (.15
                    )
 
 54
 **RECLASSIFICATIONS
              AND ADJUSTMENTS**
 
 Certain
              prior year amounts have been reclassified to conform to the current period’s
              presentation. The accrual for vendor allowances of $3,718 and $1,079
              as of
              November 30, 2006 and 2005, respectively, which was included as a component
              of
              accrued liabilities, has been reclassified as a reduction of accounts
              receivable
              and is included as a component of the allowance of $10,907 and $3,417
              that
              reduces accounts receivable as of November 30, 2006 and 2005, respectively,
              to
              the estimated net realizable value.
 
 **RECENT
              ACCOUNTING PRONOUNCEMENTS**
 
 In
              December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
              123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which is a revision of
              SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). SFAS 123R
              supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB
              25”) and amends SFAS No. 95, “Statement of Cash Flows”. SFAS 123R focuses
              primarily on accounting for transactions in which an entity obtains
              employee
              services in share-based payment transactions and requires all share-based
              payments to employees, including grants of employee stock options,
              to be
              recognized as additional compensation expense in the financial statements
              based
              on the calculated fair value of the awards. SFAS 123R also requires
              the benefits
              of tax deductions in excess of recognized compensation costs to be
              reported as a
              financing cash flow. This requirement will reduce net operating cash
              flows and
              increase net financing cash flows in periods after adoption. We adopted
              SFAS
              123R effective for our fiscal year beginning December 1, 2005. We have
              described
              the impact of adopting SFAS 123R in our consolidated financial statements
              in
              Note 2, Stock-Based Compensation.
 
 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 AJCA should be accounted
              for as a special deduction in accordance with SFAS 109 and not as a tax
              rate reduction. In accordance with FSP 109-1, we treat the deduction
              for
              qualified domestic manufacturing activities, which became effective
              beginning
              December 1, 2005, as a reduction of the income tax provision in future
              years
              when realized.
 
 In
              July 2006, FASB issued Interpretation No. 48 (“FIN 48”), “Accounting
              for Uncertainty in Income Taxes,” which clarifies the accounting for uncertainty
              in income taxes recognized in the financial statements in accordance
              with FASB
              Statement No. 109, “Accounting for Income Taxes”. FIN 48 provides guidance
              on the financial statement recognition and measurement of a tax position
              taken
              or expected to be taken in a tax return. FIN 48 also provides guidance
              on
              de-recognition, classification, interest and penalties, accounting
              in interim
              periods, disclosures, and transition. FIN 48 is effective for fiscal
              years
              beginning after December 15, 2006, or our fiscal year beginning December 1,
              2007. We are evaluating the impact of adopting FIN 48 on our consolidated
              financial statements.
 
 In
              September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS
              157”). SFAS 157 provides guidance for using fair value to measure assets
              and
              liabilities and is intended to respond to investors’ requests for expanded
              information about the extent to which companies measure assets and
              liabilities
              at fair value, the information used to measure fair value, and the
              effect of
              fair value measurements on earnings. SFAS 157 applies whenever other
              standards
              require (or permit) assets or liabilities to be measured at fair value
              but does
              not expand the use of fair value in any new circumstances. SFAS 157
              also
              requires expanded disclosure of the effect on earnings for items measured
              using
              unobservable data, establishes a fair value hierarchy that prioritizes
              the
              information used to develop those assumptions and requires separate
              disclosure
              by level within the fair value hierarchy. The provisions of SFAS 157
              are
              effective for interim financial statements issued for fiscal years
              beginning
              after November 15, 2007, or our fiscal 2008.
 
 In
              September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined
              Benefit Pension and Other Postretirement Plans -- An Amendment of FASB
              Statements No. 87, 88, 106, and 132R” (“SFAS 158”). SFAS 158 requires an
              employer to recognize in its balance sheet an asset or liability for a
              plan’s funded status, measure a plan’s assets and obligations as of the end of
              the employer’s fiscal year and recognize changes in the funded status in the
              year in which the changes occur. SFAS 158 also enhances the current
              disclosure
              requirements for pension and other postretirement plans to include
              disclosure
              related to certain effects on net periodic benefit cost. The requirement
              to
              recognize the funded status of a benefit plan and the disclosure requirements
              are effective as of the end of the fiscal year ending after December
              15, 2006,
              or
  55
 our
              fiscal 2007. The requirement to measure plan assets and benefit obligations
              as
              of the employer’s fiscal year-end is effective for fiscal years ending after
              December 15, 2008, or our fiscal 2009.
 
 In
              September 2006, the Securities and Exchange Commission released Staff
              Accounting
              Bulletin 108 (“SAB 108”). SAB 108 provides interpretative guidance on how the
              effects of the carryover or reversal of prior year misstatements should
              be
              considered in quantifying a current year misstatement. SAB 108 is effective
              for
              fiscal years ending after November 15, 2006. SAB 108 did not have an
              impact on
              our financial statements.
 
 **(3)** **SHAREHOLDERS’
              EQUITY**
 
  **COMPUTATION
              OF EARNINGS PER SHARE**
 
 The
              following table presents the computation of per share earnings for
              the years
              ended November 30, 2006, 2005 and 2004, respectively:
  For
                        the year ended November 30,2006
                    
                    2005
                    
                    2004NET
                        INCOME:
                    
                    $
                    45,112
                    
                    $
                    36,047
                    
                    $
                    1,451NUMBER
                        OF COMMON SHARES:Weighted
                        average outstanding
                    
                    
                    19,036
                    
                    
                    19,652
                    
                    
                    19,379Issued
                        upon assumed exercise ofoutstanding
                        stock options
                    
                    
                    209
                    
                    
                    684
                    
                    
                    786Effect
                        of issuance of restricted common shares
                    
                    
                    17
                    
                    
                    30
                    
                    
                    60Weighted
                        average and potential dilutive outstanding(1**)**
                    
                    
                    19,262
                    
                    
                    20,366
                    
                    
                    20,225NET
                        INCOME PER COMMON SHARE:Basic
                    
                    $
                    2.37
                    
                    $
                    1.83
                    
                    $
                    .07Diluted
                    
                    $
                    2.34
                    
                    $
                    1.77
                    
                    $
                    .07
 (1) Because
              their effects are anti-dilutive, excludes shares issuable under stock
              option
              plans and restricted stock issuance whose grant price was greater than
              the
              average market price of common shares outstanding as follows:  797 shares
              in fiscal 2006, 267 shares in fiscal 2005 and 303 shares in fiscal
              2004.
 
 56
 **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 2006, 2005 and 2004
              is presented
              below:
 
 2006
                    
                    2005
                    
                    2004Shares
                      Under
                      Option
                    
                    Weighted
                      Average
                      Exercise
                      Price
                    
                    Shares
                      Under
                      Option
                    
                    Weighted
                      Average
                      Exercise
                      Price
                    
                    Shares
                      Under
                      Option
                    
                    Weighted
                      Average
                      Exercise
                      PriceOutstanding
                        at beginning of year
                    
                    
                    1,753
                    
                    $
                    23.94
                    
                    
                    2,032
                    
                    $
                    15.38
                    
                    
                    2,444
                    
                    $
                    9.72Granted
                    
                    
                    449
                    
                    
                    37.87
                    
                    
                    548
                    
                    
                    41.99
                    
                    
                    545
                    
                    
                    28.33Exercised
                    
                    
                    (174
                    )
                    
                    14.26
                    
                    
                    (635
                    )
                    
                    10.51
                    
                    
                    (839
                    )
                    
                    7.33Cancelled
                    
                    
                    (92
                    )
                    
                    32.49
                    
                    
                    (192
                    )
                    
                    27.85
                    
                    
                    (118
                    )
                    
                    15.22Outstanding
                        at end of year
                    
                    
                    1,936
                    
                    $
                    27.63
                    
                    
                    1,753
                    
                    $
                    23.94
                    
                    
                    2,032
                    
                    $
                    15.38Options
                        exercisable at year-end
                    
                    
                    1,126
                    
                    $
                    25.13
                    
                    
                    989
                    
                    $
                    25.93
                    
                    
                    418
                    
                    $
                    9.99Weighted
                        average fair value of options granted
                    
                    
                    
                    
                    $
                    16.75
                    
                    
                    
                    
                    $
                    19.73
                    
                    
                    
                    
                    $
                    13.86Fair
                        value of options granted
                    
                    
                    
                    
                    $
                    7,520
                    
                    
                    
                    
                    $
                    11,716
                    
                    
                    
                    
                    $
                    7,690Fair
                        value of options vested
                    
                    
                    
                    
                    $
                    4,882
                    
                    
                    
                    
                    $
                    14,713
                    
                    
                    
                    
                    $
                    4,465Intrinsic
                        value of options exercised
                    
                    
                    
                    
                    $
                    4,518
                    
                    
                    
                    
                    $
                    20,393
                    
                    
                    
                    
                    $
                    15,750
 
 
 As
              of
              November 30, 2006, the aggregate intrinsic value of stock options outstanding
              was $41,543 and the weighted average remaining contractual life was
              six years.
              The aggregate intrinsic value of stock options exercisable was $26,985
              and the
              weighted average remaining contractual life was six years.
 
 As
              of
              November 30, 2006, we had $8,770 of unrecognized compensation cost
              related to
              stock options that will be recorded over a weighted average period
              of
              approximately two years.
 
 57
 A
              summary
              of the exercise prices for options outstanding under our stock-based
              compensation plans at November 30, 2006 is presented below:
  Range
                        of
                      Exercise
                        Prices
                    
                    Shares
                        Under
                      Option
                    
                    Weighted
                      Average
                        Exercise
                      Price
                    
                    Weighted
                        Average
                      Remaining
                        Life in
                      Years
                    
                    Shares
                      Exercisable
                    
                    Weighted
                      Average
                      Exercise
                        Price
                      of
                        Shares
                      Exercisable$
                         4.66 - $14.50
                    
                    
                    658
                    
                    $
                    11.68
                    
                    
                    5.71
                    
                    
                    512
                    
                    $
                    10.87$15.01
                        - $28.39
                    
                    
                    405
                    
                    
                    27.65
                    
                    
                    7.27
                    
                    
                    196
                    
                    
                    27.22$33.00
                        - $37.96
                    
                    
                    98
                    
                    
                    36.64
                    
                    
                    6.53
                    
                    
                    53
                    
                    
                    37.75$38.07
                        - $38.07
                    
                    
                    404
                    
                    
                    38.07
                    
                    
                    5.16
                    
                    
                    0
                    
                    
                    0$42.09
                        - $43.78
                    
                    
                    371
                    
                    
                    42.17
                    
                    
                    5.45
                    
                    
                    365
                    
                    
                    42.14Total
                    
                    
                    1,936
                    
                    
                    27.63
                    
                    
                    5.91
                    
                    
                    1,126
                    
                    
                    25.13
 
 **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, 2006 and 2005,
              no shares
              of any series of preferred stock were issued and outstanding.
 
 **STOCK
              REPURCHASE**
 
 On
              July
              25, 2006, we successfully completed a consent solicitation from the
              holders of
              the 7% Subordinated Notes to an amendment to the indenture to increase
              our
              capacity to make restricted payments by an additional $85.0 million,
              including
              payments for the repurchase of our common stock and adjust the fixed
              charge
              coverage ratio as defined in the indenture. In connection with the
              consent
              solicitation, our Board of Directors authorized the repurchase of up
              to an
              additional $100.0 million of our common stock under the terms of our
              existing
              stock repurchase program.
 
 In
              fiscal
              2006, 1,172 shares were repurchased at a cost of $39,332, in fiscal
              2005, 882
              shares at a cost of $34,084 were repurchased and 191 shares at a cost
              of $5,034
              were repurchased in fiscal 2004. The repurchased shares were retired
              and
              returned to unissued. As of February 1, 2007, the current amount available
              under
              the authorization from the Board of Directors was $88,147.
 
 **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, 2006,
              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 and 70 restricted shares of common stock to certain employees in
              fiscal 2005 and 2004, respectively. The market value of these shares
              on the
              dates of issuance was $1,769 and $1,399 in fiscal 2005 and 2004, 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 $712, $825 and $1,071 in fiscal 2006, 2005 and 2004,
              respectively, with the unamortized value of $1,000 and $1,818 being
              included as
              a component of shareholders’ equity in the November 30, 2006 and 2005
              consolidated balance sheets, respectively. The shares issued in fiscal
              2005 and
              2004 reduced the number of shares available for issuance under our
              2003 Stock
              Incentive Plan. No restricted shares of common stock were issued in
              fiscal
              2006.
 
 58
 A
              summary
              of our nonvested restricted stock activity as of November 30, 2006
              is presented
              below:
 
 Nonvested
                        Restricted Stock
                    
                    Number
                        of shares
                    
                    Weighted
                      Average
                        Grant-
                      Date
                        Fair ValueNonvested
                        at November 30, 2005
                    
                    
                    75
                    
                    $
                    24.27Granted
                    
                    
                    —
                    
                    
                    —Vested
                    
                    
                    (35
                    )
                    
                    21.13Forfeited
                    
                    
                    (3
                    )
                    
                    35.37Nonvested
                        at November 30, 2006
                    
                    
                    37
                    
                    $
                    26.45
 
 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 in
              fiscal 2005.
 
  **(4)** **PATENT,
              TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS**
 
 
 We
              account for intangible assets within the provisions of SFAS 142. In
              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 $20,000, which
              is
              included in our consolidated statement of income for fiscal 2004. During
              fiscal
              2006 and fiscal 2005, 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 as of November 30, 2006 and November 30,
              2005,
              respectively.
 
 The
              gross
              carrying amount of intangible assets subject to amortization at both
              November
              30, 2006 and November 30, 2005, which consist primarily of non-compete
              agreements, was $2,139, respectively. The related accumulated amortization
              of
              these intangible assets at November 30, 2006 and November 30, 2005,
              was $1,973
              and $1,735, respectively. Amortization of our intangible assets subject
              to
              amortization under the provisions of SFAS 142 was $238, $251 and $294
              for fiscal
              2006, 2005 and 2004, respectively. Estimated annual amortization expense
              for
              these assets for fiscal 2007, 2008, 2009, 2010 and 2011 is $106, $40,
              $20, $0
              and $0, respectively. Royalty expense related to other purchased product
              rights
              for fiscal 2006, 2005 and 2004 was $78, $112 and $107, respectively.
              Amortization and royalty expense are included in advertising and
              promotion expense in the accompanying consolidated statements of
              income.
 
 **(5)** **LONG-TERM
              DEBT**
 
  Long-term
              debt consisted of the following as of November 30, 2006 and 2005:
  2006
                    
                    2005Amended
                        Revolving Credit Facility due 2010 at a variable rate of
                        8.25% and
                        7.00% as ofNovember
                        30, 2006 and 2005, respectively
                    
                    $
                    —
                    
                    $
                    —Floating
                        Rate Senior Notes due 2010 at a variable rate of 7.41%  and 6.87% as
                        of December 30, 2005 (date redeemed) and November 30, 2005,
                        respectively
                    
                    
                    —
                    
                    
                    75,0002.0%
                        Convertible Senior Notes due 2013
                    
                    
                    125,000
                    
                    
                    —7.0%
                        Senior Subordinated Notes due 2014
                    
                    
                    107,500
                    
                    
                    107,500Total
                        long-term debt
                    
                    
                    232,500
                    
                    
                    182,500Less:
                      current maturities
                    
                    
                    —
                    
                    
                    37,000Total
                        long-term debt, net of current maturities
                    
                    $
                    232,500
                    
                    $
                    145,500
 
 59
 On
              February 26, 2004, we entered into a new Senior Secured Revolving Credit
              Facility with a maturity date of February 26, 2009 (the “Revolving Credit
              Facility”) with Bank of America, N.A. that provided an initial borrowing
              capacity of $25,000 and an additional $25,000, subject to successful
              syndication. On March 9, 2004, we entered into a new commitment agreement
              with a
              syndicate of commercial banks led by Bank of America, N.A., as agent,
              that
              enabled us to borrow up to a total of $50,000 under the Revolving Credit
              Facility and an additional $50,000, subject to successful syndication.
              On
              November 29, 2005, we entered into an amendment to our Revolving Credit
              Facility
              (the “Amended Revolving Credit Facility”) that, among other things, increased
              our borrowing capacity under the facility from $50,000 to $100,000,
              increased
              our flexibility to repurchase shares of our stock, improved our borrowing
              rate
              under the facility and extended the maturity date to November 15, 2010.
              Upon
              successful syndication, we are able to increase the borrowing capacity
              under the
              Amended Revolving Credit Facility by $50,000 to an aggregate of $150,000.
              On
              November 16, 2006, we entered into an amendment to our Amended Revolving
              Credit
              Facility that, among other things, permitted the sale of the Convertible
              Notes.
              On January 2, 2007, we completed an amended credit facility providing
              for up to
              a $100,000 revolving credit facility and a $300,000 term loan (the “Credit
              Facility”).
              The proceeds from the term loan under the Credit Facility were used
              to finance
              in part the acquisition of the five consumer and OTC brands from Johnson
&
Johnson. The Credit Facility includes an “accordian” feature that permits us
              under certain circumstances to increase our borrowings under the revolving
              credit facility by $50,000 and to borrow an additional $50,000 as a
              term
              loan.
  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
              up to 0.5%.
              The applicable percentages are calculated based on our leverage ratio.
              As of
              November 30, 2006 and 2005, there were no borrowings outstanding under
              the
              Amended Revolving Credit Facility, and the variable rate was 8.25% and
              7.00%, respectively. 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. As of February 1, 2007, we had $38,000
              of
              borrowings outstanding under the revolving credit facility under our
              Credit
              Facility and our borrowing capacity was $62,000.
 
 On
              February 26, 2004, we issued and sold $75,000 of Floating Rate Senior
              Notes due
              March 1, 2010 (the “Floating Rate Senior Notes”) and $125,000 of 7.0%
              Subordinated Notes due 2014, the proceeds of which were used to purchase
              the
              outstanding $204,538 of our 8.875% Senior Subordinated Notes due 2008
              on
              February 26, 2004 and April 1, 2004 and refinance our then existing
              credit
              facility. The repurchases resulted in a loss on early extinguishment
              of debt of
              $12,958.
 
 On
              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. As of November 30, 2006,
              increases
              in the variable interest rate of up to $60,000 of LIBOR based borrowings
              could
              be hedged under the provisions of the cap. We had $0 of LIBOR based
              borrowings
              with an interest rate capped at 4.0% as of November 30, 2006. During
              the year
              ended November 30, 2006, 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 $312, was recorded as a component
              of interest
              expense on the accompanying consolidated statement of income. The current
              portion of the premium on the interest rate cap agreement of $284 is
              included in prepaid expenses and other current assets, and the long-term
              portion
              of $484 is included in other non-current assets. As of November 30,
              2006, the
              interest rate cap was deemed to be an ineffective cash flow hedge resulting
              in
              de-designation. A loss of $27 from other comprehensive income was reflected
              in
              the income statement as interest expense. 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.
 
 Interest
              payments on the 7.0% Subordinated Notes are due semi-annually in arrears
              on
              March 1 and September 1. Our domestic subsidiaries are guarantors of
              the 7.0%
              Subordinated Notes. The guarantees of the 7.0% Subordinated Notes are
              unsecured
              senior subordinated obligations of the guarantors. At any time after
              March 1,
              2009, we may redeem any of the 7.0% Subordinated Notes upon not less
              than 30 nor
              more than 60 days’ notice at redemption prices (expressed in percentages of
              principal amount), plus accrued and unpaid interest, if any, and liquidation
              damages, if any, to the applicable redemption rate, if redeemed during
              the
              twelve-month periods beginning March 1, 2009 at 103.500%, March 1,
              2010 at
              102.333%, March 1, 2011 at 101.167% and March 1, 2012 and thereafter
              at
              100.000%. At any time prior to March 1, 2007, we may redeem up to 35%
              of the
              aggregate principal amount of the 7.0% Subordinated Notes (including
              any
              additional 7.0% Subordinated Notes) at a redemption price of 107.0%
              of the
              principal amount thereof, plus accrued and unpaid interest and liquidated
              damages, if any, thereon to the applicable redemption rate, with the
              net cash
              proceeds of one or more qualified equity offerings; provided, that
              (i) at least
              65.0% of the aggregate principal amount of the 7.0% Subordinated Notes
              remains
              outstanding immediately after the occurrence of such redemption (excluding
              the
              7.0% Subordinated Notes held by us and our subsidiaries); and (ii)
              the
              redemption must occur within 90 days of the date of the closing of
              such
              qualified equity offering.
 
 60
 The
              indenture governing the 7.0% Subordinated Notes, among other things,
              limits our
              ability and the ability of our restricted subsidiaries to: (i) borrow
              money or
              sell preferred stock, (ii) create liens, (iii) pay dividends on or
              redeem or
              repurchase stock, (iv) make certain types of investments, (v) sell
              stock in our
              restricted subsidiaries, (vi) restrict dividends or other payments
              from
              restricted subsidiaries, (vii) enter into transactions with affiliates,
              (viii)
              issue guarantees of debt and (ix) sell assets or merge with other companies.
              In
              addition, if we experience specific kinds of changes in control, we
              must offer
              to purchase the 7.0% Subordinated Notes at 101.0% of their principal
              amount plus
              accrued and unpaid interest.
 
 During fiscal
              2005, we repurchased $17,500 of our 7.0% Subordinated Notes in the
              open market
              at an average premium of 1.6% over the principal amount of the notes.
              The
              repurchases resulted in a loss on early extinguishment of debt, including
              related expenses of $750. The outstanding balance of the remaining
              7.0%
              Subordinated Notes was reduced to $107,500.
 
 On
              November 30, 2005, we called our $75,000 of Floating Rate Senior Notes
              for full
              redemption on December 30, 2005. On December 30, 2005, we fully redeemed
              our
              $75,000 of Floating Rate Senior Notes at a price of 102% of par plus
              accrued
              interest to December 30, 2005. We utilized borrowings of $38,000 under
              our
              Amended Revolving Credit Facility and $38,948 of our cash on hand to
              fund the
              redemption of the Floating Rate Senior Notes. As a result of the redemption,
              we
              paid a 2% premium over par or $1,500, retired associated debt issuance
              costs of
              $1,303 and incurred other related call fees, which resulted in a loss
              on early
              extinguishment of debt of $2,805 during the first quarter of fiscal
              2006.
 
 On
              July
              25, 2006, we successfully completed a consent solicitation from the
              holders of
              the 7.0% Subordinated Notes to an amendment to the indenture to increase
              our
              capacity to make restricted payments by an additional $85,000, including
              payments for the repurchase of our common stock, and adjust the fixed
              charge
              coverage ratio as defined in the indenture.
 
 On
              November 22, 2006, we completed a private offering of $125,000 of 2.0%
              convertible senior notes due 2013 (“Convertible Notes”) to qualified
              institutional investors pursuant to Section 4(2) of the Securities
              Act of 1933.
              The Convertible Notes bear interest at an annual rate of 2.0%, payable
              semi-annually on May 15 and November 15 of each year, with the first
              interest
              payment due on May 15, 2007. The Convertible Notes are convertible
              into our
              common stock at an initial conversion price of $58.92 per share, upon
              the
              occurrence of certain events, including the closing price of our common
              stock
              exceeding 130% of the conversion price per share for 20 of the last
              30 trading
              days of the conversion reference period. The stock price at which the
              notes
              would be convertible is $76.59 and as of November 30, 2006 our closing
              stock
              price was $48.65. Upon
              conversion, a holder will receive, in lieu of common stock, an amount
              of cash
              equal to the lesser of (i) the principal amount of the convertible note, or
              (ii) the conversion value, determined in the manner set forth in the
              indenture governing the Convertible Notes, of a number of shares equal
              to the
              conversion rate. If the conversion value exceeds the principal amount
              of the
              Convertible Note on the conversion date, we will also deliver, at our
              election,
              cash or common stock or a combination of cash and common stock with
              respect to
              the conversion value upon conversion. If conversion occurs in connection
              with a
              change of control, we may be required to deliver additional shares
              of our common
              stock by increasing the conversion rate with respect to such notes.
              The maximum
              aggregate number of shares that we would be obligated to issue upon
              conversion
              of the Convertible Notes is 2,673.
 
 Concurrently
              with the sale of the Convertible Notes, we purchased a note hedge from
              an
              affiliate of Merrill Lynch (the “Counterparty”), which is designed to mitigate
              potential dilution from the conversion of Convertible Notes. Under
              the note
              hedge, the Counterparty is required to deliver to us the number of
              shares of our
              common stock that we are obligated to deliver to the holders of the
              Convertible
              Notes with respect to the conversion, calculated exclusive of shares
              deliverable
              by us by reason of any additional premium relating to the Convertible
              Notes or
              by reason of any election by us to unilaterally increase the conversion
              rate
              pursuant to the indenture governing the Convertible Notes. The note
              hedge
              expires at the close of trading on November 15, 2013, which is the maturity
              date of the Convertible Notes, although the Counterparty will have
              ongoing
              obligations with respect to Convertible Notes properly converted on
              or prior to
              that date of which the Counterparty has been timely notified.
 
 In
              addition, we issued warrants to the Counterparty that could require
              us to issue
              up to approximately 2,122 shares of our common stock on November 15, 2013
              upon notice of exercise by the Counterparty. The exercise price is
              $74.82 per
              share, which represented a 60.0% premium over the closing price of
              our shares of
              common stock on November 16, 2006. If the Counterparty exercises the
              warrant, we will have the option to settle in cash or shares the excess
              of the
              price of our shares on that date over the initially established exercise
              price.
 
 The
              note
              hedge and warrant are separate and legally distinct instruments that
              bind Chattem and the Counterparty and have no binding effect on the holders
              of the Convertible Notes.
 
 61
 Pursuant
              to EITF 90-19, *Convertible Bonds with Issuer Option to Settle for Cash upon
              Conversion* ,
              (“EITF
              90-19”), *Accounting for Derivative Financial Instruments Indexed to, and Potentially
              Settled in, a Company’s Own Stock* (“EITF
              00-19”), and EITF 01-6, *The
              Meaning of Indexed to a Company’s Own Stock* (“EITF
              01-6”), the Convertible Notes are accounted for as convertible debt in the
              accompanying consolidated balance sheet and the embedded conversion
              option in
              the Convertible Notes has not been accounted for as a separate derivative.
              Additionally, pursuant to EITF 00-19 and EITF 01-6, the note hedge
              and warrants
              are accounted for as equity transactions, and therefore, the payment
              associated
              with the issuance of the note hedge and the proceeds received from
              the issuance
              of the warrants were recorded as a charge and an increase, respectively,
              in
              common shares in shareholders’ equity as separate equity
              transactions.
 
 For
              income tax reporting purposes, we have elected to integrate the Convertible
              Notes and the note hedge transaction. Integration of the note hedge
              with the
              Convertible Notes creates an in-substance original issue debt discount
              for
              income tax reporting purposes and therefore the cost of the note hedge
              will be
              accounted for as interest expense over the term of the Convertible
              Notes for
              income tax reporting purposes. The associated income tax benefit was
              recognized
              as a deferred tax asset.
 
 Proceeds
              from the Convertible Notes were used to repay amounts outstanding under
              our
              Amended Revolving Credit Facility at the date of the sale of the notes,
              pay
              $32,042 for the cost of the note hedge, pay approximately $3,465 in
              issuance
              costs and partially fund the acquisition as described in Note 9.
 
 On
              November 22, 2006, we entered into a forward starting interest rate
              cap
              agreement effective January 15, 2007. The forward starting cap has
              decreasing
              notional principal amounts beginning October 15, 2007 and a cap rate
              of 5.0%
              over the life of the agreement. We paid a $687 premium to enter into
              the forward
              starting cap agreement, which will be amortized over the life of the
              agreement.
              During the year ended November 30, 2006, the value of the premium on
              the forward
              starting cap was compared to the fair value of the forward starting
              cap and the
              change in the market value of the premium of $104, net of tax, was
              recorded to
              other comprehensive income. The current portion of the premium on the
              forward
              starting cap agreement of $231 is included in prepaid expenses and other
              current assets, and the long-term portion of $291 is included in other
              non-current assets. As of November 30, 2006, the entire forward starting
              cap was
              deemed to be an effective cash flow hedge. The fair value of the forward
              starting cap agreement is valued by a third party. The forward starting
              cap
              agreement terminates on January 15, 2010.
 
 On
              November 22, 2006, we entered into a forward starting interest rate
              swap
              agreement effective January 15, 2007. The forward starting swap has
              decreasing
              notional principal amounts beginning October 15, 2007 and a swap rate
              of 4.98%
              over the life of the agreement. During the year ended November 30,
              2006, the
              value of the premium on the forward starting swap was compared to the
              fair value
              of the forward starting swap and the change in the market value of
              $493, net of
              tax, was recorded to other comprehensive income. The current portion
              of the fair
              value of the forward starting swap of $230 is included in accrued
              liabilities, and the long-term portion of $560 is included in other
              non-current
              liabilities. As of November 30, 2006, the entire forward starting swap
              was
              deemed to be an effective cash flow hedge. The fair value of the forward
              starting swap agreement is valued by a third party. The forward starting
              swap
              agreement terminates on January 15, 2010.
 
 The
              future maturities of long-term debt outstanding as of November 30,
              2006 are as
              follows:
 
 2007
                    
                    $
                    —2008
                    
                    
                    —2009
                    
                    
                    —2010
                    
                    
                    —2011
                    
                    
                    —Thereafter
                    
                    
                    232,500$
                    232,500
 
 Cash
              interest payments during 2006, 2005 and 2004 were $10,831, $12,791
              and $14,092,
              respectively.
 
 **(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.
 
 62
 At
              November 30, 2006, the carrying value of the 7.0% Subordinated Notes
              and the
              Convertible Notes equaled their estimated fair market value. 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
              2006,
              2005 and 2004:
 
 2006
                    
                    2005
                    
                    2004Current:Federal
                    
                    $
                    23,009
                    
                    $
                    12,710
                    
                    $
                    2,916State
                    
                    
                    1,058
                    
                    
                    359
                    
                    
                    14Deferred
                    
                    
                    111
                    
                    
                    3,894
                    
                    
                    (2,227
                    )$
                    24,178
                    
                    $
                    16,963
                    
                    $
                    703
 
 As
              of
              November 30, 2006, we had a foreign tax credit of $2,049 which will
              expire over
              nine years beginning in fiscal 2009 through 2014, and state net operating
              loss
              carry forwards of $6,384, which will begin to expire in 2019 through
              2020 if
              unused. In fiscal 2006, 2005 and 2004 income tax benefits of $1,627,
              $5,839 and
              $5,568, respectively, attributable to employee stock option transactions
              were
              allocated to shareholders’ equity.
      
 63
 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, 2006 and 2005,
              are as
              follows:
 
 2006
                    
                    2005Deferred
                        tax assets:Allowances
                        and accruals
                    
                    $
                    761
                    
                    $
                    1,511Inventory
                        reserve
                    
                    
                    1,034
                    
                    
                    166Stock-based
                        compensation expense
                    
                    
                    1,737
                    
                    
                    —Allowance
                        for product returns
                    
                    
                    2,150
                    
                    
                    651State
                        net operating loss carryforwards
                    
                    
                    270
                    
                    
                    836Accrued
                        postretirement health care benefits
                    
                    
                    535
                    
                    
                    671Note
                        hedge call option
                    
                    
                    12,048
                    
                    
                    —Other
                    
                    
                    3,929
                    
                    
                    2,422Gross
                        deferred tax assets
                    
                    
                    22,464
                    
                    
                    6,257Valuation
                        allowance
                    
                    
                    —
                    
                    
                    —Net
                        deferred tax assets
                    
                    
                    22,464
                    
                    
                    6,257Deferred
                        tax liabilities:Depreciation
                        and amortization
                    
                    
                    33,588
                    
                    
                    29,402Prepaid
                        advertising
                    
                    
                    788
                    
                    
                    751Inventory
                    
                    
                    350
                    
                    
                    —Other
                    
                    
                    1,065
                    
                    
                    1,362Gross
                        deferred tax liabilities
                    
                    
                    35,791
                    
                    
                    31,515Net
                        deferred liability
                    
                    $
                    13,327
                    
                    $
                    25,258
  The
              deferred provision for income taxes excludes the tax effect of the
              note hedge
              call option of $12,048 for fiscal 2006, the interest rate cap adjustment
              of $311
              and $131 for fiscal 2006 and 2005, respectively, and the foreign currency
              translation adjustment of $317 and $191 for fiscal 2006 and 2005, respectively,
              which are included in the consolidated statements of shareholders’
equity.
  In
              fiscal
              2005, we released a previously recorded 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 by the United States statutory
              rate for
              fiscal 2006, 2005 and 2004 is summarized as follows:
  2006
                    
                    2005
                    
                    2004Expected
                        federal tax provision
                    
                    $
                    24,252
                    
                    $
                    18,544
                    
                    $
                    751State
                        income taxes, net of federal income tax benefit
                    
                    
                    1,022
                    
                    
                    424
                    
                    
                    29Foreign
                        permanently reinvested
                    
                    
                    —
                    
                    
                    —
                    
                    
                    (643
                    )Reversal
                        of valuation allowance
                    
                    
                    —
                    
                    
                    (610
                    )
                    
                    —Other,
                        net
                    
                    
                    (1,096
                    )
                    
                    (1,395
                    )
                    
                    566$
                    24,178
                    
                    $
                    16,963
                    
                    $
                    703
 
 
 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 2006, 2005 and 2004 were $21,665, $6,733 and $323,
              respectively. We received income tax refunds of $376, $97 and $2,554
              during
              fiscal 2006, 2005 and 2004, respectively.
 
 64
 **(8)** **SUPPLEMENTAL
              FINANCIAL INFORMATION**
 
 
 Inventories
              consisted of the following at November 30, 2006 and 2005:
 
 2006
                    
                    2005Raw
                        materials and work in process
                    
                    $
                    15,495
                    
                    $
                    12,388Finished
                        goods
                    
                    
                    15,894
                    
                    
                    11,243Total
                        inventories
                    
                    $
                    31,389
                    
                    $
                    23,631
 
 International
              inventories included above were $2,785 and $3,009 at November 30, 2006 and
              2005, respectively.
 
 Property,
              plant and equipment consisted of the following at November 30, 2006
              and
              2005:
 
 2006
                    
                    2005Land
                    
                    $
                    1,123
                    
                    $
                    1,046Buildings
                        and improvements
                    
                    
                    10,607
                    
                    
                    9,727Machinery
                        and equipment
                    
                    
                    57,116
                    
                    
                    53,500Package
                        design and tooling
                    
                    
                    6,928
                    
                    
                    6,504Construction
                        in progress
                    
                    
                    1,265
                    
                    
                    2,288Total
                        property, plant and equipment
                    
                    
                    77,039
                    
                    
                    73,065Less
                        - accumulated depreciation
                    
                    
                    (46,686
                    )
                    
                    (43,181
                    )Property,
                        plant and equipment, net
                    
                    $
                    30,353
                    
                    $
                    29,884
 
 Accrued
              liabilities consisted of the following at November 30, 2006 and
              2005:
  2006
                    
                    2005Interest
                    
                    $
                    2,599
                    
                    $
                    3,201Salaries,
                        wages and commissions
                    
                    
                    3,878
                    
                    
                    5,991Product
                        advertising and promotion
                    
                    
                    1,936
                    
                    
                    1,510Litigation
                        settlements and legal fees
                    
                    
                    1,162
                    
                    
                    2,212Income
                        Taxes Payable
                    
                    
                    635
                    
                    
                    —Other
                    
                    
                    1,595
                    
                    
                    2,334Total
                        accrued liabilities
                    
                    $
                    11,805
                    
                    $
                    15,248
 
 **(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,
              except that Abbott continued to manufacture *Selsun* for us
              for the European, Middle East and several Latin American markets at
              agreed upon
              rates until 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).
 
 65
 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.
  On
              January 2, 2007, we acquired the U.S. rights to five leading consumer
              and OTC brands from Johnson & Johnson for $410,000. The acquisition was
              funded with the proceeds from a new $300,000 term loan provided under
              our Credit
              Facility, borrowings under the revolving credit facility under the
              Credit
              Facility and through the use of a portion of the proceeds derived from
              the
              Convertible Notes. Due to the timing of the acquisition relative to
              our year-end
              and the issuance date of our annual results, we are in the process of
              obtaining a third-party valuation to assist in the purchase price
              allocation.
 
 **(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,
              2006 and 2005
              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 2006
              and 2004, a
              curtailment loss of $54 and $88, respectively, resulted from benefits
              paid
              exceeding interest costs.
 
 Net
              periodic pension cost for fiscal 2006, 2005 and 2004 comprised the
              following
              components:
  2006
                    
                    2005
                    
                    2004Service
                        cost
                    
                    $
                    —
                    
                    $
                    —
                    
                    $
                    —Interest
                        cost on projected benefit obligation
                    
                    
                    610
                    
                    
                    622
                    
                    
                    609Actual
                        return on plan assets
                    
                    
                    (882
                    )
                    
                    (858
                    )
                    
                    (2,626
                    )Net
                        amortization and deferral
                    
                    
                    5
                    
                    
                    28
                    
                    
                    2,038Settlement/Curtailment
                        loss
                    
                    
                    54
                    
                    
                    —
                    
                    
                    88Net
                        pension cost (benefit)
                    
                    $
                    (213
                    )
                    $
                    (208
                    )
                    $
                    109
 
 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 2006 and 2005:
  2006
                    
                    2005Projected
                        benefit obligation, beginning of year
                    
                    $
                    11,119
                    
                    $
                    10,998Interest
                        cost
                    
                    
                    610
                    
                    
                    622Actuarial
                        loss
                    
                    
                    9
                    
                    
                    —Benefits
                        paid
                    
                    
                    (1,005
                    )
                    
                    (501
                    )Settlements
                    
                    
                    —
                    
                    
                    —Projected
                        benefit obligation, end of year
                    
                    $
                    10,733
                    
                    $
                    11,119
 
 The
              change in Plan assets resulted from the following components for fiscal
              2006 and
              2005:
 2006
                    
                    2005Fair
                        value of plan assets, beginning of year
                    
                    $
                    11,564
                    
                    $
                    11,020Actual
                        return on plan assets
                    
                    
                    1,481
                    
                    
                    1,045Employer
                        contribution
                    
                    
                    —
                    
                    
                    —Benefits
                        paid
                    
                    
                    (1,005
                    )
                    
                    (501
                    )Fair
                        value of plan assets, end of year
                    
                    $
                    12,040
                    
                    $
                    11,564
 
 The
              following table sets forth the funded status of the Plan as of November
              30, 2006
              and 2005:
 
 2006
                    
                    2005Plan
                        assets at fair market value
                    
                    $
                    12,040
                    
                    $
                    11,564Projected
                        benefit obligation
                    
                    
                    10,733
                    
                    
                    11,119Funded
                        status
                    
                    
                    1,307
                    
                    
                    445Unrecognized
                        net loss
                    
                    
                    526
                    
                    
                    1,176Prepaid
                        pension costs
                    
                    
                    1,833
                    
                    
                    1,621Net
                        pension asset recognized in balance sheets at end of year
                    
                    $
                    1,833
                    
                    $
                    1,621
  66
 The
              discount rate used in determining the actuarial present value of the
              projected
              benefit obligation was 5.75% in fiscal 2006 and 2005, respectively. The
              expected long-term rate of return on plan assets was 8% in fiscal 2006 and
              2005, respectively. The Plan’s long-term return on assets is based on the
              weighted-average of the Plan’s invested allocation as of the measurement date
              and the available historical returns for those asset categories as
              published by
              Ibbotson Associates, a leading provider of historical financial market
              data.
 
 Our
              existing investment policy of the 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, 2006 and 2005
              by asset
              class are as follows:
 
 Plan
                        Assets at
                      November
                        30,Asset
                        Class
                    
                    2006
                    
                    2005Mutual
                        funds
                    
                    
                    92
                    %
                    
                    93
                    %Equity
                        securities
                    
                    
                    8
                    
                    
                    6Debt
                        securities
                    
                    
                    —
                    
                    
                    —Money
                        Market
                    
                    
                    —
                    
                    
                    1Total
                    
                    
                    100
                    %
                    
                    100
                    %
 
 As
              of
              November 30, 2006, we had 20 shares of our common stock in the Plan
              with a fair
              value of $1,002.
 
 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 8.55%
              for fiscal 2006 and 8.44% for fiscal 2005.
 
 The
              following benefit payments, which reflect expected future service,
              as
              appropriate, are expected to be paid:
 
 Estimated
                        BenefitPayment2007
                    
                    $
                    6002008
                    
                    
                    6102009
                    
                    
                    6202010
                    
                    
                    6302011
                    
                    
                    6402012-2016
                    
                    
                    2,500
 
 No
              employer contributions are expected to be required to be paid in fiscal
              2007.
 
 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 $249, $235
              and $223
              in fiscal 2006, 2005 and 2004, 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
              $758, $751 and $698 in fiscal 2006, 2005 and 2004, 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. Effective May 31, 2006, we adopted
              an amendment
              to change the eligibility requirements for employee participation and
              limit the
              annual benefit to be paid. This action resulted in a curtailment gain
              of
  67
 $496
              and
              is included as a component of selling, general and administrative expenses
              in
              the accompanying condensed consolidated statements of income.
  Net
              periodic postretirement health care benefits cost for fiscal 2006,
              2005 and 2004
              included the following components:
 
 2006
                    
                    2005
                    
                    2004Service
                        cost
                    
                    $
                    57
                    
                    $
                    72
                    
                    $
                    63Interest
                        cost on accumulated postretirement
                      benefit
                        obligation
                    
                    
                    73
                    
                    
                    82
                    
                    
                    80Amortization
                        of prior service cost
                    
                    
                    15
                    
                    
                    15
                    
                    
                    15Amortization
                        of net gain
                    
                    
                    (16
                    )
                    
                    (17
                    )
                    
                    (30
                    )Net
                        periodic postretirement benefits cost
                    
                    $
                    129
                    
                    $
                    152
                    
                    $
                    128
 
 The
              change in the accumulated benefit obligation resulted from the following
              components for fiscal 2006 and 2005:
 
 2006
                    
                    2005Accumulated
                        benefit obligation, beginning of year
                    
                    $
                    1,566
                    
                    $
                    1,488Service
                        cost
                    
                    
                    57
                    
                    
                    72Interest
                        cost
                    
                    
                    73
                    
                    
                    82Actuarial
                        (gain)/loss
                    
                    
                    19
                    
                    
                    (13
                    )Benefits
                        paid
                    
                    
                    (71
                    )
                    
                    (63
                    )Curtailments
                    
                    
                    (550
                    )
                    
                    —Accumulated
                        benefit obligation, end of year
                    
                    $
                    1,094
                    
                    $
                    1,566
 
 The
              following table sets forth the funded status of the plan at November
              30, 2006
              and 2005:
 
 2006
                    
                    2005Accumulated
                        benefit obligation
                    
                    $
                    1,094
                    
                    $
                    1,566Fair
                        value of plan assets
                    
                    
                    —
                    
                    
                    —Funded
                        status
                    
                    
                    (1,094
                    )
                    
                    (1,566
                    )Unrecognized
                        prior service cost
                    
                    
                    —
                    
                    
                    69Unrecognized
                        actuarial gain
                    
                    
                    (334
                    )
                    
                    (368
                    )Accrued
                        postretirement benefits cost
                    
                    $
                    (1,428
                    )
                    $
                    (1,865
                    )
  The
              weighted-average discount rate used in determining the accumulated
              postretirement benefit obligation was 5.75% at November 30, 2006 and
              2005,
              respectively.
 
 For
              measurement purposes in fiscal 2006 and 2005, 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, 2006 or the aggregate of the
              service and
              interest cost components of the net annual postretirement benefit cost for
              the year ended November 30, 2006.
 
 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
                        BenefitPayment2007
                    
                    $
                    782008
                    
                    
                    782009
                    
                    
                    782010
                    
                    
                    782011
                    
                    
                    782012-2016
                    
                    $
                    400
 
 68
 Employer
              contributions expected for fiscal 2007 are approximately $78.
 
 **(12)** **PRODUCT
              AND GEOGRAPHICAL SEGMENT INFORMATION**
 
 We
              currently operate in only one primary segment - OTC health care. This
              segment
              includes topical pain care, medicated skin care, dietary supplement,
              medicated
              dandruff shampoo and other OTC products.
 
 Geographical
              segment information is as follows for fiscal 2006, 2005 and 2004:
 
 2006
                    
                    2005
                    
                    2004Revenues:Domestic
                    
                    $
                    276,397
                    
                    $
                    252,436
                    
                    $
                    234,003International(1)
                    
                    
                    24,151
                    
                    
                    26,882
                    
                    
                    24,152Total
                    
                    $
                    300,548
                    
                    $
                    279,318
                    
                    $
                    258,155Long-Lived
                        Assets(2)Domestic
                    
                    $
                    235,909
                    
                    $
                    235,729
                    
                    $
                    254,059International
                    
                    
                    593
                    
                    
                    542
                    
                    
                    266Total
                    
                    $
                    236,502
                    
                    $
                    236,271
                    
                    $
                    254,325
  (1)
                      International
                          sales include export sales from United States operations
                          and royalties
                          from international sales of*Selsun*.
                          These
                          royalties were $228, $178 and $621 for fiscal 2006, 2005
                          and 2004,
                          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 2006, 2005 and 2004:
 
 2006
                    
                    2005
                    
                    2004Revenues:Topical
                        pain care products
                    
                    $
                    101,396
                    
                    $
                    89,539
                    
                    $
                    76,300Medicated
                        skin care products
                    
                    
                    67,238
                    
                    
                    62,458
                    
                    
                    60,495Dietary
                        supplements
                    
                    
                    35,081
                    
                    
                    33,828
                    
                    
                    33,011Medicated
                        dandruff shampoos
                    
                    
                    37,742
                    
                    
                    34,880
                    
                    
                    31,309Other
                        OTC and toiletry products
                    
                    
                    34,940
                    
                    
                    31,731
                    
                    
                    32,888Total
                    
                    $
                    276,397
                    
                    $
                    252,436
                    
                    $
                    234,003
  **(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 J. Rothstein ( *In
              Re
              Phenylpropanolamine (“PPA”) Products Liability Litigation, MDL No.
              1407* ).
              The
              remaining lawsuits were filed in state court in a number of different
              states.
  On
              April
              13, 2004, we entered into a class action settlement agreement with
              representatives of the plaintiffs’ settlement class, which provided for a
              national class action settlement of all *Dexatrim* PPA
              claims. On November 12, 2004, Judge Barbara J. Rothstein of the United
              States
              District Court for the Western District of Washington entered a final
              order and
              judgment certifying the class and granting approval of the *Dexatrim* PPA
              settlement.
  The *Dexatrim* PPA
              settlement included claims against us involving alleged injuries by *Dexatrim* products
              containing PPA in which the alleged injury occurred after December
              21, 1998, the
              date we acquired the *Dexatrim* brand.
              In accordance with the terms of the class action settlement agreement,
              we
              previously published notice of the settlement and details as to the
  69
 manner
              in
              which claims could be submitted. The deadline for submission of claims
              was July
              7, 2004. A total of 391 claims were certified by the court as timely
              submitted. A
              total
              of 14 claimants with alleged injuries that occurred after December
              21, 1998
              elected to opt out of the class settlement. Subsequently, we have settled eleven of the
              opt out claims. The three remaining opt out claimants may pursue claims for damages against us
              in separate
              lawsuits. As of  January,
              2007, one of the three remaining
              opt-out claimants has filed a
              lawsuit against
              us .
              The
              other two opt-outs have not filed lawsuits against us and we believe
              the
              applicable statutes of limitation have run against their claims. Consequently, we are currently defending one PPA products liability
              claim.
  In
              accordance with the terms of the class action settlement, approximately
              $70,885
              was initially funded into a settlement trust .
              Over
              the past two years, we have resolved all of the claims submitted in
              the *Dexatrim* PPA
              settlement. All claims in the settlement and expenses of the trust
              have now been
              paid. On June 14, 2006, we filed a motion to dissolve the settlement
              trust. The
              court granted this motion on July 14, 2006. On August 31, 2006, the
              settlement
              trust paid us $10,720, which is included as a component of litigation
              settlement
              in our condensed consolidated statement of income for 2006.
              The settlement trust currently has a balance of approximately $2,805.
              We expect
              to use those funds to resolve the pending
              opt-out PPA case .
              Any
              funds remaining after we resolve the opt-out case will be
              returned to one of our insurance carriers. We currently do not expect
              to record
              any additional charges relative to the settlement of the PPA litigation,
              except
              for legal expenses that will be recorded in the period incurred. During
              the past
              year
              ending November
              30 ,
              2006,
              we also recorded net expenses of approximately $178 related to the *Dexatrim* litigation.
  We
              were
              also named as a defendant in approximately 206 lawsuits relating to *Dexatrim* containing PPA which involve alleged injuries by *Dexatrim* products
              containing PPA manufactured and sold prior to our acquisition of *Dexatrim* on
              December 21, 1998. The
              DELACO Company (“DELACO”), successor by merger to the Thompson Medical Company,
              Inc., which owned the brand prior to December 21, 1998
              owed
              us an indemnity obligation for any liabilities arising from these
              lawsuits. On
              February 12, 2004, DELACO filed a Chapter 11 bankruptcy petition in
              the United
              States Bankruptcy Court for the Southern District of New York. We filed
              a claim
              in DELACO’s bankruptcy .
  We entered
              into a settlement agreement with DELACO dated June 30, 2005 that
              resolved DELACO’s indemnity obligations to us (“the
              DELACO Agreement”). The DELACO Agreement was approved by the DELACO bankruptcy
              court on July 28, 2005. Pursuant to the DELACO Agreement, we agreed
              to assume
              responsibility for all claims against DELACO and its predecessor, Thompson
              Medical Company, Inc., or us relating to *Dexatrim* products
              involving an injury date after December 21, 1998, and hold the DELACO
              bankruptcy
              estate harmless from any such claims. In exchange, a settlement trust
              that was
              established under DELACO’s bankruptcy plan agreed to pay us $8,750 and assume
              responsibility for all claims related to *Dexatrim* products
              alleging injury dates on or before December 21, 1998. On February 17,
              2006, the
              DELACO bankruptcy court entered an order confirming the DELACO bankruptcy
              plan
              which incorporated the terms of the DELACO Agreement. In accordance
              with the
              DELACO bankruptcy plan, the settlement trust established under the
              plan paid us
              $8,750 on March 17, 2006, which is included in our condensed consolidated
              statement of income, net of legal expenses, as litigation settlement
              for 2006.
              In
              addition, this order will allow us to dismiss all cases against us
              with injury
              dates prior to December 21,  1998. The
              DELACO settlement trust is currently resolving and paying *Dexatrim* claims
              with injury dates prior to December 21, 1998 in accordance with the
              DELACO
              bankruptcy plan.
  The
              confirmation of the DELACO bankruptcy plan effectively released us
              from
              liability for all PPA products liability cases with injury dates prior
              to
              December 21, 1998. The payment to us by the DELACO settlement trust
              of $8,750
              and the channeling of cases to the DELACO settlement trust as described
              above
              has conclusively compromised and settled our indemnity claim filed
              in the DELACO
              bankruptcy.
  On
              December 30, 2003, the United States Food and Drug Administration (“FDA”) issued
              a consumer alert on the safety of dietary supplements containing ephedrine
              alkaloids and on February 6, 2004 published a final rule with respect
              to these
              products. The final rule prohibits the sale of dietary supplements
              containing
              ephedrine alkaloids because such supplements present an unreasonable
              risk of
              illness or injury. The final rule became effective on April 11, 2004.
              Although
              we discontinued the manufacturing and shipment of *Dexatrim* containing ephedrine in September 2002, the FDA’s final rule may result in
              additional lawsuits being filed against us alleging damages related
              to the use
              or purchase of *Dexatrim* containing ephedrine. There are currently two *Dexatrim* with
              ephedrine products liability lawsuits pending against us.
  We
              maintain insurance coverage for product liability claims relating to
              our
              products, including *Dexatrim* products
              containing ephedrine, under claims-made policies which are subject
              to annual
              renewal. For the current annual policy period beginning June 1, 2006,
              we
              maintain product liability insurance coverage in the amount of $25,000
              through
              our captive insurance subsidiary, of which approximately $6,610 has
              been funded
              as of February 1, 2007. We also have $20,000 of
  70
 excess
              coverage through a third party reinsurance policy, which excludes coverage
              for
              our *Dexatrim* products
              containing ephedrine.
  We
              were
              named as a defendant in a putative class action lawsuit filed in the
              Superior
              Court of the State of California for the County of Los Angeles on February
              11,
              2004, relating to the labeling, advertising, promotion and sale of
              our *Bullfrog* suncare
              products. We filed an answer to this lawsuit on June 28, 2004. An amended
              complaint was filed March 29, 2006, pursuant to a court order formally
              consolidating this lawsuit with eight existing lawsuits involving other
              manufacturers of sunscreen products into a coordinated proceeding in
              California
              state court. The amended lawsuit seeks class certification of all persons
              who
              purchased our *Bullfrog* sun care
              products in California during a four-year period prior to February
              11, 2004. The
              amended lawsuit seeks restitution and/or disgorgement of profits, actual
              damages, injunctive relief, punitive damages and attorneys fees and
              costs
              arising out of alleged deceptive, untrue or misleading advertising
              and breach of
              warranty, fraudulent or negligent misrepresentations, in connection
              with the
              manufacturing, labeling, advertising, promotion and sale of *Bullfrog* products
              in California. We filed an answer to the lawsuit in April 2006, and
              we are
              vigorously defending this lawsuit.
  On
              March
              9, 2006, we were named in a lawsuit filed in the Southern District
              of New York
              by Novogen, Inc. Novogen alleges that our product *New
              Phase* infringes upon Novogen patents by containing certain phytoestrogens
              from clover
              or equivalent sources. Novogen seeks to force us to reformulate our
              product and
              to recover damages **.** We
              filed
              an answer to the lawsuit on April 12, 2006 and we are vigorously defending
              Novogen’s allegations.
  Other
              claims, suits and complaints arise in the ordinary course of our business
              involving such matters as patents and trademarks, product liability,
              environmental matters, employment law issues and other alleged injuries
              or
              damage. The outcome of such litigation cannot be predicted, but, in
              the opinion
              of management, based in part upon assessments from counsel, all such
              other
              pending matters are without merit or are of such kind or involve such
              other
              amounts as would not have a material adverse effect on our financial
              position,
              results of operations or cash flows if disposed of unfavorably.
 
 **REGULATORY**
 
 On
              December 30, 2003, the FDA issued a consumer alert on the safety of
              dietary
              supplements containing ephedrine alkaloids and on February 6, 2004
              published a
              final rule with respect to these products. The final rule prohibits
              the sale of
              dietary supplements containing ephedrine alkaloids because such supplements
              present an unreasonable risk of illness or injury. The final rule became
              effective on April 11, 2004. Although we discontinued the manufacturing
              and
              shipment of *Dexatrim* containing ephedrine in September 2002, the FDA’s final rule may result in
              lawsuits in addition to those we currently have being filed against
              us alleging
              damages related to the use or purchase of *Dexatrim* containing ephedrine. In April 2005, a Utah federal court called into
              question
              the 2004 final rule. The court decision is being appealed and may have
              an effect
              on the FDA’s enforcement of the ephedrine alkaloid final rule.
 
 We
              were
              notified in October 2000 that the FDA denied a citizen petition submitted
              by
              Thompson Medical Company, Inc., the previous owner of *Sportscreme* and *Aspercreme.* The
              petition sought a determination that 10% trolamine salicylate, the
              active
              ingredient in *Sportscreme* and *Aspercreme* ,
              was
              clinically proven to be an effective active ingredient in external
              analgesic OTC
              drug products and should be included in the FDA’s yet-to-be finalized monograph
              for external analgesics. We have met with the FDA and submitted a proposed
              protocol study to evaluate the efficacy of 10% trolamine salicylate
              as an active
              ingredient in OTC external analgesic drug products. We are working
              to develop
              alternate formulations for *Sportscreme* and *Aspercreme* in the
              event that the FDA does not consider the available clinical data to
              conclusively
              demonstrate the efficacy of trolamine salicylate when the OTC external
              analgesic
              monograph is finalized. If 10% trolamine salicylate is not included
              in the final
              monograph, we would likely be required to discontinue these products
              as
              currently formulated and remove them from the market after expiration
              of an
              anticipated grace period. If this occurred, we believe we could still
              market
              these products as homeopathic products or reformulate them using ingredients
              included in the FDA monograph. We are uncertain as to when the monograph
              is
              likely to become final.
 
 Certain
              of our topical analgesic products are currently marketed under a FDA
              tentative
              final external analgesic monograph. The FDA has proposed that the final
              monograph exclude external analgesic products in patch, plaster or
              poultice
              form, unless the FDA receives additional data supporting the safety
              and efficacy
              of these products. On October 14, 2003, we submitted to the FDA information
              regarding the safety of our *Icy
              Hot* patches
              and arguments to support our product’s inclusion in the final monograph. We have
              also participated in an industry effort coordinated by Consumer Healthcare
              Products Association (“CHPA”) to establish with the FDA a protocol of additional
              research that will allow the patches to be marketed under the final
              monograph
              even if the final monograph does not explicitly allow them. The CHPA
              submission
              to FDA was made on October 15, 2003. Thereafter, in April 2004, we
              launched the *Icy
              Hot* Sleeve,
              a flexible, non-occlusive fabric patch
  71
 containing
              16% menthol. In February 2006, we launched the *Icy
              Hot Pro-Therapy* Medicated Foam Pad with Knee Wrap containing 5% menthol, and the *Capzasin* Back
& Body patch containing 0.025% capsaicin. All of these drug products
              contain
              levels of active ingredients consistent with levels permitted in the
              OTC
              monograph. If additional research is required either as a preliminary
              to final
              FDA monograph approval and/or as a requirement of future individual
              product
              sale, we may need to invest in a considerable amount of expensive testing
              and
              data analysis. Any preliminary cost may be shared with other patch
              manufacturers. Because the 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
              twelve months to rule on an NDA once it is submitted.
 
 We
              have
              responded to certain questions with respect to efficacy received from
              the FDA in
              connection with clinical studies for pyrilamine maleate, one of the
              active
              ingredients used in certain of the *Pamprin* and *Prēmsyn
              PMS* products. While we addressed all of the FDA questions in detail, the
              final
              monograph for menstrual drug products, which has not yet been issued,
              will
              determine if the FDA considers pyrilamine maleate safe and effective
              for
              menstrual relief products. If pyrilamine maleate were not included
              in the final
              monograph, we would be required to reformulate the products to continue
              to
              provide the consumer with multi-symptom relief benefits. We have been
              actively
              monitoring the process and do not believe that either *Pamprin* or *Prēmsyn
              PMS,* as
              brands, will be materially affected by the FDA review. We believe that
              any
              adverse finding by the FDA would likewise affect our principal competitors
              in
              the menstrual product category and that finalization of the menstrual
              products
              monograph is not imminent. Moreover, we have formulated alternative *Pamprin* products
              that fully comply with both the internal analgesic and menstrual product
              monographs.
 
 In
              early
              2005, infrequent, but serious, adverse cardiovascular events were reported
              to
              the FDA associated with patients who were prescribed a subclass of
              COX-2
              inhibitor non-steroidal anti-inflammatory drugs (“NSAID’s”) for long periods to
              relieve pain of chronic diseases such as arthritis. These products
              include
              Vioxx®, Bextra®, and Celebrex®. In February 2005, the FDA held a joint advisory
              committee meeting to seek external counsel on the extent to which manufacturers
              might further warn patients of these cardiovascular risks on prescription
              product labeling, or prohibit sale of these prescription products.
              As part of
              its response on this issue, the FDA has recommended labeling changes
              for both
              the prescription and OTC NSAID’s. Well-known OTC NSAID’s such as ibuprofen and
              naproxen, which have been sold in vast quantities since the 1970s,
              were affected
              by this regulatory action. Manufacturers of OTC NSAID’s were asked to revise
              their labeling to provide more specific information about the potential
              cardiovascular and gastrointestinal risks recognizing the limited dose
              and
              duration of treatment of these products. Our *Pamprin
              All Day* product,
              which contains naproxen sodium, is subject to these new labeling requirements. *Pamprin
              All Day* is
              manufactured for us by The Perrigo Company (“Perrigo”), holder of an abbreviated
              NDA for naproxen sodium. As holder of the abbreviated NDA, Perrigo
              made the
              mandated labeling changes within the time frame required by the FDA.
              Product
              with revised labeling compliant with new FDA regulations began shipping
              in
              February 2006. We are also aware of the FDA’s concern about the potential
              toxicity due to concomitant use of OTC and prescription products that
              contain
              the analgesic ingredient acetaminophen, an ingredient also found in *Pamprin* and *Prēmsyn
              PMS* .
              We are
              also aware that the FDA will revise acetaminophen labeling to reflect
              the
              concerns similar to NSAID analgesics such as naproxen. We are participating
              in
              an industry-wide effort to reassure the FDA that the current recommended
              dosing
              regimen is safe and effective and that proper labeling and public education
              by
              both OTC and prescription drug companies are the best policies to abate
              the
              FDA’s concern. The FDA will address both issues in its effort to finalize
              the
              monograph on internal analgesic products. We believe the FDA may issue
              revised
              labeling requirements within the next year, perhaps prior to monograph
              closure
              that will cause the industry to relabel its analgesic products to better
              inform
              consumers.
 
 During
              the finalization of the monograph on sunscreen products, the FDA chose
              to hold
              in abeyance specific requirements relating to the characterization
              of a
              product’s ability to reduce UVA radiation. A final ruling on this matter would
              be expected to result in new UVA testing requirements and subsequent
              labeling
              changes related to sun protection factor, or SPF, ratings, and other
              labeling
              claims. We expect that the FDA may take action on this matter within
              the next
              six months. If implemented, the final rules would likely result in
              new testing
              requirements and revised labeling of our *Bullfrog* product
              line, and all of our competitors’ products in the suncare category, within one
              year after issuance of the final rules.
 
 Our
              business is also regulated by the California Safe Drinking Water and
              Toxic
              Enforcement Act of 1986, known as Proposition 65. Proposition 65 prohibits
              businesses from exposing consumers to chemicals that the state has
              determined
              cause cancer or reproduction toxicity without first giving fair and
              reasonable
              warning unless the level of exposure to the carcinogen or
  72
 reproductive
              toxicant falls below prescribed levels. From time to time, one or more
              ingredients in our products could become subject to an inquiry under
              Proposition
              65. If an ingredient is on the state’s list as a carcinogen, it is possible that
              a claim could be brought in which case we would be required to demonstrate
              that
              exposure is below a “no significant risk” level for consumers. Any such claims
              may cause us to incur significant expense, and we may face monetary
              penalties or
              injunctive relief, or both, or be required to reformulate our product
              to
              acceptable levels. The State of California under Proposition 65 is
              also
              considering the inclusion of titanium dioxide on the state’s list of suspected
              carcinogens. Titanium dioxide has a long history of widespread use
              as an
              excipient in prescription and OTC pharmaceuticals, cosmetics, dietary
              supplements and skin care products and is an active ingredient in our *Bullfrog* Superblock products. We have participated in an industry-wide submission
              to the
              State of California, facilitated through the CHPA, presenting evidence
              that
              titanium dioxide presents “no significant risk” to consumers.
 
 In
              March
              2006, the FDA conducted a routine site audit of our manufacturing plants
              and
              laboratories. There were no material adverse findings resulting from
              the
              audit.
 
 **LEASES
              AND ENDORSEMENTS**
 
 The
              minimum rental commitments under all noncancelable operating leases,
              primarily
              real estate, in effect at November 30, 2006 are as follows:
  2007
                    
                    $
                    1,4882008
                    
                    
                    6012009
                    
                    
                    4372010
                    
                    
                    1992011
                    
                    
                    165Thereafter
                    
                    
                    412$
                    3,302
 
 Rental
              expense was $2,060, $2,135 and $1,960 for fiscal 2006, 2005 and 2004,
              respectively.
 
 The
              minimum commitments under noncancelable endorsement contracts related
              to our
              advertising in effect at November 30, 2006 are as follows:
  2007
                    
                    $
                    1,6752008
                    
                    
                    1,5502009
                    
                    
                    800$
                    4,025
 
 
 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. As of November 30, 2006,
              our
              remaining purchase commitment obligations based on the last price paid
              are
              approximately $1,242 and $1,242 for our 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, 2006 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,
              2006 is $232,500.
 
 73
 Note
              14
 **CHATTEM,
              INC. AND SUBSIDIARIES**
 **CONSOLIDATING
              BALANCE SHEETS**
 
 *NOVEMBER
              30, 2006*
 (In
              thousands)
 CHATTEM
                    
                    GUARANTOR
                        SUBSIDIARY
                      COMPANIES
                    
                    NON-GUARANTOR
                        SUBSIDIARY
                                 COMPANIES
                    
                    ELIMINATIONS
                    
                    CONSOLIDATEDASSETSCURRENT
                        ASSETS:Cash
                        and cash equivalents
                    
                    $
                    80,198
                    
                    $
                    1,967
                    
                    $
                    8,362
                    
                    $
                    —
                    
                    $
                    90,527Accounts
                        receivable, less allowances of $10,907
                    
                    
                    24,946
                    
                    
                    9,407
                    
                    
                    4,649
                    
                    
                    (9,407
                    )
                    
                    29,595Other
                        receivables
                    
                    
                    257
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    257Interest
                        receivable
                    
                    
                    17
                    
                    
                    625
                    
                    
                    —
                    
                    
                    (642
                    )
                    
                    —Inventories
                    
                    
                    24,444
                    
                    
                    4,160
                    
                    
                    2,785
                    
                    
                    —
                    
                    
                    31,389Refundable
                        income taxes
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —Deferred
                        income taxes
                    
                    
                    4,304
                    
                    
                    —
                    
                    
                    37
                    
                    
                    —
                    
                    
                    4,341Prepaid
                        expenses and other current assets
                    
                    
                    3,666
                    
                    
                    —
                    
                    
                    2,191
                    
                    
                    —
                    
                    
                    5,857Total
                        current assets
                    
                    
                    137,832
                    
                    
                    16,159
                    
                    
                    18,024
                    
                    
                    (10,049
                    )
                    
                    161,966PROPERTY,
                        PLANT AND EQUIPMENT, NET
                    
                    
                    28,985
                    
                    
                    775
                    
                    
                    593
                    
                    
                    —
                    
                    
                    30,353OTHER
                        NONCURRENT ASSETS:Patents,
                        trademarks and other purchased product rights, net
                    
                    
                    166
                    
                    
                    268,273
                    
                    
                    —
                    
                    
                    (62,290
                    )
                    
                    206,149Debt
                        issuance costs, net
                    
                    
                    11,399
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    11,399Investment
                        in subsidiaries
                    
                    
                    313,922
                    
                    
                    33,000
                    
                    
                    66,860
                    
                    
                    (413,782
                    )
                    
                    —Note
                        receivable
                    
                    
                    —
                    
                    
                    33,000
                    
                    
                    —
                    
                    
                    (33,000
                    )
                    
                    —Other
                    
                    
                    4,978
                    
                    
                    468
                    
                    
                    —
                    
                    
                    —
                    
                    
                    5,446Total
                        other noncurrent assets
                    
                    
                    330,465
                    
                    
                    334,741
                    
                    
                    66,860
                    
                    
                    (509,072
                    )
                    
                    222,994TOTAL
                        ASSETS
                    
                    $
                    497,282
                    
                    $
                    351,675
                    
                    $
                    85,477
                    
                    $
                    (519,121
                    )
                    $
                    415,313LIABILITIES
                        AND SHAREHOLDERS’ EQUITYCURRENT
                        LIABILITIES:Current
                        maturities of long-term debt
                    
                    $
                    —
                    
                    $
                    —
                    
                    $
                    —
                    
                    $
                    —
                    
                    $
                    —Accounts
                        payable and other
                    
                    
                    10,473
                    
                    
                    —
                    
                    
                    1,580
                    
                    
                    (2,105
                    )
                    
                    9,948Bank
                        overdrafts
                    
                    
                    5,824
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    5,824Accrued
                        liabilities
                    
                    
                    17,869
                    
                    
                    1,132
                    
                    
                    748
                    
                    
                    (7,944
                    )
                    
                    11,805Total
                        current liabilities
                    
                    
                    34,166
                    
                    
                    1,132
                    
                    
                    2,328
                    
                    
                    (10,049
                    )
                    
                    27,577LONG-TERM
                        DEBT, less current maturities
                    
                    
                    232,500
                    
                    
                    —
                    
                    
                    33,000
                    
                    
                    (33,000
                    )
                    
                    232,500DEFERRED
                        INCOME TAXES
                    
                    
                    (16,517
                    )
                    
                    34,185
                    
                    
                    —
                    
                    
                    —
                    
                    
                    17,668OTHER
                        NONCURRENT LIABILITIES
                    
                    
                    1,987
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    1,987INTERCOMPANY
                        ACCOUNTS
                    
                    
                    109,564
                    
                    
                    (114,014
                    )
                    
                    4,450
                    
                    
                    —
                    
                    
                    —SHAREHOLDERS’
                        EQUITY:Preferred
                        shares, without par value, authorized 1,000, none issued
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —Common
                        shares, without par value, authorized 100,000, issued
                        18,669
                    
                    
                    30,452
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    30,452Share
                        capital of subsidiaries
                    
                    
                    —
                    
                    
                    329,705
                    
                    
                    39,803
                    
                    
                    (369,508
                    )
                    
                    —Retained
                        earnings
                    
                    
                    105,965
                    
                    
                    100,667
                    
                    
                    5,679
                    
                    
                    (106,346
                    )
                    
                    105,965Total
                    
                    
                    136,417
                    
                    
                    430,372
                    
                    
                    45,482
                    
                    
                    (475,854
                    )
                    
                    136,417Cumulative
                        other comprehensive income, net oftaxes:Interest rate cap adjustment
                    
                    
                    (597
                    )
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    (597
                    )Foreign
                        currency translation adjustment
                    
                    
                    (238
                    )
                    
                    —
                    
                    
                    217
                    
                    
                    (218
                    )
                    
                    (239
                    )Total
                        shareholders’ equity
                    
                    
                    135,582
                    
                    
                    430,372
                    
                    
                    45,699
                    
                    
                    (476,072
                    )
                    
                    135,581TOTAL
                        LIABILITIES AND SHAREHOLDERS’ EQUITY
                    
                    $
                    497,282
                    
                    $
                    351,675
                    
                    $
                    85,477
                    
                    $
                    (519,121
                    )
                    $
                    415,313
 
 74
 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 $3,417
                    
                    
                    28,141
                    
                    
                    11,181
                    
                    
                    4,452
                    
                    
                    (11,181
                    )
                    
                    32,593Other
                        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
                    
                    
                    100,523
                    
                    
                    16,217
                    
                    
                    17,445
                    
                    
                    (12,243
                    )
                    
                    121,942PROPERTY,
                        PLANT AND EQUIPMENT, NET
                    
                    
                    28,567
                    
                    
                    775
                    
                    
                    542
                    
                    
                    —
                    
                    
                    29,884OTHER
                        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
                    
                    
                    4,704
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    4,704Total
                        other noncurrent assets
                    
                    
                    286,392
                    
                    
                    334,273
                    
                    
                    66,860
                    
                    
                    (472,137
                    )
                    
                    215,388TOTAL
                        ASSETS
                    
                    $
                    415,482
                    
                    $
                    351,265
                    
                    $
                    84,847
                    
                    $
                    (484,380
                    )
                    $
                    367,214LIABILITIES
                        AND SHAREHOLDERS’ EQUITYCURRENT
                        LIABILITIES:Current
                        maturities of long-term debt
                    
                    $
                    37,000
                    
                    $
                    —
                    
                    $
                    —
                    
                    $
                    —
                    
                    $
                    37,000Accounts
                        payable and other
                    
                    
                    14,841
                    
                    
                    —
                    
                    
                    2,397
                    
                    
                    —
                    
                    
                    17,238Accrued
                        liabilities
                    
                    
                    20,353
                    
                    
                    969
                    
                    
                    6,169
                    
                    
                    (12,243
                    )
                    
                    15,248Total
                        current liabilities
                    
                    
                    72,194
                    
                    
                    969
                    
                    
                    8,566
                    
                    
                    (12,243
                    )
                    
                    69,486LONG-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 100,000, 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 oftaxes: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
                    
                    $
                    415,482
                    
                    $
                    351,265
                    
                    $
                    84,847
                    
                    $
                    (484,380
                    )
                    $
                    367,214
 
  
 75
 Note
              14
 **CHATTEM,
              INC. AND SUBSIDIARIES**
 **CONSOLIDATING
              STATEMENTS OF INCOME**
 
 *FOR
              THE YEAR ENDED NOVEMBER 30, 2006*
 (In
              thousands)
 
 CHATTEM
                    
                    GUARANTOR
                      SUBSIDIARY
                      COMPANIES
                    
                    NON-GUARANTOR
                      SUBSIDIARY
                      COMPANIES
                    
                    ELIMINATIONS
                    
                    CONSOLIDATEDTOTAL
                        REVENUES
                    
                    $
                    248,219
                    
                    $
                    79,722
                    
                    $
                    19,686
                    
                    $
                    (47,079
                    )
                    $
                    300,548COSTS
                        AND EXPENSES:Cost
                        of sales
                    
                    
                    78,044
                    
                    
                    9,661
                    
                    
                    8,784
                    
                    
                    (2,453
                    )
                    
                    94,036Advertising
                        and promotion
                    
                    
                    80,316
                    
                    
                    10,713
                    
                    
                    5,042
                    
                    
                    —
                    
                    
                    96,071Selling,
                        general and administrative
                    
                    
                    47,059
                    
                    
                    (93
                    )
                    
                    23
                    
                    
                    —
                    
                    
                    46,989Executive
                        severance charges
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —Litigation
                        settlement
                    
                    
                    (19,292
                    )
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    (19,292
                    )Equity
                        in subsidiary income
                    
                    
                    (36,764
                    )
                    
                    —
                    
                    
                    —
                    
                    
                    36,764
                    
                    
                    —Total
                        costs and expenses
                    
                    
                    149,363
                    
                    
                    20,281
                    
                    
                    13,849
                    
                    
                    34,311
                    
                    
                    217,804INCOME
                        FROM OPERATIONS
                    
                    
                    98,856
                    
                    
                    59,441
                    
                    
                    5,837
                    
                    
                    (81,390
                    )
                    
                    82,744OTHER
                        INCOME (EXPENSE):Interest
                        expense
                    
                    
                    (11,582
                    )
                    
                    —
                    
                    
                    (2,618
                    )
                    
                    2,475
                    
                    
                    (11,725
                    )Investment
                        and other income, net
                    
                    
                    483
                    
                    
                    2,535
                    
                    
                    3,033
                    
                    
                    (4,975
                    )
                    
                    1,076Loss
                        on early extinguishment of debt
                    
                    
                    (2,805
                    )
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    (2,805
                    )Royalties
                    
                    
                    (39,017
                    )
                    
                    (5,610
                    )
                    
                    —
                    
                    
                    44,627
                    
                    
                    —Corporate
                        allocations
                    
                    
                    3,324
                    
                    
                    (3,260
                    )
                    
                    (64
                    )
                    
                    —
                    
                    
                    —Total
                        other income (expense)
                    
                    
                    (49,597
                    )
                    
                    (6,335
                    )
                    
                    351
                    
                    
                    42,127
                    
                    
                    (13,454
                    )INCOME
                        (LOSS) BEFORE INCOME TAXES
                    
                    
                    49,259
                    
                    
                    53,106
                    
                    
                    6,188
                    
                    
                    (39,263
                    )
                    
                    69,290(BENEFIT
                        FROM) PROVISION FOR INCOME TAXES
                    
                    
                    4,147
                    
                    
                    17,940
                    
                    
                    2,091
                    
                    
                    —
                    
                    
                    24,178NET
                        INCOME
                    
                    $
                    45,112
                    
                    $
                    35,166
                    
                    $
                    4,097
                    
                    $
                    (39,263
                    )
                    $
                    45,112
 
 
 
 
 
 
 
 76
 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
 
 
 
 
 
 
   77
 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
                    
                    CONSOLIDATEDTOTAL
                        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
 
 
 
 
 
   78
 Note
              14
  **CHATTEM,
              INC. AND SUBSIDIARIES**
 **CONSOLIDATING
              STATEMENTS OF CASH FLOWS**
 
 FOR
              THE
              YEAR ENDED NOVEMBER 30, 2006
 (In
              thousands)
 CHATTEM
                    
                    GUARANTOR
                      SUBSIDIARY
                      COMPANIES
                    
                    NON-GUARANTOR
                      SUBSIDIARY
                      COMPANIES
                    
                    ELIMINATIONS
                    
                    CONSOLIDATEDOPERATING
                        ACTIVITIES:Net
                        income
                    
                    $
                    45,112
                    
                    $
                    35,166
                    
                    $
                    4,097
                    
                    $
                    (39,263
                    )
                    $
                    45,112Adjustments
                        to reconcile net income to net cash(used
                        in) provided by operating activities:Depreciation
                        and amortization
                    
                    
                    5,655
                    
                    
                    —
                    
                    
                    180
                    
                    
                    —
                    
                    
                    5,835Deferred
                        income tax provision
                    
                    
                    (5,204
                    )
                    
                    5,653
                    
                    
                    (36
                    )
                    
                    —
                    
                    
                    413Stock-based
                        compensation
                    
                    
                    4,745
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    4,745Loss
                        on early extinguishment of debt
                    
                    
                    2,805
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    2,805Tax
                        benefit realized from stock options
                    
                    
                    (1,627
                    )
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    (1,627
                    )Other,
                        net
                    
                    
                    127
                    
                    
                    —
                    
                    
                    257
                    
                    
                    —
                    
                    
                    384Equity
                        in subsidiary income
                    
                    
                    (39,263
                    )
                    
                    —
                    
                    
                    —
                    
                    
                    39,263
                    
                    
                    —Changes
                        in operating assets and liabilities:Accounts
                        receivable
                    
                    
                    12,538
                    
                    
                    1,774
                    
                    
                    (197
                    )
                    
                    (1,774
                    )
                    
                    12,341Inventories
                    
                    
                    (6,115
                    )
                    
                    (1,730
                    )
                    
                    224
                    
                    
                    —
                    
                    
                    (7,621
                    )Refundable
                        income taxes
                    
                    
                    2,834
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    2,834Prepaid
                        expenses and other current assets
                    
                    
                    574
                    
                    
                    —
                    
                    
                    425
                    
                    
                    (420
                    )
                    
                    579Accounts
                        payable and accrued liabilities
                    
                    
                    (7,497
                    )
                    
                    163
                    
                    
                    (6,238
                    )
                    
                    2,194
                    
                    
                    (11,378
                    )Net
                        cash provided by (used in) operating activities
                    
                    
                    14,684
                    
                    
                    41,026
                    
                    
                    (1,288
                    )
                    
                    —
                    
                    
                    54,422INVESTING
                        ACTIVITIES:Purchases
                        of property, plant and equipment
                    
                    
                    (4,473
                    )
                    
                    —
                    
                    
                    (232
                    )
                    
                    —
                    
                    
                    (4,705
                    )Increase
                        in other assets, net
                    
                    
                    (487
                    )
                    
                    (468
                    )
                    
                    (1,156
                    )
                    
                    —
                    
                    
                    (2,111
                    )Net
                        cash used in provided by investing activities
                    
                    
                    (4,960
                    )
                    
                    (468
                    )
                    
                    (1,388
                    )
                    
                    —
                    
                    
                    (6,816
                    )FINANCING
                        ACTIVITIES:Repayment
                        of long-term debt
                    
                    
                    (75,000
                    )
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    (75,000
                    )Proceeds
                        from long-term debt
                    
                    
                    125,000
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    125,000Proceeds
                        from borrowing under revolving credit facility
                    
                    
                    75,500
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    75,500Repayments
                        of revolving credit facility
                    
                    
                    (75,500
                    )
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    (75,500
                    )Bank
                        overdraft
                    
                    
                    5,824
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    5,824Repurchase
                        of common shares
                    
                    
                    (39,332
                    )
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    (39,332
                    )Proceeds
                        from exercise of stock options
                    
                    
                    2,480
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    2,480Payment
                        for purchase of note hedge
                    
                    
                    (32,042
                    )
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    (32,042
                    )Proceeds
                        from issuance of warrant
                    
                    
                    18,581
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    18,581Increase
                        in debt issuance costs
                    
                    
                    (9,099
                    )
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    (9,099
                    )Debt
                        retirement costs
                    
                    
                    (1,501
                    )
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    (1,501
                    )Premium
                        on interest rate cap agreement
                    
                    
                    (687
                    )
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    (687
                    )Tax
                        benefit realized from stock options
                    
                    
                    1,627
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    1,627Changes
                        in intercompany accounts
                    
                    
                    37,976
                    
                    
                    (38,073
                    )
                    
                    97
                    
                    
                    —
                    
                    
                    —Dividends
                        paid
                    
                    
                    —
                    
                    
                    (2,500
                    )
                    
                    2,500
                    
                    
                    —
                    
                    
                    —Net
                        cash provided by (used in) financing activities
                    
                    
                    33,827
                    
                    
                    (40,573
                    )
                    
                    2,597
                    
                    
                    —
                    
                    
                    (4,149
                    )EFFECT
                        OF EXCHANGE RATE CHANGES ONCASH
                        AND CASH EQUIVALENTS
                    
                    
                    —
                    
                    
                    —
                    
                    
                    (257
                    )
                    
                    —
                    
                    
                    (257
                    )CASH
                        AND CASH EQUIVALENTS:Increase
                        (decrease) for the year
                    
                    
                    43,551
                    
                    
                    (15
                    )
                    
                    (336
                    )
                    
                    —
                    
                    
                    43,200At
                        beginning of year
                    
                    
                    36,647
                    
                    
                    1,982
                    
                    
                    8,698
                    
                    
                    —
                    
                    
                    47,327At
                        end of year
                    
                    $
                    80,198
                    
                    $
                    1,967
                    
                    $
                    8,362
                    
                    $
                    —
                    
                    $
                    90,527
 
 
 79
 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
                    
                    
                    (3,987
                    )
                    
                    (2,448
                    )
                    
                    923
                    
                    
                    2,443
                    
                    
                    (3,069
                    )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
                    
                    
                    (2,675
                    )
                    
                    (137
                    )
                    
                    2,045
                    
                    
                    (2,880
                    )
                    
                    (3,647
                    )Net
                        cash (used in) provided by operating activities
                    
                    
                    11,616
                    
                    
                    38,010
                    
                    
                    5,390
                    
                    
                    —
                    
                    
                    55,016INVESTING
                        ACTIVITIES:Purchases
                        of property, plant and equipment
                    
                    
                    (4,027
                    )
                    
                    —
                    
                    
                    (275
                    )
                    
                    —
                    
                    
                    (4,302
                    )Sales
                        (purchases) of patents, trademarks and other
                      product
                        rights
                    
                    
                    3,199
                    
                    
                    —
                    
                    
                    —
                    
                    
                    —
                    
                    
                    3,199Decrease
                        in other assets, net
                    
                    
                    224
                    
                    
                    —
                    
                    
                    221
                    
                    
                    —
                    
                    
                    445Net
                        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 ONCASH
                        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
 
 
 80
 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
                    
                    CONSOLIDATEDOPERATING
                        ACTIVITIES:Net
                        income
                    
                    $
                    1,451
                    
                    $
                    14,148
                    
                    $
                    1,235
                    
                    $
                    (15,383
                    )
                    $
                    1,451Adjustments
                        to reconcile net income to net cashprovided
                        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
                    
                    
                    (6,804
                    )
                    
                    (1,644
                    )
                    
                    (1,627
                    )
                    
                    1,649
                    
                    
                    (8,426
                    )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
                    
                    
                    11,056
                    
                    
                    479
                    
                    
                    3,213
                    
                    
                    (1,101
                    )
                    
                    13,647Net
                        cash provided by operating activities
                    
                    
                    10,331
                    
                    
                    30,839
                    
                    
                    3,540
                    
                    
                    —
                    
                    
                    44,710INVESTING
                        ACTIVITIES:Purchases
                        of property, plant and equipment
                    
                    
                    (3,822
                    )
                    
                    —
                    
                    
                    151
                    
                    
                    —
                    
                    
                    (3,671
                    )Purchases
                        of patents, trademarks and otherproduct
                        rights
                    
                    
                    —
                    
                    
                    (7
                    )
                    
                    —
                    
                    
                    —
                    
                    
                    (7
                    )Increase
                        in note receivable
                    
                    
                    —
                    
                    
                    (33,000
                    )
                    
                    —
                    
                    
                    33,000
                    
                    
                    —Decrease
                        in other assets, net
                    
                    
                    (1,913
                    )
                    
                    —
                    
                    
                    100
                    
                    
                    —
                    
                    
                    (1,813
                    )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 ONCASH
                        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
 
 
 81
 **(15)** **QUARTERLY
              INFORMATION** ***(Unaudited
              and in thousands, except per share amounts)***
 
 
 
 **Quarter
                        Ended****Total**
                    
                    **February
                        28**
                    
                    **May
                        31**
                    
                    **August
                        31**
                    
                    **November
                        30**FISCAL
                        2006:Total
                        revenues
                    
                    $
                    300,548
                    
                    
                    84,024
                    
                    
                    79,411
                    
                    
                    72,005
                    
                    
                    65,108Gross
                        profit
                    
                    $
                    206,512
                    
                    
                    58,004
                    
                    
                    54,357
                    
                    
                    49,767
                    
                    
                    44,384Net
                        income (loss)
                    
                    $
                    45,112
                    
                    
                    14,773
                    
                    
                    10,200
                    
                    
                    15,229
                    
                    
                    4,910Net
                        income (loss) per share:Basic(2)
                    
                    $
                    2.37
                    
                    
                    .76
                    
                    
                    .53
                    
                    
                    .81
                    
                    
                    .26Diluted(2)
                    
                    $
                    2.34
                    
                    
                    .75
                    
                    
                    .52
                    
                    
                    .81
                    
                    
                    .26FISCAL
                        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
                    
                    
                    .12
 
 (1) Through
              the performance of our annual inventory control process, as of November
              30, 2005
              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 *.*
 
 
 
 
 
  82
 
 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 maintained effective internal
                  control
                  over financial reporting as of November 30, 2006, 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 opinions.
 
 A
                  company’s internal control over financial reporting is a process designed
                  to
                  provide reasonable assurance regarding the reliability of financial
                  reporting
                  and the preparation of financial statements for external purposes
                  in accordance
                  with generally accepted accounting principles. A company’s internal control over
                  financial reporting includes those policies and procedures that
                  (1) pertain to
                  the maintenance of records that, in reasonable detail, accurately
                  and fairly
                  reflect the transactions and dispositions of the assets of the
                  company; (2)
                  provide reasonable assurance that transactions are recorded as
                  necessary to
                  permit preparation of financial statements in accordance with generally
                  accepted
                  accounting principles, and that receipts and expenditures of the
                  company are
                  being made only in accordance with authorizations of management
                  and directors of
                  the company; and (3) provide reasonable assurance regarding prevention
                  or timely
                  detection of unauthorized acquisition, use, or disposition of the
                  company’s
                  assets that could have a material effect on the financial
                  statements.
 
 Because
                  of its inherent limitations, internal control over financial reporting
                  may not
                  prevent or detect misstatements. Also, projections of any evaluation
                  of
                  effectiveness to future periods are subject to the risk that controls
                  may become
                  inadequate because of changes in conditions, or that the degree
                  of compliance
                  with the policies or procedures may deteriorate.
 
 In
                  our
                  opinion, management’s assessment that Chattem, Inc. maintained effective
                  internal control over financial reporting as of November 30, 2006,
                  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, Chattem,
                  Inc.
                  maintained, in all material respects, effective internal control
                  over financial
                  reporting as of November 30, 2006, based on criteria established
                  in Internal
                  Control-Integrated Framework issued by the Committee of Sponsoring
                  Organizations
                  on the Treadway Commission (COSO).
 
 We
                  also
                  have audited, in accordance with the standards of the Public Company
                  Accounting
                  Oversight Board (United States), the balance sheets of Chattem,
                  Inc. as of
                  November 30, 2006 and 2005, and the related statements of income,
                  shareholders’
equity, and cash flows for the years then ended and our report
                  dated February 8,
                  2007 expressed an unqualified opinion on those financial
                  statements.
 
 /s/
                  GRANT
                  THORNTON LLP
 
 
 Charlotte,
                  North Carolina
 February
                  8, 2007
  83
 ***Item
              9. Changes in and Disagreements with Accountants on Accounting and
              Financial
              Disclosure***
 
 None
 
 ***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, 2006 (the “Evaluation
              Date”). Based on such evaluation, such officers have concluded that, as
              of the
              Evaluation Date, our disclosure controls and procedures were effective
              in
              alerting them on a timely basis to material information relating to
              us
              (including our consolidated subsidiaries) required to be included in
              our filings
              under the Exchange Act.
  ***Management’s
                Report on Internal Control Over Financial Reporting***
  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.
  The
                Company’s management assessed the effectiveness of the Company’s internal
                control over financial reporting as of November 30, 2006 using the
                criteria set
                forth by the Committee of Sponsoring Organizations of the Treadway
                Commission
                (COSO) in *Internal
                Control-Integrated Framework* .
                Management’s assessment included an evaluation of the design of our internal
                control over financial reporting and testing the operational effectiveness
                of
                our internal control over financial reporting. Management reviewed
                the results
                of the assessment with the Audit Committee of the Board of Directors.
                Based on
                our assessment, management determined that, at November 30, 2006,
                we maintained
                effective internal control over financial reporting.
  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, which is included herein.
 ***Item
              9B. Other Information***
  On
                February 7, 2007, upon the approval and recommendation of the Compensation
                Committee, the Company’s Board of Directors approved a special, one-time cash
                bonus to the Company’s executive officers for their efforts in fiscal 2006
                relating to the Company’s acquisition of five consumer and OTC brands from
                Johnson & Johnson. Bonus amounts payable to the Company’s chief executive
                officer, principal financial officer and other named executives are
                as follows:
                Zan Guerry - $150,000; Robert E. Bosworth - $100,000; Richard W.
                Kornhauser -
                $50,000; B. Derrill Pitts - $40,000; and Charles M. Stafford -
                $40,000.
   84
 **PART
              III**
 
 ***Item
              10. Directors and Executive Officers of the
              Registrant***
 
 (a) Directors
 
 The
              information found in our 2007 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 1, 2007, their ages and their
              positions
              and offices with the Company:
 
 NAME
                    
                    AGE
                    
                    POSITION
                        WITH REGISTRANTZan
                        Guerry
                    
                    58
                    
                    Chairman
                        of the Board and
                      Chief
                        Executive Officer; DirectorRobert
                        E. Bosworth
                    
                    59
                    
                    President
                        and Chief Operating Officer;
                      DirectorAndrea
                        M. Crouch
                    
                    48
                    
                    Vice
                        President - Brand ManagementRon
                        Galante
                    
                    63
                    
                    Vice
                        President - New Business DevelopmentRichard
                        W. Kornhauser
                    
                    52
                    
                    Vice
                        President - MarketingRobert
                        B. Long
                    
                    35
                    
                    Chief
                        Accounting OfficerB.
                        Derrill Pitts
                    
                    64
                    
                    Vice
                        President - OperationsJ.
                        Blair Ramey
                    
                    40
                    
                    Vice
                        President - Brand Management and MediaCharles
                        M. Stafford
                    
                    56
                    
                    Vice
                        President - SalesTheodore
                        K. Whitfield, Jr.
                    
                    42
                    
                    Vice
                        President, General Counsel and
                        Secretary
 
 *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.
 
 85
 *Robert
              B. Long.* Mr.
              Long
              became our Chief Accounting Officer in April 2006. Prior to joining
              us, Mr. Long
              was Chief Financial Officer of Charleston Hosiery, Inc. and served
              as a senior
              audit manager with Ernst & Young LLP from 2003 to 2005.
 
 *B.
              Derrill Pitts* .
              Mr.
              Pitts joined us in 1961 and since that time has served us in all manufacturing
              operation disciplines. He was promoted to vice president-operations
              in 1984.
 
 *J.
              Blair Ramey.*  Mr.
              Ramey
              became our vice president-brand management and media in April 2006.
              Mr. Ramey
              joined us in 1998 and previously served as a marketing manager and
              more recently
              as a marketing director.
 
 *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 2007 Proxy Statement under the heading “Section 16(a)
              Beneficial Ownership Reporting Compliance” is hereby incorporated by reference.
 
 (d)
                    Audit
                        Committee; Audit Committee Financial
                        Expert
 
 The
              information found in our 2007 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.
 
    86
 ***Item
              11. Executive Compensation***
 
 The
              information found in our 2007 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 2007 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 2007 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 2007 Proxy Statement under the headings “Corporate
              Governance - Audit Committee Pre-Approval of Services by the Independent
              Auditor” and “Corporate Governance - Audit and Non-Audit Fees” is hereby
              incorporated by reference.
 
 **PART
              IV**
 
 ***Item
              15. Exhibits and Financial Statement Schedules***
 
 (a)  1.
              Consolidated Financial Statements
 The
              following consolidated financial statements of Chattem, Inc. and Subsidiaries
              are set forth in Item 8 hereof:
 
 Reports
              of Independent Registered Public Accounting Firms
 Consolidated
              Balance Sheets as of November 30, 2006 and 2005
 Consolidated
              Statements of Income for the Years Ended November 30, 2006, 2005 and
              2004
 Consolidated
              Statements of Shareholders’ Equity for the Years Ended November 30, 2006, 2005
              and 2004
 Consolidated
              Statements of Cash Flows for the Years Ended November 30, 2006, 2005
              and
              2004
 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.
 
  87
 3.
              The
              following documents are filed or incorporated by reference as exhibits
              to this
              report :
 
 Exhibit
                      Number
                    Description
                        of Exhibit
                    References3.1
                    Restated
                      Charter of
                      Chattem, Inc., as  amended
                    (4),
                        (5), (11) and (20)3.2
                    Amended
                        and Restated By-Laws of Chattem, Inc.
                    (1),
                        (6) and (26)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)4.4
                    First
                        Amendment to and Supplemental Indenture dated July 25, 2006
                        among Chattem,
                        Inc., its domestic subsidiaries and U.S. Bank, National Association,
                        as
                        successor trustee, relating to the 7% Senior Subordinated
                        Notes due
                        2014
                    (28)4.5
                    Indenture
                        dated as of November 22, 2006 between Chattem, Inc. and U.S.
                        Bank,
                        National Association, as trustee, relating to 2% Convertible
                        Senior Notes
                        due 2013
                    (31)4.6
                    Registration
                        Rights Agreement dated November 22, 2006 among Chattem, Inc.
                        and the
                        purchasers of the 2% Convertible Senior Notes due 2013
                    (31)10.1
                    Lease
                        Agreements as amended, datedFebruary
                        1, 1996 between TammyDevelopment
                        Company and Chattem,Inc.
                        for warehouse space at 3100Williams
                        Street, Chattanooga, Tennessee
                    (6)
                        and (7)10.2
                    First
                        Amended and Restated MasterTrademark
                        License Agreement betweenSignal
                        Investment & Management Co.and
                        Chattem, Inc., effectiveJune
                        30, 1992
                    (8)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
                    (9)
  88
 
 Exhibit
                        Number
                      Description
                          of Exhibit
                      References
 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
                    (10)10.5*
                    Chattem,
                        Inc. Non-Statutory StockOption
                        Plan - 1998
                    (8)10.6*
                    1999
                        Stock Plan for Non-Employee Directors
                    (27)10.7*
                    Chattem,
                        Inc. Non-Statutory Stock Option  Plan -  2000
                    (11)
 10.8*
                    Chattem,
                        Inc. Stock Incentive Plan - 2003
                    (15)10.9*
                    Chattem,
                        Inc. Stock Incentive Plan - 2005
                    (21)10.10*
                    Form
                        of Stock Option Grant Agreement under  Chattem, Inc. Stock Incentive
                        Plan - 2005
                    (21)10.11*
                    Form
                        of Restricted Stock Agreement under  Chattem, Inc. Stock Incentive
                        Plan - 2005
                    (21)10.12*
                    Form
                        of Amendment to Grant Agreement under  2005 Stock Incentive Plan
                        pertaining only to  officers
                    (24)10.13*
                    Form
                        of Amendment to Grant Agreement under  2005 Stock Incentive Plan
                        pertaining to all  optionees other than officers
                    (24)10.14*
                    Form
                        of Employment Agreements -Zan
                        Guerry
                    (12)10.15*
                    Form
                        of Amended and Restated Severance Agreements-Zan
                        Guerry
                    (12)10.16*
                    Form
                        of Amended and Restated Non-Competition and Severance Agreements-
                      Andrea
                        M. Crouch
                      Ron
                        Galante
                      Richard
                        W. Kornhauser
                      B.
                        Derrill Pitts
                      Charles
                        M. Stafford
                    (12)10.17*
                    Non-Competition
                        and Severance Agreementdated
                        June 1, 2004 by and between Chattem,   Inc. and Theodore K.
                        Whitfield, Jr.
                    (19)
  89
 Exhibit
                      Number
                    Description
                        of Exhibit
                    References
 10.18*
                    Non-Competition
                        and Severance Agreement dated October 28, 2005 by and between
                          Chattem, Inc. and Robert E. Bosworth
                    (23)10.19*
                    Form
                        of Restricted Stock Agreements -Zan
                        Guerry
                    (13)10.20*
                    Separation
                        Agreement dated August 24, 2005  between Chattem, Inc. and A.
                        Alexander  Taylor II
                    (26)10.21
                    Asset
                        Purchase Agreement dated March 5,  2002  by and between Abbott
                        Laboratories and  Chattem, Inc. for the*Selsun
                        Blue*product line
                    (14)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.
                    (25)10.23
                    Asset
                        Purchase Agreement dated as of October 5, 2006, among Johnson
&
                        Johnson, Pfizer, Inc. and Chattem, Inc.
                    (29)10.24
                    Letter
                        Agreement dated November 16, 2006 among Chattem, Inc., Merrill
                        Lynch
                        International and Merrill Lynch, Pierce, Ferner & Smith Incorporated
                        regarding confirmation of OTC Convertible Note Hedge
                    (31)10.25
                    Letter
                        Agreement dated November 16, 2006 among Chattem, Inc. Merrill
                        Lynch
                        International and Merrill Lynch, Pierce, Ferner & Smith Incorporated
                        regarding confirmation of OTC Warrant Transaction
                    (31)10.26
                    Securities
                        Purchase Agreement dated November 16, 2006 among Chattem,
                        Inc. and the
                        purchasers of the 2% Convertible Senior Notes due 2013
                    (30)10.27
                    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)10.28
                    New
                        Commitment Agreement dated March 9,  2004 between Chattem, Inc. and
                        Bank of  America, N.A., as administrative agent
                    (17)
  90
 Exhibit
                      Number
                    Description
                        of Exhibit
                    References10.29
                    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
                    (22)10.30
                    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
                    (22)10.31
                    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
                    (24)10.32
                    Fourth
                        Amendment to Credit Agreement dated as of November 16, 2006
                        among Chattem,
                        Inc. its domestic subsidiaries, identified lenders and Bank
                        of America,
                        N.A., as agent
                    (30)10.33
                    Fifth
                        Amendment to Credit Agreement dated December 22, 2006 among
                        Chattem, Inc.,
                        its domestic subsidiaries, identified lenders and Bank of
                        America, N.A.,
                        as agent
                    (32)10.34
                    Rate
                        Cap Transaction Agreement dated March  8, 2004 between Chattem, Inc.
                        and JP Morgan  Chase Bank
                    (17)
 10.35
                    First
                        Amendment to the Second Amended and  Restated Master Trademark
                        License  Agreement between Signal Investment &  Management
                        Co. and Chattem, Inc. effective  May 31, 2003
                    (16)10.36
                    First
                        Amendment to Master Trademark License  Agreement between Signal
                        Investment &  Management Co. and SunDex, LLC, effective  May
                        31, 2003
                    (16)
 10.37
                    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
                    (15)10.38
                    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
                    (17)
  91
 Exhibit
                      Number
                    Description
                        of Exhibit
                    References10.39
                    Initial
                        Settlement Trust Agreement dated April  12, 2004 between Chattem,
                        Inc. and Amsouth  Bank
                    (17)10.40
                    Final
                        Settlement Trust Agreement between Chattem, Inc. and AmSouth
                        Bank dated
                        March 16, 2005
                    (22)10.41
                    Settlement
                        Agreement dated April 26, 2004  between Chattem, Inc. and General
                        Star  Indemnity Company
                    (17)10.42
                    Memorandum
                        of Understanding dated  December 13, 2003 between and among
                         Chattem, Inc. and Kemper Indemnity Insurance
                         Company
                    (17)10.43
                    Settlement
                        Agreement dated December 30,  2003 between Chattem, Inc. and Admiral
                         Insurance Company
                    (17)10.44
                    Settlement
                        Agreement dated July 14, 2004  between Chattem, Inc. and Sidmak
                         Laboratories
                    (18)10.45
                    *Dexatrim*Case Scoring System and Matrix for  the Chattem*Dexatrim*Class Action Settlement
                    (18)10.46
                    Settlement
                        and Coverage-In-Place Agreement  between Interstate Fire &
                        Casualty Company  and Chattem, Inc. effective March 18,
                        2005
                    (22)10.47
                    Settlement
                        Agreement dated as of June 30,  2005 by and between Chattem, Inc. and
                        The  DELACO Company
                    (21)10.48*
                    Retirement
                        Agreement effective January 31, 2007 between Chattem, Inc.
                        and Donald K.
                        Riker, Ph.D.10.49*
                    Summary
                        Description of Incentive  Compensation Plan21
                    Subsidiaries
                        of the Company23.1
                    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
                        Act
  92
 Exhibit
                      Number
                    Description
                        of Exhibit
                    References31.2
                    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
              S-8
              filed June 2, 1999.
  (5)  Form
              10-K
              for the year ended November 30, 1992.
  (6)  Form
              10-K
              for the year ended November 30, 1995.
  (7)  Form
              10-K
              for the year ended November 30, 1996.
  (8)  Form
              10-K
              for the year ended November 30, 1997.
  (9)  Form
              10-K
              for the year ended November 30, 1998.
  (10)  Form
              8-K
              filed December 28, 1998.
  (11)  Form
              10-K
              for the year ended November 30, 1999.
  (12)  Form
              10-K
              for the year ended November 30, 2000.
  (13)  Form
              10-K
              for the year ended November 30, 2001.
  (14)  Form
              8-K
              filed April 10, 2002, as amended.
  (15)  Form
              10-K
              for the year ended November 30, 2003.
  (16)  Form
              10-Q
              filed for the quarter ended May 31, 2003.
  (17)  Form
              10-Q
              filed for the quarter ended May 31, 2004.
  (18)  Form
              10-Q
              filed for the quarter ended August 31, 2004.
  (19)  Form
              10-K
              for the year ended November 30, 2004.
  93
 (20)  Schedule
              14A filed March 4, 2005.
  (21)  Form
              10-Q
              filed for the quarter ended May 31, 2005.
  (22)  Form
              10-Q
              filed for the quarter ended February 28, 2005.
  (23)  Form
              8-K
              filed November 3, 2005.
  (24)  Form
              8-K
              filed December 2, 2005.
  (25)  Form
              8-K
              filed December 5, 2005.
  (26)  Form
              8-K/A filed August 31, 2005.
  (27)  Schedule
              14A filed March 8, 1999.
  (28)  Form
              8-K
              filed July 19, 2006, as supplemented by Form 8-K filed July 26,
              2006.
  (29)  Form
              8-K
              filed November 15, 2006.
  (30)  Form
              8-K
              filed November 22, 2006.
  (31)  Form
              8-K
              filed November 29, 2006.
  (32)  Form
              8-K
              filed December 28, 2006.
  
  
 
 94
 **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 12, 2007
                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)
              2-12-07/s/
                  Robert E. Bosworth
                Robert
                  E. Bosworth
              President
                  and Director
                (Chief
                  Operating Officer)
              2-12-07/s/
                  Samuel E. Allen
                Samuel
                  E. Allen
              Director
              2-12-07/s/
                  Ruth W. Brinkley
                Ruth
                  W. Brinkley
              Director
              2-12-07/s/ Gary
                  D. Chazen
                Gary
                  D. Chazen
              Director
              2-12-07/s/
                  Bill W. Stacy
                Bill
                  W. Stacy
              Director
              2-12-07/s/
                  Philip H. Sanford
                Philip
                  H. Sanford
              Director
              2-12-07
 95
 **CHATTEM,
          INC. AND SUBSIDIARIES**
 **EXHIBIT
        INDEX**
 **EXHIBIT**
                  **NUMBER**
                
                **___   _______DESCRIPTION
                    OF EXHIBIT_________________**10.48*
                
                Retirement
                    Agreement effective January 31, 2007 between Chattem, Inc. and
                    Donald K.
                    Riker, Ph.D.10.49*
                
                Summary
                    Description of Incentive Compensation Plan21
                
                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
            96