Chattem 10Q 2007 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT

PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended May 31, 2007

Commission file number 0-5905

CHATTEM, INC.

A TENNESSEE CORPORATION

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

1715 WEST 38TH STREET

CHATTANOOGA, TENNESSEE 37409

TELEPHONE: 423-821-4571

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

YES þ NO o

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

Large accelerated filer þ

Accelerated filer o

Non-accelerated filer o

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

YES o NO þ

As of July 2, 2007, 19,139,504 shares of the Company’s common stock, without par value, were outstanding.

CHATTEM, INC.

INDEX

	PAGE NO.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets as of May 31, 2007 and November 30, 2006	3

Consolidated Statements of Income for the Three and Six Months Ended May 31, 2007 and May 31, 2006	5

Consolidated Statements of Cash Flows for the Three and Six Months Ended May 31, 2007 and May 31, 2006	6

Notes to Consolidated Financial Statements	7

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	28

Item 3. Quantitative and Qualitative Disclosures About Market Risk	38

Item 4. Controls and Procedures	39



PART II. OTHER INFORMATION

Item 1. Legal Proceedings	40

Item 1A. Risk Factors	40

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	40

Item 3. Defaults Upon Senior Securities	40

Item 4. Submission of Matters to a Vote of Security Holders	40

Item 5. Other Information	41

Item 6. Exhibits	41


SIGNATURES	42

PART 1. FINANCIAL INFORMATION

Item 1. Financial Statements

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands)

ASSETS	MAY 31, 2007		NOVEMBER 30, 2006
	(Unaudited)

CURRENT ASSETS:
Cash and cash equivalents	$	12,657	$	90,527
Accounts receivable, less allowances of $13,284 at May 31, 2007 and $10,907 at November 30, 2006		51,828		29,852
Inventories		34,225		31,389
Refundable income taxes		1,491		—
Deferred income taxes		3,711		4,341
Prepaid expenses and other current assets		3,718		5,857
Total current assets		107,630		161,966

PROPERTY, PLANT AND EQUIPMENT, NET		30,197		30,353

OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net		617,543		206,149
Debt issuance costs, net		16,975		11,399
Other		4,908		5,446
Total other noncurrent assets		639,426		222,994

TOTAL ASSETS	$	777,253	$	415,313

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

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands)

LIABILITIES AND SHAREHOLDERS’ EQUITY	MAY 31, 2007			NOVEMBER 30, 2006
	(Unaudited)

CURRENT LIABILITIES:
Current maturities of long-term debt	$	3,000		$	—
Accounts payable and other		12,831			9,948
Bank overdraft		4,432			5,824
Accrued liabilities		28,812			11,805
Total current liabilities		49,075			27,577

LONG-TERM DEBT, less current maturities		533,500			232,500

DEFERRED INCOME TAXES		14,100			17,668

OTHER NONCURRENT LIABILITIES		1,464			1,987

COMMITMENTS AND CONTINGENCIES (Note 19)

SHAREHOLDERS’ EQUITY:
Preferred shares, without par value, authorized 1,000, none issued		—			—
Common shares, without par value, authorized 100,000, issued and outstanding 19,139 at May 31, 2007 and 18,669 at November 30, 2006		44,134			30,452
Retained earnings		134,523			105,965
		178,657			136,417
Cumulative other comprehensive income, net of tax:
Interest rate hedge adjustment		485			(597	)
Foreign currency translation adjustment		(28	)		(239	)
Total shareholders’ equity		179,114			135,581

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	777,253		$	415,313

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

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited and in thousands, except per share amounts)

	FOR THE THREE MONTHS ENDED MAY 31,						FOR THE SIX MONTHS ENDED MAY 31,

	2007			2006			2007			2006
REVENUES:
Net sales	$	112,915		$	79,352		$	213,694		$	163,329
Royalties		49			59			101			106
Total revenues		112,964			79,411			213,795			163,435

COSTS AND EXPENSES:
Cost of sales		35,095			25,054			66,075			51,074
Advertising and promotion		29,664			24,781			58,451			51,968
Selling, general and administrative		14,311			11,528			26,897			23,119
Acquisition expenses		886			—			2,057			—
Litigation settlement		—			108			—			(8,505	)
Total costs and expenses		79,956			61,471			153,480			117,656

INCOME FROM OPERATIONS		33,008			17,940			60,315			45,779

OTHER INCOME (EXPENSE):
Interest expense		(8,319	)		(2,456	)		(15,555	)		(5,300	)
Investment and other income, net		291			234			1,059			428
Loss on early extinguishment of debt		(2,219	)		—			(2,219	)		(2,805	)
Total other income (expense)		(10,247	)		(2,222	)		(16,715	)		(7,677	)

INCOME BEFORE INCOME TAXES		22,761			15,718			43,600			38,102

PROVISION FOR INCOME TAXES		7,853			5,518			15,042			13,129

NET INCOME	$	14,908		$	10,200		$	28,558		$	24,973

NUMBER OF COMMON SHARES:
Weighted average outstanding-basic		19,021			19,290			18,841			19,420
Weighted average and potential dilutive outstanding		19,359			19,529			19,237			19,705

NET INCOME PER COMMON SHARE:
Basic	$	.78		$	.53		$	1.52		$	1.29
Diluted	$	.77		$	.52		$	1.48		$	1.27

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

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited and in thousands, except per share amount)

	FOR THE SIX MONTHS ENDED
	MAY 31, 2007			MAY 31, 2006
OPERATING ACTIVITIES:
Net income	$	28,558		$	24,973
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		4,278			2,891
Deferred income taxes		6,647			2,172
Tax benefit realized from stock options		(3,966	)		(661	)
Stock-based compensation expense		2,632			2,192
Loss on early extinguishment of debt		2,219			2,805
Other, net		117			112
Changes in operating assets and liabilities, net of effects from acquisitions:
Accounts receivable and other		(21,976	)		3,280
Inventories		3,255			(4,900	)
Refundable income taxes		2,475			804
Prepaid expenses and other current assets		1,130			1,936
Accounts payable and accrued liabilities		18,006			(7,482	)
Net cash provided by operating activities		43,375			28,122

INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(1,580	)		(2,091	)
Acquisition of brands		(415,980	)		—
Increase in other assets, net		2,458			(1,430	)
Net cash used in investing activities		(415,102	)		(3,521	)

FINANCING ACTIVITIES:
Repayment of long-term debt		(128,000	)		(75,000	)
Proceeds from long-term debt		400,000			—
Proceeds from borrowings under revolving credit facility		89,000			38,000
Repayments of revolving credit facility		(57,000	)		—
Proceeds from exercise of stock options		8,434			658
Change in bank overdraft		(1,392	)		3,701
Repurchase of common shares		—			(21,332	)
Purchase of note hedge		(29,500	)		—
Proceeds from issuance of warrant		17,430			—
Increase in debt issuance costs		(9,110	)		(15	)
Debt retirement costs		—			(1,501	)
Tax benefit realized from stock options		3,966			661
Net cash provided by (used in) financing activities		293,828			(54,828	)

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		29			(47	)

CASH AND CASH EQUIVALENTS:
Decrease for the period		(77,870	)		(30,274	)
At beginning of period		90,527			47,327
At end of period	$	12,657		$	17,053

PAYMENTS FOR:
Interest	$	13,025		$	5,933
Taxes	$	6,434		$	9,439

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

CHATTEM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

1.	BASIS OF PRESENTATION

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

2.	CASH AND CASH EQUIVALENTS

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

3.	RECLASSIFICATIONS

Certain prior year amounts have been reclassified to conform to the current period’s presentation. The accrual for vendor allowances of $3,663 for the six months ended May 31, 2006, which was included as a component of accrued liabilities, has been reclassified as a reduction of accounts receivable. The bank overdraft of $3,701 for the six months ended May 31, 2006, which was included in cash and cash equivalents, has been reclassified as an increase to total current liabilities.

4.	RECENT ACCOUNTING PRONOUNCEMENTS

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

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

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

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

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

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits entities to choose to measure certain financial assets and liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We are evaluating the impact of adopting SFAS 159 on our consolidated financial statements.

5.	STOCK-BASED COMPENSATION

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

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

For the three and six months ended May 31, 2007, we recorded compensation expense related to stock options that reduced income from operations by $1,428 and $2,632, provision for income taxes by $493 and $908, net income by $935 and $1,724 and basic and diluted net income per share by $0.05 and $0.09, respectively. The stock option compensation expense was included partly in cost of sales, advertising and promotion expenses and selling, general and administrative expenses in the accompanying consolidated statements of income. We capitalized $217 of stock option compensation cost as a component of the carrying cost of inventory on-hand as of May 31, 2007.

The weighted average grant-date fair value of stock options granted during the three months ended May 31, 2007 and 2006 was $24.50 and $16.56, respectively, and for the six months ended May 31, 2007 and 2006 was $24.50 and $16.83, respectively. The fair value of each stock option grant was estimated on the date of grant using a Flex Lattice Model. The following assumptions were used to determine the fair value of stock option grants during the six months ended May 31, 2007 and 2006:

	Six Months Ended May 31,
	2007	2006
Expected life	6.0 years	6.0 years
Volatility	34%	43%
Risk-free interest rate	4.47%	4.48%
Dividend yield	0%	0%
Forfeitures	1.2%	0.9%

The expected life of stock options represents the period of time that the stock options granted are expected to be outstanding based on historical exercise trends. The expected volatility is based on consideration of the historical and implied price volatility of our common stock for fiscal 2007 and historical price volatility of our common stock for fiscal 2006. The risk-free interest rate represents the U.S. Treasury bill rate for the expected life of the related stock options. The dividend yield represents our anticipated cash dividend over the expected life of the stock options. In connection with using the Flex Lattice Model to determine the fair value of stock option grants, the forfeiture rate was determined by analyzing post vesting stock option activity for three separate groups (non-employee directors, officers and other employees).

A summary of stock option activity for the six months ended May 31, 2007 is presented below:

	For the Six Months Ended May 31, 2007
	Shares Under Option			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life	Aggregate Intrinsic Value
Outstanding at December 1, 2006		1,936		$	27.63
Granted		412			59.74
Exercised		(469	)		17.97
Cancelled		(26	)		35.72

Outstanding at May 31, 2007		1,853		$	37.11	5.5 years	$	50,312

Exercisable at May 31, 2007		1,016		$	28.58	5.4 years	$	36,244

The total fair value of stock options that vested during the three months ended May 31, 2007 and 2006 was $1,450 and $1,325, respectively, and during the six months ended May 31, 2007 and 2006 was $2,665 and $2,379, respectively. The total intrinsic value of stock options exercised during the three months ended May 31, 2007 and 2006 was $6,434 and $976, respectively, and during the six months ended May 31, 2007 and 2006 was $17,906 and $1,836, respectively.

As of May 31, 2007, we had $15,513 of unrecognized compensation cost related to stock options that will be recorded over a weighted average period of approximately three years.

We are also authorized to grant restricted shares of common stock to employees under our stock incentive plans that have been approved by shareholders. The restricted shares under these plans meet the definition of “nonvested shares” in SFAS 123R. The restricted shares generally vest over a four year service period commencing upon the date of grant. The total fair market value of restricted shares on the date of grant is amortized to expense on a straight line basis over the four-year vesting period. The amortization expense related to restricted shares during the three months ended May 31, 2007 and 2006 was $175 and $184, respectively, and for the six months ended May 31, 2007 and 2006 was $358 and $367, respectively.

Restricted share activity under the plans is summarized as follows:

	Number of Shares			Weighted Average Grant Date Fair Value
Nonvested at December 1, 2006		37		$	26.45
Granted		—			—
Vested		(17	)	$	20.93
Forfeited		(1	)	$	35.37
Nonvested at May 31, 2007		19		$	30.69

6.	EARNINGS PER SHARE

The following table presents the computation of per share earnings for the three and six months ended May 31, 2007 and 2006, respectively:

	For the Three Months Ended May 31,				For the Six Months Ended May 31,
	2007		2006		2007		2006

NET INCOME	$	14,908	$	10,200	$	28,558	$	24,973

NUMBER OF COMMON SHARES:
Weighted average outstanding		19,021		19,290		18,841		19,420
Issued upon assumed exercise of outstanding stock options		328		203		385		248
Effect of issuance of restricted common shares		10		36		11		37
Weighted average and potential dilutive outstanding (1)		19,359		19,529		19,237		19,705

NET INCOME PER COMMON SHARE:
Basic	$	.78	$	.53	$	1.52	$	1.29
Diluted	$	.77	$	.52	$	1.48	$	1.27

(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: 168 and 862 shares for the three months ended May 31, 2007 and 2006, respectively, and 85 and 787 shares for the six months ended May 31, 2007 and 2006, respectively.

7.	LONG-TERM DEBT

Long-term debt consisted of the following as of May 31, 2007 and November 30, 2006:

	2007			2006
Revolving Credit Facility due 2010 at a variable rate of 6.82% and 8.25% as of May 31, 2007 and November 30, 2006, respectively	$	32,000		$	—
2.0% Convertible Senior Notes due 2013		125,000			125,000
1.625% Convertible Senior Notes due 2014		100,000			—
Term Loan due 2013 at a variable rate of 7.11% as of May 31, 2007		172,000			—
7.0% Senior Subordinated Notes due 2014		107,500			107,500
Total long-term debt		536,500			232,500
Less: current maturities		(3,000	)		—
Total long-term debt, net of current maturities	$	533,500		$	232,500

In February 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. In March 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. In November 2005, we entered into an amendment to our Revolving Credit Facility (the “Amended Revolving Credit Facility”) that, among other things, increased our borrowing capacity under the facility from $50,000 to $100,000, increased our flexibility to repurchase shares of our stock, improved our borrowing rate under the facility and extended the maturity date to November 15, 2010. Upon successful syndication, we were able to increase the borrowing capacity under the Amended Revolving Credit Facility by $50,000 to an aggregate of $150,000. In November 2006, we entered into an amendment to our Amended Revolving Credit Facility that, among other things, permitted the sale of the 2.0% Convertible Senior Notes due 2013 (the “2.0% Convertible Notes”). In January 2007, we completed an 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 over-the-counter (“OTC”) brands from Johnson & Johnson. The Credit Facility includes an “accordion” 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. In April 2007, we entered into an amendment to our Credit Facility that, among other things, permitted the sale of the 1.625% Convertible Senior Notes due 2014 (the “1.625% Convertible Notes”) and reduced the applicable interest rates on the revolving credit facility portion of our Credit Facility.

Borrowings under the revolving credit facility portion of our Credit Facility bear interest at LIBOR plus applicable percentages of 0.875% to 1.500% or the higher of the federal funds rate plus 0.5% or the prime rate (the “Base Rate”). The applicable percentages are calculated based on our leverage ratio. As of May 31, 2007 and November 30, 2006, we had $32,000 and $0, respectively, of borrowings outstanding under the revolving credit facility portion of our Credit Facility. As of July 2, 2007, we had $29,000 of borrowings outstanding under the revolving credit facility portion of our Credit Facility and our borrowing capacity was $71,000.

The term loan under the Credit Facility bears interest at either LIBOR plus 1.75% or the Base Rate plus 0.75%. The term loan borrowings are to be repaid in increments of $750 each calendar quarter, with the first principal payment paid on June 30, 2007. The principal outstanding after scheduled repayment and any unscheduled prepayments is due January 2, 2013. On April 16, 2007, we utilized the net proceeds from the 1.625% Convertible Notes and borrowings under the revolving credit facility portion of our Credit Facility to repay $128,000 of the term loan under the Credit Facility. In connection with this repayment, we retired a proportional share of the term loan debt issuance costs, which resulted in a loss on early extinguishment of debt of $2,219 during the second quarter of fiscal 2007.

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

In February 2004, we issued and sold $75,000 of Floating Rate Senior Notes due March 1, 2010 (the “Floating Rate Senior Notes”) and $125,000 of 7.0% Senior Subordinated Notes due 2014 (the “7.0% Subordinated Notes”). In November 2005, we called our $75,000 of Floating Rate Senior Notes for full redemption on December 30, 2005 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 retired associated debt issuance costs of $1,303 and incurred other related call fees, which resulted in a loss on early extinguishment of debt of $2,805 during the first quarter of fiscal 2006.

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

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

In March 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. During the second quarter of fiscal 2007, the interest rate cap was sold for $353. As a result, $49 was recorded as additional interest expense in the accompanying consolidated statement of income for the second quarter of fiscal 2007.

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

In November 2006, we completed a private offering of $125,000 of the 2.0% Convertible Notes to qualified institutional purchasers pursuant to Section 4(2) of the Securities Act of 1933. The 2.0% Convertible Notes bear interest at an annual rate of 2.0%, payable semi-annually on May 15 and November 15 of each year. The 2.0% Convertible Notes are convertible into our common stock at an initial conversion price of $58.92 per share, upon the occurrence of certain events, including the closing price of our common stock exceeding 130% of the 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 May 31, 2007 our closing stock price was $63.67. Upon conversion, a holder will receive, in lieu of common stock, an amount of cash equal to the lesser of (i) the principal amount of the 2.0% Convertible Notes, or (ii) the conversion value, determined in the manner set forth in the indenture governing the 2.0% Convertible Notes, of a number of shares equal to the conversion rate. If the conversion value exceeds the principal amount of the 2.0% Convertible 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 2.0% Convertible Notes is 2,673.

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

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

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

In November 2006, we entered into a forward starting interest rate swap agreement effective January 15, 2007. The forward starting swap has decreasing notional principal amounts beginning October 15, 2007 and a swap rate of 4.98% over the life of the agreement. As of May 31, 2007, we had $175,500 of LIBOR based borrowings hedged under the provisions of the swap. During the three months ended May 31, 2007, the increase in fair value of the forward starting swap of $669, net of tax, was recorded to other comprehensive income. The current portion of the fair value of the forward starting swap of $313 is included in prepaid expenses and other current assets, and the long-term portion of $548 is included in other non-current assets. As of May 31, 2007, the 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.

In November 2006, we entered into a forward starting interest rate cap agreement effective January 15, 2007. The forward starting cap had 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. During the second fiscal quarter of 2007, the interest rate cap was sold for $555. As a result, $50 was recorded as additional interest expense in the accompanying consolidated statement of income.

In April 2007, we entered into an interest rate cap agreement. The cap has decreasing notional principal amounts beginning May 15, 2007 and a cap rate of 5.0% over the life of the agreement. We paid a $114 premium to enter into the cap agreement, which will be amortized over the life of the agreement. As of May 31, 2007, we had $28,500 of LIBOR based borrowings hedged under the provisions of the cap. During the three months ended May 31, 2007, the value of the premium on the cap was compared to the fair value of the cap and the increase in the market value of the premium of $8, net of tax, was recorded to other comprehensive income. The current portion of the premium on the cap agreement of $80 is included in prepaid expenses and other current assets, and the long-term portion of $23 is included in other non-current assets. As of May 31, 2007, a portion of the interest rate cap was deemed an ineffective cash flow hedge due to the reduction of variable rate debt resulting in an insignificant charge recorded as additional interest expense in the accompanying consolidated statement of income for the second quarter of fiscal 2007. The balance of the cash flow hedge was deemed to be effective. The fair value of the cap agreement is valued by a third party. The cap agreement terminates on September 15, 2008.

In April 2007, we completed a private offering of $100,000 of the 1.625% Convertible Notes to qualified institutional investors pursuant to Section 144A of the Securities Act of 1933. The 1.625% Convertible Notes bear interest at an annual rate of 1.625%, payable semi-annually on May 1 and November 1 of each year, with the first interest payment due on November 1, 2007. The 1.625% Convertible Notes are convertible into our common stock at an initial conversion price of $73.20 per share, upon the occurrence of certain events, including the closing price of our common stock exceeding 130% of the 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 $95.16. Upon conversion, a holder will receive, in lieu of common stock, an amount of cash equal to the lesser of (i) the principal amount of the 1.625% Convertible Notes, or (ii) the conversion value, determined in the manner set forth in the indenture governing the 1.625% Convertible Notes, of a number of shares equal to the conversion rate. If the conversion value exceeds the principal amount of the 1.625% Convertible Note on the conversion date, we will also deliver, at our election, cash or common stock or a combination of cash and common stock with respect to the conversion value upon conversion. If conversion occurs in connection with a change of control, we may be required to deliver additional shares of our common stock by increasing the conversion rate with respect to such notes. The maximum aggregate number of shares that we would be obligated to issue upon conversion of the 1.625% Convertible Notes is 1,694.

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

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

Proceeds from the 1.625% Convertible Notes were used to repay a portion of the amount outstanding under the Credit Facility term loan, pay for a note hedge and pay approximately $2,500 in debt issuance costs. The note hedge and warrant are separate and legally distinct instruments that bind us and the Counterparty and have no binding effect on the holders of the 1.625% Convertible Notes.

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 2.0% Convertible Notes and the 1.625% Convertible Notes are accounted for as convertible debt in the accompanying consolidated balance sheet and the embedded conversion option in the 2.0% Convertible Notes and the 1.625% Convertible Notes has not been accounted for as a separate derivative. Additionally, pursuant to EITF 00-19 and EITF 01-6, the note hedges and warrants are accounted for as equity transactions, and therefore, the payments associated with the issuance of the note hedges and the proceeds received from the issuance of the warrants were recorded as a charge and an increase, respectively, in common shares in shareholders’ equity as separate equity transactions.

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

The future maturities of long-term debt to be funded for the next five successive fiscal years and those thereafter as of May 31, 2007 are as follows:

2007	$	1,500
2008		3,000
2009		3,000
2010		35,000
2011		3,000
Thereafter		491,000
	$	536,500

8.	ACQUISITION AND SALES OF BRANDS

On January 2, 2007, we acquired the U.S. rights to five leading consumer and OTC brands from Johnson & Johnson (“J&J Acquisition”). The acquired brands are: ACT, an anti-cavity mouthwash/mouth rinse; Unisom, an OTC sleep-aid; Cortizone, a hydrocortisone anti-itch product; Kaopectate, an anti-diarrhea product; and Balmex, a diaper rash product. The J&J Acquisition was funded with the proceeds from the new $300,000 term loan provided under our Credit Facility, borrowings under the revolving credit facility of the Credit Facility and through the use of a portion of the proceeds derived from the 2.0% Convertible Notes. The purchase price of the J&J Acquisition was $410,000 plus $2,262 of costs directly related to the acquisition, of which $469 was incurred and funded during our fiscal year ended November 30, 2006. The purchase price relates to $5,916 of inventory, $1,884 of assumed liabilities, $463 of equipment, $403,853 of trademarks which were assigned an indefinite life and $3,914 of distribution rights which was assigned a useful life of five years. This is a preliminary assignment of values that will be completed during fiscal 2007. Johnson & Johnson will continue to manufacture and supply certain of the products for a period of up to 18 months from acquisition close, or such earlier date as we are able to move production to our facilities. The price we pay Johnson & Johnson for these products is equivalent to the manufacturing cost, which includes all costs associated with the manufacturing and delivery of the product. For a period of up to six months from acquisition close, Johnson & Johnson was to provide transition services consisting of consumer affairs, distribution and collection services (including related financial, accounting and reporting services). We terminated the distribution and collections services effective April 2, 2007 and the consumer affairs services effective June 21, 2007. The costs charged for these transition services approximates the actual costs incurred by Johnson & Johnson. During the three and six months ended May 31, 2007, we incurred $886 and $2,057, respectively, of expenses related to these transition services.

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

PRO FORMA CONSOLIDATED RESULTS OF OPERATIONS (Unaudited)

	Three Months Ended May 31,				Six Months Ended May 31,
	2007		2006		2007		2006

Total revenue	$	112,964	$	111,734	$	222,976	$	225,428
Net income		14,908		14,493		29,341		32,137
Earnings per share – basic:		0.78		0.75		1.56		1.65
Earnings per share – diluted:		0.77		0.74		1.53		1.63

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

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

9.	ADVERTISING EXPENSES

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

10.

SHIPPING AND HANDLING

Shipping and handling costs of $3,163 and $2,321 are included in selling expenses for the three months ended May 31, 2007 and 2006, respectively, and $5,565 and $4,585 for the six months ended May 31, 2007 and 2006, respectively.

11.

PATENT, TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS

The carrying value of trademarks, which are not subject to amortization under the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), was $613,875 and $205,983 as of May 31, 2007 and November 30, 2006, respectively. The gross carrying amount of intangible assets subject to amortization at May 31, 2007 and November 30, 2006, which consist primarily of non-compete agreements and distribution rights, was $6,053 and $2,139, respectively. The related accumulated amortization of intangible assets at May 31, 2007 and November 30, 2006 was $2,385 and $1,973, respectively. Amortization of our intangible assets subject to amortization under the provisions of SFAS 142 for the three months ended May 31, 2007 and 2006 was $222 and $59, respectively, and for the six months ended May 31, 2007 and 2006 was $412 and $119, respectively. Estimated annual amortization expense for these assets for the years ended November 30, 2008, 2009, 2010, 2011 and 2012 is $823, $803, $783, $783 and $65, respectively.

12.

INVENTORIES

Inventories consisted of the following as of May 31, 2007 and November 30, 2006:

	2007		2006

Raw materials and work in process	$	10,033	$	15,495
Finished goods		24,192		15,894
Total inventories	$	34,225	$	31,389

13.

ACCRUED LIABILITIES

Accrued liabilities consisted of the following as of May 31, 2007 and November 30, 2006:

	2007		2006

Interest	$	3,957	$	2,599
Salaries, wages and commissions		4,129		3,878
Product advertising and promotion		9,294		1,936
Litigation settlement and legal fees		1,404		1,162
Income taxes payable		—		635
Transition services and acquisition costs		8,209		—
Other		1,819		1,595
Total accrued liabilities	$	28,812	$	11,805

14.

COMPREHENSIVE INCOME

Comprehensive income consisted of the following components for the three and six months ended May 31, 2007 and 2006, respectively:

	For the Three Months Ended May 31,					For the Six Months Ended May 31,
	2007		2006			2007		2006

Net income	$	14,908	$	10,200		$	28,558	$	24,973
Other – interest rate hedge adjustment		748		134			1,082		187
Other – foreign currency translation adjustment		282		(231	)		211		11
Total	$	15,938	$	10,103		$	29,851	$	25,171

15.

STOCK REPURCHASE

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

16.

RETIREMENT PLANS AND POSTRETIREMENT HEALTH CARE BENEFITS

RETIREMENT PLANS

We have a noncontributory defined benefit pension plan (the “Plan”), which covers substantially all employees as of December 31, 2000. The Plan provides benefits based upon years of service and the employee's compensation. Our contributions are based on computations by independent actuaries. Plan assets at May 31, 2007 and November 30, 2006 were invested primarily in United States government and agency securities and corporate debt and equity securities. Effective December 31, 2000, participation and benefits under the Plan were frozen.

Net periodic pension cost for the three and six months ended May 31, 2007 and 2006 included the following components:

	For the Three Months Ended May 31,						For the Six Months Ended May 31,
	2007			2006			2007			2006
Service cost	$	—		$	—		$	—		$	—
Interest cost on projected benefit obligation		153			156			306			311
Actual return on plan assets		(220	)		(226	)		(440	)		(451	)
Net amortization and deferral		—			—			—			—
Net pension cost (benefit)	$	(67	)	$	(70	)	$	(134	)	$	(140	)

No employer contributions were made for the three and six months ended May 31, 2007 and 2006, and no employer contributions are expected to be made in fiscal 2007.

POSTRETIREMENT HEALTH CARE BENEFITS

We maintain certain postretirement health care benefits for eligible employees. Employees become eligible for these benefits if they meet certain age and service requirements. We pay a portion of the cost of medical benefits for certain retired employees over the age of 65. Effective 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 $496 in the three months ended May 31, 2006 and is included as a component of selling, general and administrative expenses in the accompanying consolidated statements of income. Employer contributions expected for fiscal 2007 are approximately $78.

Net periodic postretirement health care benefits cost for the three and six months ended May 31, 2007 and 2006 included the following components:

	For the Three Months Ended May 31,						For the Six Months Ended May 31,
	2007			2006			2007			2006
Service cost	$	14		$	20		$	28		$	40
Interest cost on accumulated postretirement benefit obligation		18			22			36			44
Amortization of prior service cost		4			4			8			8
Amortization of net gain		(4	)		(4	)		(8	)		(8	)
Curtailment gain		—			(496	)		—			(496	)
Net periodic postretirement benefits cost (benefit)	$	32		$	(454	)	$	64		$	(412	)

17.

INCOME TAXES

We account for income taxes using the asset and liability approach as prescribed by SFAS No. 109 and applicable FASB Staff Positions and Interpretations. This approach requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Using the enacted tax rates in effect for the year in which the differences are expected to reverse, deferred tax assets and liabilities are determined based on the differences between the financial reporting and the tax basis of an asset or liability. We record income tax expense in our consolidated financial statements based on an estimated annual effective income tax rate. Our effective tax rate was 34.5% for each of the six months ended May 31, 2007 and 2006.

Undistributed earnings of Chattem Canada amounted to approximately $708 and $807 for the three and six months ended May 31, 2007, respectively. These earnings are considered to be reinvested indefinitely and, accordingly, no provision for U.S. federal and state income taxes has been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, those earnings would be subject to U.S. income taxes (subject to an adjustment for foreign tax credits).

18.

PRODUCT SEGMENT INFORMATION

Net sales of our domestic product categories within our single healthcare business segment for the three and six months ended May 31, 2007 and 2006 are as follows:

	For the Three Months Ended May 31,					For the Six Months Ended May 31,
	2007			2006		2007		2006
Topical pain care	$	24,927		$	28,397	$	52,153	$	60,838
Medicated skin care		31,595			15,389		59,427		32,280
Oral care		13,731	��		1,703		22,218		3,318
Internal OTC products		12,014			3,032		20,463		5,592
Medicated dandruff shampoos		8,339			8,461		18,636		20,278
Dietary supplements		6,824			8,909		14,854		17,762
Other OTC and toiletry products		8,788			6,262		13,090		10,528
Total	$	106,218		$	72,153	$	200,841	$	150,596

19.

COMMITMENTS AND CONTINGENCIES

GENERAL LITIGATION

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

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

The Dexatrim PPA settlement included claims against us involving alleged injuries by Dexatrim products containing PPA in which the alleged injury occurred after December 21, 1998, the date we acquired the Dexatrim brand. In accordance with the terms of the class action settlement agreement, we previously published notice of the settlement and details as to the manner in which claims could be submitted. The deadline for submission of claims was July 7, 2004. A total of 391 claims were certified by the court as timely submitted. A total of 14 claimants with alleged injuries that occurred after December 21, 1998 elected to opt-out of the class settlement. Subsequently, we have settled twelve of the opt-out claims. The other two opt-outs have not filed lawsuits against us, and we believe the applicable statutes of limitation have run against their claims. Consequently, we are not currently defending any PPA products liability claims.

In accordance with the terms of the class action settlement, approximately $70,885 was initially funded into a settlement trust. 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 $2,500.

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 until 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 is currently one Dexatrim with ephedrine products liability lawsuit 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, 2007, we maintain product liability insurance coverage in the amount of $30,000 through our captive insurance subsidiary, of which approximately $3,600 has been funded as of July 2, 2007. We also have $25,000 of 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 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 on or about 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 sought class certification of all persons who purchased our Bullfrog suncare products in California during a four year period prior to February 11, 2004. The amended lawsuit sought restitution and/or disgorgement of profits, actual damages, injunctive relief, punitive damages and attorneys fees and costs. Following the deposition of Plaintiff William C. Jordan, we filed a motion for summary judgment which was heard on April 18, 2007. The court found there was no merit to any of the causes of action that Jordan asserted against us. The court entered judgment in our favor on May 8, 2007. There has been no further activity since that date and we are no longer participating in the coordinated proceedings.

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

On March 9, 2006, we were named in a lawsuit filed in the Southern District of New York by Novogen Research Pty. Ltd. Novogen alleged that our product New Phase infringed upon Novogen patents by containing certain phytoestrogens from clover or equivalent sources. On June 8, 2007, we entered into an agreement with Novogen to settle this litigation. A Stipulation and Order of Dismissal was entered by the court on June 18, 2007. The terms of the settlement agreement had no material effect on our financial position or results of operations.

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

REGULATORY

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

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

Certain of our topical analgesic products are currently marketed under a FDA tentative final external analgesic monograph. The FDA has proposed that the final monograph exclude external analgesic products in patch, plaster or poultice form, unless the FDA receives additional data supporting the safety and efficacy of these products. On October 14, 2003, we submitted to the FDA information regarding the safety of our Icy Hot patches and arguments to support our product’s inclusion in the final monograph. We have also participated in an industry effort coordinated by Consumer Healthcare Products Association (“CHPA”) to establish with the FDA a protocol of additional research that will allow the patches to be marketed under the final monograph even if the final monograph does not explicitly allow them. The CHPA submission to FDA was made on October 15, 2003. Thereafter, in April 2004, we launched the Icy Hot Sleeve, a flexible, non-occlusive fabric patch containing 16% menthol. In February 2006, we launched the Icy Hot Pro-Therapy Medicated Foam Pad with Knee Wrap containing 5% menthol, and the Capzasin Back & Body patch containing 0.025% capsaicin. All of these drug products contain levels of active ingredients consistent with levels permitted in the OTC monograph. If additional research is required either as a preliminary to final FDA monograph approval and/or as a requirement of future individual product sale, we may need to invest in a considerable amount of expensive testing and data analysis. Any preliminary cost may be shared with other patch manufacturers. Because the submissions made into the FDA docket have been forwarded from its OTC Division to its Dermatological Division within the Center for Drug Evaluation and Research (“CDER”), we are uncertain as to when this matter is likely to become final. For example, the FDA could choose to hold in abeyance a final ruling on alternative dose forms even if the monograph is otherwise finalized. If the final monograph excludes such products, we will have to file a new drug application (“NDA”) for previously marketed drugs in order to continue to market the Icy Hot and Aspercreme Patches, the Icy Hot Sleeve, the Icy Hot Pro-Therapy Medicated Foam Pad with Knee Wrap, Capzasin Back & Body Patch and/or similar delivery systems under our other topical analgesic brands. In such case, we would likely have to remove the existing products from the market one year from the effective date of the final monograph, pending FDA review and approval of an NDA. The preparation of an NDA would likely take us six to 18 months and would be expensive. It typically takes the FDA at least twelve months to rule on an NDA once it is submitted.

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

In early 2005, infrequent, but serious, adverse cardiovascular events were reported to the FDA associated with patients who were prescribed a subclass of COX-2 inhibitor non-steroidal anti-inflammatory drugs (“NSAID’s”) for long periods to relieve pain of chronic diseases such as arthritis. These products include Vioxx®, Bextra®, and Celebrex®. In February 2005, the FDA held a joint advisory committee meeting to seek external counsel on the extent to which manufacturers might further warn patients of these cardiovascular risks on prescription product labeling, or prohibit sale of these prescription products. As part of its response on this issue, the FDA has recommended labeling changes for both the prescription and OTC NSAID’s. Well-known OTC NSAID’s such as ibuprofen and naproxen, which have been sold in vast quantities since the 1970s, were affected by this regulatory action. Manufacturers of OTC NSAID’s were asked to revise their labeling to provide more specific information about the potential cardiovascular and gastrointestinal risks recognizing the limited dose and duration of treatment of these products. Our Pamprin All Day product, which contains naproxen sodium, is subject to these new labeling requirements.

Pamprin All Day is manufactured for us by The Perrigo Company (“Perrigo”), holder of an abbreviated NDA for naproxen sodium. As holder of the abbreviated NDA, Perrigo made the mandated labeling changes within the time frame required by the FDA. Product with revised labeling compliant with new FDA regulations began shipping in February 2006. We are also aware of the FDA's concern about the potential toxicity due to concomitant use of OTC and prescription products that contain the analgesic ingredient acetaminophen, an ingredient also found in Pamprin and Prēmsyn PMS. We are also aware that the FDA will revise acetaminophen labeling to reflect the concerns similar to NSAID analgesics such as naproxen. We are participating in an industry-wide effort to reassure the FDA that the current recommended dosing regimen is safe and effective and that proper labeling and public education by both OTC and prescription drug companies are the best policies to abate the FDA's concern. The FDA will address both issues in its effort to finalize the monograph on internal analgesic products. We believe the FDA may issue revised labeling requirements within the next year, perhaps prior to monograph closure that will cause the industry to relabel its analgesic products to better inform consumers.

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

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

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

20.

CONSOLIDATING FINANCIAL STATEMENTS

The consolidating financial statements, for the dates or periods indicated, of Chattem, Inc. (“Chattem”), Signal Investment & Management Co. (“Signal”), SunDex, LLC (“SunDex”) and Chattem (Canada) Holdings, Inc. (“Canada”), the guarantors of the long-term debt of Chattem, and the non-guarantor direct and indirect wholly-owned subsidiaries of Chattem are presented below. Signal is 89% owned by Chattem and 11% owned by Canada. SunDex and Canada are wholly-owned subsidiaries of Chattem. The guarantees of Signal, SunDex and Canada are full and unconditional and joint and several. The guarantees of Signal, SunDex and Canada as of May 31, 2007 arose in conjunction with Chattem’s Credit Facility and Chattem’s issuance of the 7.0% Subordinated Notes (See Note 7). The maximum amount of future payments the guarantors would be required to make under the guarantees as of May 31, 2007 is $311,500.

Note 20

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING BALANCE SHEETS

MAY 31, 2007

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES		ELIMINATIONS			CONSOLIDATED
ASSETS

CURRENT ASSETS:
Cash and cash equivalents	$	3,961		$	664		$	8,032	$	—		$	12,657
Accounts receivable, less allowances of $13,284		46,433			17,360			5,395		(17,360	)		51,828
Interest receivable		17			625			182		(824	)		—
Inventories		27,533			4,069			2,623		—			34,225
Refundable income taxes		1,491			—			—		—			1,491
Deferred income taxes		3,675			—			36		—			3,711
Prepaid expenses and other current assets		2,561			—			1,187		(30	)		3,718
Total current assets		85,671			22,718			17,455		(18,214	)		107,630

PROPERTY, PLANT AND EQUIPMENT, NET		28,835			775			587		—			30,197

OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net		3,668			674,709			1,456		(62,290	)		617,543
Debt issuance costs, net		16,975			—			—		—			16,975
Investment in subsidiaries		337,510			33,000			66,860		(437,370	)		—
Note receivable		—			33,000			—		(33,000	)		—
Other		4,908			—			—		—			4,908
Total other noncurrent assets		363,061			740,709			68,316		(532,660	)		639,426

TOTAL ASSETS	$	477,567		$	764,202		$	86,358	$	(550,874	)	$	777,253

LIABILITIES AND SHAREHOLDERS’ EQUITY

CURRENT LIABILITIES:
Current maturities of long-term debt	$	3,000		$	—		$	—	$	—		$	3,000
Accounts payable and other		11,218			—			1,613		—			12,831
Bank overdraft		4,432			—			—		—			4,432
Accrued liabilities		42,500			1,130			3,396		(18,214	)		28,812
Total current liabilities		61,150			1,130			5,009		(18,214	)		49,075

LONG-TERM DEBT, less current maturities		539,900			(1,200	)		27,800		(33,000	)		533,500

DEFERRED INCOME TAXES		(20,085	)		34,185			—		—			14,100

OTHER NONCURRENT LIABILITIES		1,464			—			—		—			1,464

INTERCOMPANY ACCOUNTS		(283,976	)		277,842			6,134		—			—

SHAREHOLDERS’ EQUITY:
Preferred shares, without par value, authorized 1,000, none issued		—			—			—		—			—
Common shares, without par value, authorized 50,000, issued and outstanding 19,139		44,134			—			—		—			44,134
Shares of subsidiaries		—			329,705			39,803		(369,508	)		—
Retained earnings		134,523			122,540			7,192		(129,732	)		134,523
Total		178,657			452,245			46,995		(499,240	)		178,657
Cumulative other comprehensive income, net of tax:
Interest rate swap/cap adjustment		485			—			—		—			485
Foreign currency translation adjustment		(28	)		—			420		(420	)		(28	)
Total shareholders’ equity		179,114			452,245			47,415		(499,660	)		179,114

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	477,567		$	764,202		$	86,358	$	(550,874	)	$	777,253

Note 20

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING BALANCE SHEETS

NOVEMBER 30, 2006

(In thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES		ELIMINATIONS			CONSOLIDATED
ASSETS

CURRENT ASSETS:
Cash and cash equivalents	$	80,198		$	1,967		$	8,362	$	—		$	90,527
Accounts receivable, less allowances of $10,907		25,203			9,407			4,649		(9,407	)		29,852
Interest receivable		17			625			—		(642	)		—
Inventories		24,444			4,160			2,785		—			31,389
Deferred income taxes		4,304			—			37		—			4,341
Prepaid expenses and other current assets		3,666			—			2,191		—			5,857
Total current assets		137,832			16,159			18,024		(10,049	)		161,966

PROPERTY, PLANT AND EQUIPMENT, NET		28,985			775			593		—			30,353

OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net		166			268,273			—		(62,290	)		206,149
Debt issuance costs, net		11,399			—			—		—			11,399
Investment in subsidiaries		313,922			33,000			66,860		(413,782	)		—
Note receivable		—			33,000			—		(33,000	)		—
Other		4,978			468			—		—			5,446
Total other noncurrent assets		330,465			334,741			66,860		(509,072	)		222,994

TOTAL ASSETS	$	497,282		$	351,675		$	85,477	$	(519,121	)	$	415,313

LIABILITIES AND SHAREHOLDERS’ EQUITY

CURRENT LIABILITIES:
Accounts payable and other	$	10,473		$	—		$	1,580	$	(2,105	)	$	9,948
Bank overdraft		5,824			—			—		—			5,824
Accrued liabilities		17,869			1,132			748		(7,944	)		11,805
Total current liabilities		34,166			1,132			2,328		(10,049	)		27,577

LONG-TERM DEBT, less current maturities		232,500			—			33,000		(33,000	)		232,500

DEFERRED INCOME TAXES		(16,517	)		34,185			—		—			17,668

OTHER NONCURRENT LIABILITIES		1,987			—			—		—			1,987

INTERCOMPANY 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			—			—		—			30,452
Share capital of subsidiaries		—			329,705			39,803		(369,508	)		—
Retained earnings		105,965			100,667			5,679		(106,346	)		105,965
Total		136,417			430,372			45,482		(475,854	)		136,417
Cumulative other comprehensive income, net of taxes:
Interest rate swap/cap adjustment		(597	)		—			—		—			(597	)
Foreign currency translation adjustment		(238	)		—			217		(218	)		(239	)
Total shareholders’ equity		135,582			430,372			45,699		(476,072	)		135,581

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	497,282		$	351,675		$	85,477	$	(519,121	)	$	415,313

Note 20

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF INCOME

FOR THE SIX MONTHS ENDED MAY 31, 2007

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED

TOTAL REVENUES	$	189,701		$	47,237		$	10,512		$	(33,655	)	$	213,795

COSTS AND EXPENSES:
Cost of sales		58,130			4,413			4,895			(1,363	)		66,075
Advertising and promotion		50,098			5,418			2,935			—			58,451
Selling, general and administrative		26,526			(391	)		762			—			26,897
Acquisition expenses		2,057			—			—			—			2,057
Equity in subsidiary income		(23,385	)		—			—			23,385			—
Total costs and expenses		113,426			9,440			8,592			22,022			153,480

INCOME FROM OPERATIONS		76,275			37,797			1,920			(55,677	)		60,315

OTHER INCOME (EXPENSE):
Interest expense		(15,650	)		—			(1,324	)		1,419			(15,555	)
Investment and other income, net		709			1,274			1,746			(2,670	)		1,059
Loss on early extinguishment of debt		(2,219	)		—			—			—			(2,219	)
Royalties		(29,853	)		(2,439	)		—			32,292			—
Corporate allocations		1,363			(1,331	)		(32	)		—			—
Total other income (expense)		(45,650	)		(2,496	)		390			31,041			(16,715	)

INCOME BEFORE INCOME TAXES		30,625			35,301			2,310			(24,636	)		43,600

PROVISION FOR INCOME TAXES		2,067			12,178			797			—			15,042

NET INCOME	$	28,558		$	23,123		$	1,513		$	(24,636	)	$	28,558

Note 20

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF INCOME

FOR THE SIX MONTHS ENDED MAY 31, 2006

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED

TOTAL REVENUES	$	136,865		$	42,143		$	10,143		$	(25,716	)	$	163,435

COSTS AND EXPENSES:
Cost of sales		42,951			5,064			4,501			(1,442	)		51,074
Advertising and promotion		44,124			5,328			2,516			—			51,968
Selling, general and administrative		22,795			(146	)		470			—			23,119
Litigation settlement		(8,505	)		—			—			—			(8,505	)
Equity in subsidiary income		(19,319	)		—			—			19,319			—
Total costs and expenses		82,046			10,246			7,487			17,877			117,656

INCOME FROM OPERATIONS		54,819			31,897			2,656			(43,593	)		45,779

OTHER INCOME (EXPENSE):
Interest expense		(5,310	)		—			(1,228	)		1,238			(5,300	)
Investment and other income, net		265			1,261			1,389			(2,487	)		428
Loss on early extinguishment of debt		(2,805	)		—			—			—			(2,805	)
Royalties		(21,388	)		(2,886	)		—			24,274			—
Corporate allocations		1,682			(1,652	)		(30	)		—			—
Total other income (expense)		(27,556	)		(3,277	)		131			23,025			(7,677	)

INCOME BEFORE INCOME TAXES		27,263			28,620			2,787			(20,568	)		38,102

PROVISION FOR INCOME TAXES		2,290			9,877			962			—			13,129

NET INCOME	$	24,973		$	18,743		$	1,825		$	(20,568	)	$	24,973

Note 20

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED MAY 31, 2007

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED

OPERATING ACTIVITIES:
Net income	$	28,558		$	23,123		$	1,513		$	(24,636	)	$	28,558
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		4,192			—			86			—			4,278
Deferred income taxes		6,648			—			(1	)		—			6,647
Tax benefit realized from stock options		(3,966	)		—			—			—			(3,966	)
Stock-based compensation		2,632			—			—			—			2,632
Loss on early extinguishment of debt		2,219			—			—			—			2,219
Other, net		146			—			(29	)		—			117
Equity in subsidiary income		(24,636	)		—			—			24,636			—
Changes in operating assets and liabilities:
Accounts receivable		(21,229	)		(7,953	)		(747	)		7,953			(21,976	)
Interest Receivable		—			—			(182	)		182			—
Inventories		3,001			92			162			—			3,255
Refundable income taxes		2,475			—			—			—			2,475
Prepaid expenses and other current assets		1,105			—			(5	)		30			1,130
Accounts payable and accrued liabilities		23,492			(2	)		2,681			(8,165	)		18,006
Net cash provided by (used in) operating activities		24,637			15,260			3,478			—			43,375

INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(1,501	)		—			(79	)		—			(1,580	)
Sales (purchases) of trademarks and other product rights		(8,090	)		(406,435	)		(1,455	)		—			(415,980	)
Change in other assets, net		779			467			1,212			—			2,458
Net cash used in investing activities		(8,812	)		(405,968	)		(322	)		—			(415,102	)

FINANCING ACTIVITIES:
Repayment of long-term debt		(128,000	)		—			—			—			(128,000	)
Intercompany debt proceeds (payments)		6,400			(1,200	)		(5,200	)		—			—
Proceeds from long–term debt		400,000			—			—			—			400,000
Proceeds from borrowings under revolving credit facility		89,000			—			—			—			89,000
Repayments of revolving credit facility		(57,000	)		—			—			—			(57,000	)
Change in bank overdraft		(1,392	)		—			—			—			(1,392	)
Proceeds from exercise of stock options		8,434			—			—			—			8,434
Purchase of note hedge		(29,500	)		—			—			—			(29,500	)
Proceeds from issuance of warrants		17,430			—			—			—			17,430
Increase in debt issuance costs		(9,110	)		—			—			—			(9,110	)
Excess tax benefit from stock-based compensation		3,966			—			—			—			3,966
Changes in intercompany accounts		(392,290	)		391,855			435			—			—
Dividends paid		—			(1,250	)		1,250			—			—
Net cash (used in) provided by financing activities		(92,062	)		389,405			(3,515	)		—			293,828

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		—			—			29			—			29

CASH AND CASH EQUIVALENTS:
(Decrease) increase for the period		(76,237	)		(1,303	)		(330	)		—			(77,870	)
At beginning of period		80,198			1,967			8,362			—			90,527
At end of period	$	3,961		$	664		$	8,032		$	—		$	12,657

Note 20

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED MAY 31, 2006

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED

OPERATING ACTIVITIES:
Net income	$	24,973		$	18,743		$	1,825		$	(20,568	)	$	24,973
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		2,702			—			189			—			2,891
Deferred income taxes		(884	)		3,091			(35	)		—			2,172
Excess tax benefit from stock-based compensation		(661	)		—			—			—			(661	)
Stock-based compensation		2,192			—			—			—			2,192
Loss on early extinguishment of debt		2,805			—			—			—			2,805
Other, net		65			—			47			—			112
Equity in subsidiary income		(20,568	)		—			—			20,568			—
Changes in operating assets and liabilities:
Accounts receivable		3,827			(588	)		(547	)		588			3,280
Inventories		(4,260	)		(257	)		(383	)		—			(4,900	)
Refundable income taxes		804			—			—			—			804
Prepaid expenses and other current assets		2,372			—			(46	)		(390	)		1,936
Accounts payable and accrued liabilities		(5,759	)		510			(2,035	)		(198	)		(7,482	)
Net cash provided by (used in) operating activities		7,608			21,499			(985	)		—			28,122

INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(1,893	)		—			(198	)		—			(2,091	)
Increase in other assets, net		(905	)		—			(525	)		—			(1,430	)
Net cash used in investing activities		(2,798	)		—			(723	)		—			(3,521	)

FINANCING ACTIVITIES:
Repayment of long-term debt		(75,000	)		—			—			—			(75,000	)
Proceeds from borrowings under revolving credit facility		38,000			—			—			—			38,000
Proceeds from exercise of stock options		658			—			—			—			658
Change in bank overdraft		3,701			—			—			—			3,701
Repurchase of common shares		(21,332	)		—			—			—			(21,332	)
Increase in debt issuance costs		(15	)		—			—			—			(15	)
Retirement of debt issuance costs		(1,501	)		—			—			—			(1,501	)
Excess tax benefit from stock-based compensation		661			—			—			—			661
Changes in intercompany accounts		18,530			(20,229	)		1,699			—			—
Dividends paid		—			(1,250	)		1,250			—			—
Net cash (used in) provided by financing activities		(36,298	)		(21,479	)		2,949			—			(54,828	)

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		—			—			(47	)		—			(47	)

CASH AND CASH EQUIVALENTS:
(Decrease) increase for the period		(31,488	)		20			1,194			—			(30,274	)
At beginning of period		36,647			1,982			8,698			—			47,327
At end of period	$	5,159		$	2,002		$	9,892		$	—		$	17,053

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

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

Overview

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

•

Icy Hot, Capzasin and Aspercreme – topical pain care;

•

Gold Bond, Balmex and Cortizone – medicated skin care;

•

Selsun Blue and Selsun Salon – medicated dandruff shampoos;

•

ACT and Herpecin-L – oral care;

•

Unisom, Pamprin and Kaopectate – internal OTC;

•

Dexatrim, Garlique and New Phase – dietary supplements; and

•

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

Our products target niche markets that are often outside the focus of larger companies where we believe we can achieve and sustain significant market share through innovation and strong advertising and promotion support. Many of our products are among the U.S. market leaders in their respective categories. For example, our portfolio of topical analgesic brands and our Gold Bond medicated body powders have the leading U.S. market share in these categories. We support our brands through extensive and cost-effective advertising and promotion, the expenditures for which represented approximately 27% of our total revenues in the first half of fiscal 2007. We sell our products nationally through mass merchandiser, drug and food channels, principally utilizing our own sales force.

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

Developments During Fiscal 2007

Acquisition of Brands

On January 2, 2007, we acquired the U.S. rights to five leading consumer and OTC brands from Johnson & Johnson (“J&J Acquisition”). The acquired brands are: ACT, an anti-cavity mouthwash/mouth rinse; Unisom, an OTC sleep-aid; Cortizone, a hydrocortisone anti-itch product; Kaopectate, an anti-diarrhea product; and Balmex, a diaper rash product. The J&J Acquisition was funded with the proceeds from the new $300.0 million term loan provided under our Credit Facility, borrowings under the revolving credit facility portion of the Credit Facility and through the use of a portion of the proceeds derived from the 2.0% Convertible Notes. The purchase price of the J&J Acquisition was $410.0 million plus $2.3 million of costs directly related to the acquisition, of which $0.5 million was incurred and funded during our fiscal year ended November 30, 2006. The purchase price relates to $5.9 million of inventory, $1.9 million of assumed liabilities, $0.5 million of equipment, $403.9 million of trademarks which were assigned an indefinite life and $3.9 million of distribution rights which was assigned a useful life of five years. This is a preliminary assignment of values that will be completed during fiscal 2007. Johnson & Johnson will continue to manufacture and supply certain of the products for a period of up to 18 months from acquisition close, or such earlier date as we are able to move production to our facilities. The price we pay Johnson & Johnson for these products is equivalent to the manufacturing cost, which includes all costs associated with the manufacturing and delivery of the product. For a period of up to six months from acquisition close, Johnson & Johnson was to provide transition services consisting of consumer affairs, distribution and collection services (including related financial, accounting and reporting services). We terminated the distribution and collections services effective April 2, 2007 and the consumer affairs services effective June 21, 2007. The costs charged for these transition services approximates the actual costs incurred by Johnson & Johnson.

On May 25, 2007, we acquired the worldwide trademark and rights to sell and market ACT in Western Europe from Johnson & Johnson (“ACT Acquisition”) for $4.1 million in cash plus certain assumed liabilities. The ACT Acquisition was funded with existing cash.

Products

In the first six months of fiscal 2007, we introduced the following product line extensions: Icy Hot Heat Therapy, Icy Hot Vanishing Scent Cream, Capzasin No-Mess, Bullfrog Marathon Mist, Selsun Naturals and Dexatrim Max Evening Appetite Control.

Debt

In January 2007, we completed an amended credit facility providing for up to a $100.0 million revolving credit facility and a $300.0 million term loan (the “Credit Facility”). The proceeds from the term loan under the Credit Facility were used to finance in part the J&J Acquisition. The Credit Facility includes an “accordion” feature that permits us under certain circumstances to increase our borrowings under the revolving credit facility by $50.0 million and to borrow an additional $50.0 million as a term loan. In April 2007, we entered into an amendment to our Credit Facility that, among other things, permitted the sale of the 1.625% Convertible Senior Notes due 2014 (the “1.625% Convertible Notes”) and reduced the applicable interest rates on the revolving credit facility portion of our Credit Facility.

Borrowings under the revolving credit facility portion of our Credit Facility bear interest at LIBOR plus applicable percentages of 0.875% to 1.5% or the higher of the federal funds rate plus 0.5% or the prime rate (the “Base Rate”). The applicable percentages are calculated based on our leverage ratio. As of May 31, 2007 and November 30, 2006, we had $32.0 million and $0, respectively, of borrowings outstanding under the revolving credit facility portion of our Credit Facility. As of July 2, 2007, we had $29.0 million of borrowings outstanding under the revolving credit facility portion of our Credit Facility and our borrowing capacity was $71.0 million.

The term loan under the Credit Facility bears interest of either LIBOR plus 1.75% or the Base Rate plus 0.75%. The term loan borrowings are to be repaid in increments of $0.8 million each calendar quarter, with the first principal payment paid on June 30, 2007. The principal outstanding after scheduled repayment and any unscheduled prepayments is due January 2, 2013. On April 16, 2007, we utilized the net proceeds from the 1.625% Convertible Notes and borrowings under the revolving credit facility portion of our Credit Facility to repay $128.0 million of the term loan under the Credit Facility. In connection with this repayment, we retired a proportional share of the term loan debt issuance costs, which resulted in a loss on early extinguishment of debt of $2.2 million during the second quarter of fiscal 2007.

In April 2007, we completed a private offering of $100.0 million of the 1.625% Convertible Notes, the proceeds of which were used to repay a portion of the amount outstanding under the Credit Facility term loan, pay for a note hedge and pay approximately $2.5 million in debt issuance costs. The 1.625% Convertible Notes bear interest at an annual rate of 1.625%, payable semi-annually on May 1 and November 1 of each year, with the first interest payment due on November 1, 2007. Concurrently with the sale of the 1.625% Convertible Notes, we purchased a note hedge for $29.5 million and issued warrants for proceeds of $17.4 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 1.625% Convertible Notes.

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:

	For the Three Months Ended						For the Six Months Ended
	May 31, 2007			May 31, 2006			May 31, 2007			May 31, 2006

TOTAL REVENUES		100.0	%		100.0	%		100.0	%		100.0	%

COSTS AND EXPENSES:
Cost of sales		31.1			31.6			30.9			31.3
Advertising and promotion		26.2			31.2			27.3			31.8
Selling, general and administrative		12.7			14.5			12.6			14.1
Acquisition expense		0.8			—			1.0			—
Litigation settlement		—			0.1			—			(5.2	)
Total costs and expenses		70.8			77.4			71.8			72.0

INCOME FROM OPERATIONS		29.2			22.6			28.2			28.0

OTHER INCOME (EXPENSE):
Interest expense		(7.4	)		(3.1	)		(7.3	)		(3.3	)
Investment and other income, net		0.3			0.3			0.5			0.3
Loss on early extinguishment of debt		(2.0	)		—			(1.0	)		(1.7	)
Total other income (expense)		(9.1	)		(2.8	)		(7.8	)		(4.7	)

INCOME BEFORE INCOME TAXES		20.1			19.8			20.4			23.3

PROVISION FOR INCOME TAXES		6.9			6.9			7.0			8.0

NET INCOME		13.2	%		12.9	%		13.4	%		15.3	%

Critical Accounting Policies

The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to use estimates. Several different estimates or methods can be used by management that might yield different results. The following are the significant estimates used by management in the preparation of the unaudited consolidated financial statements for the three and six months ended May 31, 2007.

Allowance for Doubtful Accounts

As of May 31, 2007, an estimate was made of the collectibility of the outstanding accounts receivable balances. This estimate requires the utilization of outside credit services, knowledge about the customer and the customer’s industry, new developments in the customer’s industry and operating results of the customer as well as general economic conditions and historical trends. When all these facts are compiled, a judgment as to the collectibility of the individual account is made. Many factors can impact this estimate, including those noted in this paragraph. The adequacy of the estimated allowance may be impacted by the deterioration in the financial condition of a large customer, weakness in the economic environment resulting in a higher level of customer bankruptcy filings or delinquencies and the competitive environment in which the customer operates. During the second quarter of fiscal 2007, we performed a detailed assessment of the collectibility of trade accounts receivable and did not make any significant adjustments to our estimate of allowance for doubtful accounts. The balance of allowance for doubtful accounts was $0.4 and $0.3 million at May 31, 2007 and November 30, 2006, respectively.

Revenue Recognition

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

and retail point of sale data on existing and newly introduced products. The level of returns may fluctuate from our estimates due to several factors including weather conditions, customer inventory levels and competitive conditions. We charge the allowance account resulting from this accrual with any authorized deduction from remittance by the customer or product returns upon receipt of the product.

We separate returns into the two categories of seasonal and non-seasonal products. We use the historical return detail of seasonal and non-seasonal products for at least the most recent three fiscal years on generally all products, which is normalized for any specific occurrence that is not reasonably likely to recur, to determine the amount of product return as a percentage of sales, and estimate an allowance for potential returns based on product sold in the current period. To consider product sold in current and prior periods, an estimate of inventory held by our retail customers is calculated based on customer inventory detail. This estimate of inventory held by our customers, along with historical returns as a percentage of sales, is used to determine an estimate of potential product returns. This estimate of the allowance for seasonal and non-seasonal returns is further analyzed by considering retail customer point of sale data. We also consider specific events, such as discontinued product or product divestitures, when determining the adequacy of the allowance. Based on consideration of the sales of Icy Hot Pro-Therapy performing below expectations, review of retail point of sales data and an estimate of inventory on hand at customers, an allowance for returns of $3.3 million was recorded as of November 30, 2006. As of May 31, 2007, the allowance remaining for Icy Hot Pro-Therapy returns after fiscal 2007 returns activity through May 31, 2007 is $2.3 million. Our estimate of product returns for seasonal and non-seasonal products as of May 31, 2007 was $2.5 million and $1.2 million, respectively, and $1.2 million and $1.3 million, respectively, as of November 30, 2006. For the six months ended May 31, 2007, we increased our estimate of returns for seasonal products by approximately $1.3 million which resulted in a decrease to net sales in our consolidated financial statements and decreased our estimate for non-seasonal returns by approximately $0.1 million which resulted in an increase to net sales in our consolidated financial statements. During the six months ended May 31, 2006, we increased our estimate of returns for seasonal products and non-seasonal returns by approximately $1.5 million and $0.2 million, respectively, which resulted in a decrease to net sales in our consolidated financial statements. Each percentage point change in the seasonal return rate would impact net sales by approximately $0.2 million. Each percentage point change in the non-seasonal return rate would impact net sales by approximately $0.5 million.

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

We analyze promotional programs in two primary categories -- coupons and vendor allowances. Customers normally utilize vendor allowances in the form of temporary price reductions, scan downs, display activity and participations in in-store programs provided uniquely by the customer. We estimate the accrual for outstanding coupons by utilizing a third-party clearinghouse to track coupons issued, coupon value, distribution and expiration dates, quantity distributed and estimated redemption rates that are provided by us. We estimate the redemption rates based on internal analysis of historical coupon redemption rates and expected future retail sales by considering recent point of sale data. The estimate for vendor allowances is based on estimated unit sales of a product under a program and amounts committed for such programs in each fiscal year. Estimated unit sales are determined by considering customer forecasted sales, point of sale data and the nature of the program being offered. The three most recent years of expected program payments versus actual payments made and current year retail point of sale trends are analyzed to determine future expected payments. Customer delays in requesting promotional program payments due to their audit of program participation and resulting request for reimbursement is also considered to evaluate the accrual for vendor allowances. The costs of these programs is often variable based on the number of units actually sold. As of May 31, 2007, the coupon accrual and reserve for vendor allowances were $2.0 million and $5.9 million, respectively, and $1.2 million and $3.7 million, respectively, as of November 30, 2006. Each percentage point change in promotional program participation and advertising and promotion expense would impact net sales by an insignificant amount.

Income Taxes

We account for income taxes using the asset and liability approach as prescribed by SFAS 109 and applicable FASB Staff Positions and Interpretations. This approach requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in our 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 effective tax rate was 34.5% for each of the six months ended May 31, 2007 and 2006.

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

Comparison of Three Months Ended May 31, 2007 and 2006

To facilitate discussion of our operating results for the three months ended May 31, 2007 and 2006, we have included the following selected data from our Consolidated Statements of Income:

					Increase (Decrease)
	2007		2006		Amount			Percentage
	(dollars in thousands)
Domestic net sales	$	106,218	$	72,153	$	34,065			47.2	%
International revenues (including royalties)		6,746		7,258		(512	)		(7.1	)
Total revenues		112,964		79,411		33,553			42.3
Cost of sales		35,095		25,054		10,041			40.1
Advertising and promotion expense		29,664		24,781		4,883			19.7
Selling, general and administrative expense		14,311		11,528		2,783			24.1
Acquisition expenses		886		—		886			100.0
Litigation settlement		—		108		(108	)		(100.0	)
Interest expense		8,319		2,456		5,863			238.7
Loss on early extinguishment of debt		2,219		—		2,219			100.0
Net income		14,908		10,200		4,708			46.2

Domestic Net Sales

Domestic net sales for the three months ended May 31, 2007 increased $34.1 million, or 47.2%, to $106.2 million from $72.2 million in the prior year quarter. A comparison of domestic net sales for the categories of products included in our portfolio of OTC healthcare products is as follows:


					Increase (Decrease)
	2007		2006		Amount			Percentage
	(dollars in thousands)
Topical pain care	$	24,927	$	28,397	$	(3,470	)		(12.2	)%
Medicated skin care		31,595		15,389		16,206			105.3
Oral care		13,731		1,703		12,028			706.3
Internal OTC products		12,014		3,032		8,982			296.2
Medicated dandruff shampoos		8,339		8,461		(122	)		(1.4	)
Dietary supplements		6,824		8,909		(2,085	)		(23.4	)
Other OTC and toiletry products		8,788		6,262		2,526			40.3
Total	$	106,218	$	72,153	$	34,065			47.2

Net sales in the topical pain care category decreased $3.5 million, or 12.2%, for the second quarter of fiscal 2007 compared to the same prior year quarter, due primarily to reduced sales from Icy Hot Pro-Therapy. Excluding sales of Icy Hot Pro-Therapy, the category declined 5.0% compared to the prior year quarter, due to lower sales of our smaller topical pain care brands and the launch of the Capzasin Back and Body Patch in fiscal 2006.

Net sales in the medicated skin care category increased $16.2 million, or 105%, in the second quarter of fiscal 2007 compared to the prior year quarter. The category increase was primarily attributable to the Cortizone and Balmex brands acquired in the J&J Acquisition. Net sales of Gold Bond increased 22.8% compared to the prior year quarter, led by sales of Gold Bond Ultimate Softening Lotion launched in the fourth quarter of fiscal 2006.

Net sales in the oral care category increased $12.0 million, or 706%, in the second quarter of fiscal 2007 compared to the prior year quarter. This increase was led by ACT, which was acquired in the J&J Acquisition.

Net sales in the internal OTC category increased $9.0 million, or 296%, in the second quarter of fiscal 2007 compared to the prior year quarter. This increase was led by Unisom and Kaopectate, which were acquired in the J&J Acquisition.

Net sales in the medicated dandruff shampoos category decreased $0.1 million, or 1.4%, in the second quarter of fiscal 2007 compared to the prior year quarter. Sales of Selsun Blue declined 2.0% for the quarter as a result of lower end of season shipments as well as media and promotional support weighted toward Selsun Salon, offset by a 4.0% increase in sales of Selsun Salon.

Net sales in the dietary supplements category decreased $2.1 million, or 23.4%, for the second quarter of fiscal 2007 compared to the prior year quarter. Net sales of Dexatrim decreased 14.3% as a result of initial sales of Dexatrim Max₂O in the prior year quarter. Net sales of Garlique decreased 40.2% and New Phase decreased 42.8% for the second quarter of fiscal 2007 from the prior year period as a result of lower advertising support.

Net sales in the other OTC and toiletry products category increased $2.5 million, or 40.3%, in the second quarter of fiscal 2007 compared to the prior year as a result of a 61.7% increase in Bullfrog sales, behind the fiscal 2007 introduction of Bullfrog Marathon Mist, new packaging on all Bullfrog products and timing of shipments for certain retailers in the second fiscal quarter of 2007 versus the first fiscal quarter of 2007. Sun-In also contributed to the higher category results with increased sales of 26.6% for the quarter as a result of new packaging and increased advertising.

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

International Revenues

For the second quarter of fiscal 2007, international revenues decreased $0.5 million, or 7.1%, compared to the second quarter of fiscal 2006 due principally to timing of sales to certain customers in the quarter compared to the prior year quarter. Sales variances for our international operations were principally the result of changes in unit sales volume.

Cost of Sales

Cost of sales as a percentage of total revenues was 31.1% for the second quarter of fiscal 2007 as compared to 31.6% in the prior year quarter. Gross margin for the second quarter of fiscal 2007 was 68.9% compared to 68.4% in the prior year quarter. The gross margin increase was largely attributable to decreased sales of Icy Hot Pro-Therapy which has a lower margin compared to our other brands.

Advertising and Promotion Expense

Advertising and promotion expenses in the second quarter of fiscal 2007 increased $4.9 million, or 19.7%, as compared to the prior year quarter and were 26.2% of total revenues for the three months ended May 31, 2007 compared to 31.2% for the prior year quarter. The decrease in advertising and promotion expense as a percentage of revenue for the current period reflected higher advertising and promotion spending for Icy Hot Pro-Therapy and Selsun Salon during the fiscal 2006 launch period.

Selling, General and Administrative Expense

Selling, general and administrative expenses increased $2.8 million, or 24.1%, compared to the prior year quarter. Selling, general and administrative expenses were 12.7% and 14.5% of total revenues for the second quarter of fiscal 2007 and 2006, respectively. The decrease as a percentage of revenue was attributable to increased revenue without commensurate increases in selling, general and administrative expenses.

Acquisition Expenses

Acquisition expenses of $0.9 million were recorded in the second quarter of fiscal 2007 related to transition services provided by Johnson & Johnson under a transition services agreement entered into in connection with the J&J Acquisition. The transition services provided by Johnson & Johnson included consumer affairs, distribution and collection services, which included related financial accounting and reporting services. The distribution and collection services were terminated effective April 2, 2007 and the consumer affairs services were terminated June 21, 2007.

Interest Expense

Interest expense increased $5.9 million, or 239%, in the second quarter of fiscal 2007 as compared to the prior year quarter as a result of additional indebtedness incurred to finance the J&J Acquisition. Until our indebtedness is reduced substantially, interest expense will continue to represent a significant percentage of our income from operations.

Loss on Early Extinguishment of Debt

During the second quarter of fiscal 2007, we utilized the net proceeds from the 1.625% Convertible Notes and borrowings under the revolving credit facility portion of our Credit Facility to repay $128.0 million of the term loan under the Credit Facility. In connection with the repayment, we retired a proportional share of the term loan debt issuance costs, which resulted in a loss on early extinguishment of debt of $2.2 million during the second quarter of fiscal 2007. No corresponding charge was incurred in the second quarter of fiscal 2006.

Comparison of Six Months Ended May 31, 2007 and 2006

To facilitate discussion of our operating results for the six months ended May 31, 2007 and 2006, we have included the following selected data from our Consolidated Statements of Operations:

						Increase (Decrease)
	2007		2006			Amount			Percentage
	(dollars in thousands)
Domestic net sales	$	200,841	$	150,596		$	50,245			33.4	%
International revenues (including royalties)		12,954		12,839			115			0.9
Total revenues		213,795		163,435			50,360			30.8
Cost of sales		66,075		51,074			15,001			29.4
Advertising and promotion expense		58,451		51,968			6,483			12.5
Selling, general and administrative expense		26,897		23,119			3,778			16.3
Acquisition expenses		2,057		—			2,057			100.0
Litigation settlement		—		(8,505	)		8,505			(100.0	)
Interest expense		15,555		5,300			10,255			193.5
Loss on early extinguishment of debt		2,219		2,805			(586	)		(20.9	)
Net income		28,558		24,973			3,585			14.4

Domestic Net Sales

Domestic net sales for the six months ended May 31, 2007 increased $50.2 million, or 33.4%, as compared to the corresponding period of 2006. A comparison of domestic net sales for the categories of products included in our portfolio of OTC healthcare products is as follows:


					Increase (Decrease)
	2007		2006		Amount			Percentage
	(dollars in thousands)
Topical pain care	$	52,153	$	60,838	$	(8,685	)		(14.3	)%
Medicated skin care		59,427		32,280		27,147			84.1
Oral Care		22,218		3,318		18,900			569.6
Internal OTC products		20,463		5,592		14,871			265.9
Medicated dandruff shampoos		18,636		20,278		(1,642	)		(8.1	)
Dietary supplements		14,854		17,762		(2,908	)		(16.4	)
Other OTC and toiletry products		13,090		10,528		2,562			24.3
Total	$	200,841	$	150,596	$	50,245			33.4

Net sales growth in the topical pain care products category decreased $8.7 million, or 14.3%, for the first six months of fiscal 2007 compared to the same period in fiscal 2006, due to the initial product introduction of Icy Hot Pro-Therapy in fiscal 2006. Excluding sales of Icy Hot Pro-Therapy, the category increased 9.0% compared to the same period of prior year led by the introduction of Icy Hot Heat Therapy.

Net sales in the medicated skin care category increased $27.1 million, or 84.1%, for the first six months of fiscal 2007 compared to the same period in fiscal 2006 as a result of the acquisition of Cortizone and Balmex in the first fiscal quarter of 2007 and sales of Gold Bond Ultimate Softening Lotion launched in the fourth quarter of fiscal 2006. The Gold Bond franchise had sales increases of 24.8% for the first six months of fiscal 2007 compared to the same prior year period.

Net sales in the oral care category increased $18.9 million, or 570%, for the first six months of fiscal 2007 compared to the same period in 2006. This increase was led by ACT, which was acquired in the J&J Acquisition.

Net sales in the internal OTC category increased $14.9 million, or 266%, for the first six months of fiscal 2007 compared to the same period in 2006. This increase was led by Unisom and Kaopectate, which were acquired in the J&J Acquisition.

Net sales in the medicated dandruff shampoos category decreased $1.6 million, or 8.1%, for the first six months of fiscal 2007 compared to the same period in 2006, primarily due to the launch and initial sell-in of Selsun Salon in the first quarter of fiscal 2006.

Net sales in the dietary supplements category decreased $2.9 million, or 16.4%, for the first six months of fiscal 2007 as compared to the same period in 2006. Net sales of Garlique decreased 32.9% compared to the prior year period as a result of the initial product introduction of Garlique Cardio Assist in the same period of fiscal 2006.

Net sales in the other OTC and toiletry products category increased $2.6 million, or 24.3%, for the first six months of fiscal 2007 compared to the same period in fiscal 2006 as a result of the launch of Bullfrog Marathon Mist and new packaging introductions for the Bullfrog and Sun-In product lines.

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

International Revenues

For the six months ended May 31, 2007, international revenues increased $0.1 million, or 0.9%, as compared to the same period in fiscal 2006. Sales variances for our international operations were principally the result of changes in unit sales volume.

Cost of Sales

Cost of sales as a percentage of total revenues was 30.9% for the six months ended May 31, 2007 as compared to 31.3% for the comparable period of fiscal 2006. Gross margin for the six months ended May 31, 2007 was 69.1% compared to 68.7% for the same period in fiscal 2006. The increase in gross margin was largely attributable to the launch of Icy Hot Pro-Therapy in fiscal 2006, which has a lower gross margin than our other brands.

Advertising and Promotion Expense

Advertising and promotion expenses for the six months ended May 31, 2007 increased $6.5 million, or 12.5%, as compared to the same period in fiscal 2006 and were 27.3% of total revenues for the six months ended May 31, 2007 compared to 31.8% for the comparable period of fiscal 2006. The decrease in advertising and promotion expense as a percentage of revenue for the first six months of fiscal 2007 reflected higher advertising and promotion spending for Icy Hot Pro-Therapy and Selsun Salon during the fiscal 2006 launch period.

Selling, General and Administrative Expense

Selling, general and administrative expenses for the six months ended May 31, 2007 increased $3.8 million, or 16.3%, as compared to the same period of fiscal 2006. Selling, general and administrative expenses were 12.6% and 14.1% of total revenues for the six months ended May 31, 2007 and 2006, respectively. The decrease as a percentage of total revenues was attributable to increased revenue without commensurate increases in selling, general and administrative expenses.

Acquisition Expenses

Acquisition expenses of $2.1 million were recorded in the six months ended May 31, 2007 related to transition services provided by Johnson & Johnson under a transition services agreement entered into in connection with the J&J Acquisition.

Litigation Settlement

Litigation settlement for the six months ended May 31, 2006 reflects the $8.75 million recovery from the DELACO settlement trust ($8.5 million net of legal expenses for the first six months of 2006) in the Dexatrim litigation settlement. No corresponding benefit was recorded in fiscal 2007.

Interest Expense

Interest expense increased $10.3 million, or 194%, for the six months ended May 31, 2007 as compared to the same period in fiscal 2006. The increase was the result of additional indebtedness incurred to finance the J&J Acquisition. Until our indebtedness is reduced substantially, interest expense will continue to represent a significant percentage of our income from operations.

Loss on Early Extinguishment of Debt

During the second quarter of fiscal 2007, we utilized the net proceeds from the 1.625% Convertible Notes and borrowings under the revolving credit facility portion of our Credit Facility to repay $128.0 million of the term loan under the Credit Facility. In connection with the repayment, we retired a proportional share of the term loan debt issuance costs, which resulted in a loss on early extinguishment of debt of $2.2 million during the second quarter of fiscal 2007. Our $75.0 million of Floating Rate Senior Notes were fully redeemed in the first quarter of fiscal 2006. As a result of the redemption, a loss on early extinguishment of debt of $2.8 million was recorded in the six months ended May 31, 2006.

Liquidity and Capital Resources

We have historically financed our operations with a combination of internally generated funds and borrowings. Our principal uses of cash are for operating expenses, servicing long-term debt, acquisitions, working capital, repurchases of our common stock, payment of income taxes and capital expenditures.

Cash of $43.4 million and $28.1 million was provided by operations for the six months ended May 31, 2007 and 2006, respectively. The increase in cash flows from operations over the prior year period was primarily attributable to increased accounts payable and accrued liabilities (net of acquisitions), decreased inventories (net of acquisitions) and increased net income offset by increased accounts receivable.

Investing activities used cash of $415.1 million and $3.5 million in the six months ended May 31, 2007 and 2006, respectively. The increase in the use of cash was related to amounts used to fund the J&J Acquisition on January 2, 2007and the ACT Acquisition on May 25, 2007.

Financing activities provided cash of $293.8 million and used cash of $54.8 million in the six months ended May 31, 2007 and 2006, respectively. The increase was primarily attributable to amounts borrowed to fund the J&J Acquisition.

Foreign Operations

Historically, our primary foreign operations have been conducted through our Canadian and United Kingdom (“U.K.”) subsidiaries. Effective November 1, 2004, we transitioned our European business to Chattem Global Consumer Products Limited, a wholly-owned subsidiary located in Limerick, Ireland. The functional currencies of these subsidiaries are Canadian dollars and Euros, respectively. Fluctuations in exchange rates can impact operating results, including total revenues and expenses, when translations of the subsidiary financial statements are made in accordance with SFAS No. 52, “Foreign Currency Translation”. For the six months ended May 31, 2007 and 2006, these subsidiaries accounted for 6% and 8% of total revenues, respectively, and 2% and 4% of total assets, respectively. It has not been our practice to hedge our assets and liabilities in Canada, the U.K. or Ireland or our intercompany transactions due to the inherent risks associated with foreign currency hedging transactions and the timing of payments between us and our foreign subsidiaries. Historically, gains or losses from foreign currency transactions have not had a material impact on our operating results. A gain of $0.1 million for the six months ended May 31, 2007 and an insignificant loss for the six months ended May 31, 2006 resulted from foreign currency transactions and are included in selling, general and administrative expenses in the Consolidated Statements of Income.

Recent Accounting Pronouncements

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

December 1, 2005. We have described the impact of adopting SFAS 123R in our consolidated financial statements in Note 5, Stock-Based Compensation.

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

Forward Looking Statements

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Item 3.

Quantitative and Qualitative Disclosures About Market Risks

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

Our exposure to interest rate risk currently relates to amounts outstanding under our Credit Facility. Loans under the revolving credit facility portion of our Credit Facility bear interest at LIBOR plus applicable percentages of 0.875% to 1.5% or the higher of the federal funds rate plus 0.5% or the prime rate (the “Base Rate”). The applicable percentages are calculated based on our leverage ratio. The term loan under our Credit Facility bears interest at either LIBOR plus 1.75% or the Base Rate plus 0.75%. As of May 31, 2007, $32.0 million was outstanding under the revolving credit facility and $172.0 million was outstanding under the term loan portion of our Credit Facility. The variable rate for the revolving credit facility was LIBOR plus 1.5%, or 6.82% as of May 31, 2007, and the variable rate for the term loan portion was LIBOR plus 1.75%, or 7.11%, as of May 31, 2007. The 7.0% Subordinated Notes, the 1.625% Convertible Notes and the 2.0% Convertible Notes are fixed interest rate obligations.

In March 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. During the second quarter of fiscal 2007, the interest rate cap was sold for $0.4 million. As a result, an insignificant charge was recorded as additional interest expense in the accompanying consolidated statement of income.

In November 2006, we entered into a forward starting swap agreement effective January 15, 2007. The forward starting swap has decreasing notional principal amounts beginning October 15, 2007 and a swap rate of 4.98% over the life of the agreement. As of May 31, 2007, the increase in fair value of $0.7 million, net of tax, was recorded to other comprehensive income. The swap was deemed to be an effective cash flow hedge. The forward starting swap agreement terminates on January 15, 2010.

In November 2006, we entered into a forward starting cap agreement effective January 15, 2007. The forward starting cap had decreasing notional principal amounts beginning October 15, 2007 and a cap rate of 5.0% over the life of the agreement. During the second quarter of fiscal 2007, the interest rate cap was sold for $0.6 million. As a result, $0.1 million was recorded as additional interest expense in the accompanying consolidated statement of income.

In April 2007, we entered into an interest rate cap agreement. The cap has decreasing notional principal amounts beginning May 15, 2007 and a cap rate of 5.0% over the life of the agreement. As of May 31, 2007, the value of the premium on the cap was compared to the fair value of the cap, and the insignificant increase in the market value of the premium was recorded to other comprehensive income. A portion of the interest rate cap was deemed an ineffective cash flow hedge due to the reduction of variable rate debt resulting in an insignificant charge recorded as additional interest expense in the consolidated statement of income for the second quarter of fiscal 2007. The balance of the cash flow hedge was deemed to be effective. The cap agreement terminates on September 15, 2008.

The impact on our results of operations of a one-point rate change on the July 2, 2007 outstanding revolving credit facility balance of $29.0 million and $172.0 million term loan balance of our Credit Facility for the next twelve months would be approximately $1.3 million, net of tax.

We are subject to risk from changes in the foreign exchange rates relating to our Canadian, U.K. and Irish subsidiaries. Assets and liabilities of these subsidiaries are translated to U.S. dollars at year-end exchange rates. Income and expense items are translated at average rates of exchange prevailing during the year. Translation adjustments are accumulated as a separate component of shareholders' equity. Gains and losses, which result from foreign currency transactions, are included in the consolidated statements of income. The potential loss resulting from a hypothetical 10.0% adverse change in the quoted foreign currency exchange rate amounts to approximately $1.0 million as of May 31, 2007.

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

Item 4.

Controls and Procedures

Under the supervision and with the participation of our management, including our 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 May 31, 2007 (the “Evaluation Date”). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective in alerting them on a timely basis to material information relating to us (including our consolidated subsidiaries) required to be included in our reports filed or submitted under the Exchange Act.

PART II. OTHER INFORMATION

Item 1.

Legal Proceedings

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

Item 1A.

Risk Factors

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

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

(a) Not applicable.

(b) Not applicable.

Period	Total Number of Shares Purchased		Average Price Paid Per Share (1)		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2)		Approximate Dollar Value of Shares that may yet be Purchased under the Plans or Programs (2)

March 1– March 31		—	$	—		—		88,147,224
April 1 – April 30		—		—		—		88,147,224
May 1 – May 31		—		—		—		88,147,224
Total Second Quarter		—	$	—		—		88,147,224

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

(2)

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

Item 3.

Defaults Upon Senior Securities

None.

Item 4.

Submission of Matters to a Vote of Security Holders

Our annual meeting of shareholders was held on April 25, 2007 in Chattanooga, Tennessee. At the meeting, the following items were submitted to a vote of shareholders:

(1)

The following persons were elected as directors to serve for a three-year term: Zan Guerry (12,455,898 votes for and 4,666,720 votes withheld), and Bill W. Stacy (16,200,280 votes for and 922,338 votes withheld). Other directors whose terms of office continued after the annual meeting are: Gary D. Chazen, Robert E. Bosworth, Ruth W. Brinkley, Samuel E. Allen and Philip H. Sanford.

(2)

Ratifications of the Compensation Committee’s interpretation that the maximum total number of shares that were issuable pursuant to grants under the Chattem, Inc. Non-Statutory Stock Option Plan – 1998, the Chattem, Inc. Non-Statutory Stock Option Plan – 2000 and the Chattem, Inc. Stock Incentive Plan – 2003 (collectively, the “Plans”) to any employee was the maximum number of shares issuable under the Plans (11,779,310 votes for; 2,331,231 votes against; 27,068 abstentions; and 2,965,009 broker non-votes).

(3)

Ratification of the amendment of the Chattem, Inc. Stock Incentive Plan – 2003 (the “2003 Plan”). The amendment limits the maximum number of awards an employee may be granted under the 2003 Plan to 250,000 shares in any one fiscal year (11,447,001 votes for; 2,678,970 votes against; 31,638 abstentions; and 2,965,009 broker non-votes).

(4)	Ratification of Grant Thornton, LLP as the Company’s independent auditors for fiscal 2007 (16,864,432 votes for; 240,860 votes against; and 17,325 abstentions.

Item 5.

Other Information

None.

Item 6.

Exhibits

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

Exhibit Number		Description

31.1		Certification required by Rule 13a-14(a) under the Securities Exchange Act of 1934
31.2		Certification required by Rule 13a-14(a) under the Securities Exchange Act of 1934
32		Certification required by Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350

CHATTEM, INC.

SIGNATURES

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

		CHATTEM, INC.
		(Registrant)


Dated: July 10, 2007		/s/ Zan Guerry
		Zan Guerry
		Chairman and Chief Executive Officer





Dated: July 10, 2007		/s/ Robert E. Bosworth
		Robert E. Bosworth
		President and Chief Operating Officer

Chattem, Inc. and Subsidiaries

Exhibit Index

Exhibit Number		Description of Exhibit

31.1		Certification required by Rule 13a-14(a) under the Securities Exchange Act of 1934
31.2		Certification required by Rule 13a-14(a) under the Securities Exchange Act of 1934
32		Certification required by Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. freshman Avg

Chattem (CHTT) Inactive 10-Q2007 Q2 Quarterly report

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