Chattem 10Q 2009 Q1 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 February 28, 2009

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 

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

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

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

YES  NO þ

As of April 1, 2009, 19,435,551 shares of the Company’s common stock, without par value, were outstanding.

CHATTEM, INC.

INDEX

PART I. FINANCIAL INFORMATION

	PAGE NO.
Item 1. Financial Statements

Consolidated Balance Sheets as of February 28, 2009 and November 30, 2008	3

Consolidated Statements of Income for the Three Months Ended February 28, 2009 and February 29, 2008	5

Consolidated Statements of Cash Flows for the Three Months Ended February 28, 2009 and February 29, 2008	6

Notes to Consolidated Financial Statements	7

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	27

Item 3. Quantitative and Qualitative Disclosures About Market Risk	36

Item 4. Controls and Procedures	36



PART II. OTHER INFORMATION

Item 1. Legal Proceedings	37

Item 1A. Risk Factors	37

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	37

Item 3. Defaults Upon Senior Securities	37

Item 4. Submission of Matters to a Vote of Security Holders	37

Item 5. Other Information	37

Item 6. Exhibits	38


SIGNATURES	39

PART 1. FINANCIAL INFORMATION

Item 1. Financial Statements

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands)

ASSETS	FEBRUARY 28, 2009		NOVEMBER 30, 2008
	(Unaudited)

CURRENT ASSETS:
Cash and cash equivalents	$	30,349	$	32,310
Accounts receivable, less allowances of $10,174 at February 28, 2009 and $9,718 at November 30, 2008		60,635		49,417
Inventories, net		45,173		40,933
Deferred income taxes		3,889		3,968
Prepaid expenses and other current assets		5,129		2,451
Total current assets		145,175		129,079

PROPERTY, PLANT AND EQUIPMENT, NET		32,016		32,243

OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net		616,428		616,670
Debt issuance costs, net		10,975		12,253
Other		2,706		2,727
Total other noncurrent assets		630,109		631,650

TOTAL ASSETS	$	807,300	$	792,972

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	FEBRUARY 28, 2009			NOVEMBER 30, 2008
	(Unaudited)

CURRENT LIABILITIES:
Current maturities of long-term debt	$	3,000		$	3,000
Accounts payable		23,906			18,116
Bank overdrafts		158			1,184
Accrued liabilities		26,776			21,293
Total current liabilities		53,840			43,593

LONG-TERM DEBT, less current maturities		407,550			456,500

DEFERRED INCOME TAXES		41,615			35,412

OTHER NONCURRENT LIABILITIES		1,309			1,609

COMMITMENTS AND CONTINGENCIES (Note 18)

SHAREHOLDERS’ EQUITY:
Preferred shares, without par value, authorized 1,000, none issued		—			—
Common shares, without par value, authorized 100,000, issued and outstanding 19,484 at February 28, 2009 and 18,978 at November 30, 2008		56,574			28,926
Retained earnings		250,796			231,230
		307,370			260,156
Accumulated other comprehensive income (loss), net of tax:
Interest rate hedge adjustment		(1,759	)		(1,787	)
Foreign currency translation adjustment		(1,082	)		(968	)
Unrealized actuarial gains and losses		(1,543	)		(1,543	)
Total shareholders’ equity		302,986			255,858

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	807,300		$	792,972

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
	FEBRUARY 28,			FEBRUARY 29,
	2009			2008


TOTAL REVENUES	$	116,092		$	120,773

COSTS AND EXPENSES:
Cost of sales		35,257			34,733
Advertising and promotion		28,589			34,496
Selling, general and administrative		15,426			15,466
Product recall expenses		—			6,043
Total costs and expenses		79,272			90,738

INCOME FROM OPERATIONS		36,820			30,035

OTHER INCOME (EXPENSE):
Interest expense		(5,664	)		(6,552	)
Investment and other income, net		111			137
Loss on early extinguishment of debt		(696	)		(526	)
Total other income (expense)		(6,249	)		(6,941	)

INCOME BEFORE INCOME TAXES		30,571			23,094

PROVISION FOR INCOME TAXES		11,005			8,221

NET INCOME	$	19,566		$	14,873

NUMBER OF COMMON SHARES: Weighted average outstanding - basic		19,467			19,106
Weighted average and potential dilutive outstanding		19,667			19,788

NET INCOME PER COMMON SHARE:
Basic	$	1.01		$	.78
Diluted	$	.99		$	.75

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)

	FOR THE THREE MONTHS ENDED
	FEBRUARY 28, 2009			FEBRUARY 29, 2008
OPERATING ACTIVITIES:
Net income	$	19,566		$	14,873
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,894			2,119
Deferred income taxes		4,164			4,433
Stock–based compensation expense		1,479			1,339
Loss on early extinguishment of debt		696			526
Tax benefit realized from stock options exercised		(135	)		(1,812	)
Other, net		122			112
Changes in operating assets and liabilities:
Accounts receivable		(11,218	)		(14,381	)
Inventories		(4,082	)		737
Prepaid expenses and other current assets		(2,678	)		(3,746	)
Accounts payable and accrued liabilities		9,935			6,047
Net cash provided by operating activities		19,743			10,247

INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(760	)		(1,271	)
Increase in other assets, net		(362	)		(1,656	)
Net cash used in investing activities		(1,122	)		(2,927	)

FINANCING ACTIVITIES:
Repayment of long-term debt		(750	)		(35,750	)
Proceeds from borrowings under revolving credit facility		1,000			69,500
Repayments of revolving credit facility		(20,500	)		(43,750	)
Bank overdrafts		(1,026	)		(4,734	)
Repurchase of common shares		—			(240	)
Proceeds from exercise of stock options		573			2,057
Tax benefit realized from stock options exercised		135			1,812
Net cash used in financing activities		(20,568	)		(11,105	)

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		(14	)		(3	)

CASH AND CASH EQUIVALENTS:
Decrease for the period		(1,961	)		(3,788	)
At beginning of period		32,310			15,407
At end of period	$	30,349		$	11,619

PAYMENTS FOR:
Interest	$	2,167		$	2,932
Taxes	$	1,478		$	6,104

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 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, 2008. The accompanying unaudited consolidated financial statements, in the opinion of management, include all adjustments necessary for a fair presentation. All such adjustments are of a normal recurring nature.

2.	CASH AND CASH EQUIVALENTS

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

3.	RECENT ACCOUNTING PRONOUNCEMENTS

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

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

In May 2008, the FASB issued FSP Accounting Principles Board (“APB”) Opinion No. 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP 14-1”). FSP 14-1 specifies that issuers of convertible debt instruments should separately account for the liability and equity components of the instrument in a manner that will reflect the entity’s non-convertible debt borrowing rate on the instrument’s issuance date when interest is recognized in subsequent periods. Upon adoption of FSP 14-1, the proceeds received from the issuance of the 2.0% Convertible Notes and the 1.625% Convertible Notes (collectively, the “Convertible Notes”) will be allocated between the liability and equity component by determining the fair value of the liability component using our non-convertible debt borrowing rate at the time the Convertible Notes were issued. The difference between the proceeds of the Convertible Notes and the calculated fair value of the liability component will be recorded as a debt discount with a corresponding increase to common shares in our consolidated balance sheet. The debt discount will be amortized as additional non-cash interest expense over the remaining life of the Convertible Notes using the effective interest rate method. Although FSP 14-1 will have no impact on our cash flows, FSP 14-1 will result in additional non-cash interest expense until maturity or early extinguishment of the Convertible Notes. The provisions of FSP 14-1 are to be applied retrospectively to all periods presented upon adoption and are effective for fiscal years beginning after December 15, 2008, or our fiscal 2010, and interim periods within those fiscal years. Upon adoption of FSP 14-1, we estimate non-cash interest expense for the fiscal years ended November 30, 2009 and 2008 will increase approximately $6,900 and $7,200, respectively. The additional non-cash interest expense is expected to increase as the Convertible Notes approach their respective maturity dates and accrete to their face values.

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

4.	STOCK-BASED COMPENSATION

We currently provide stock-based compensation under five stock incentive plans that have been approved by our shareholders. Our 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. The 2009 Equity Incentive Plan, which was adopted by our board of directors on January 28, 2009 and was approved by our shareholders at the April 8, 2009 annual shareholders’ meeting, provides for the issuance of up to 1,750 shares of common stock. Stock options granted under all of these plans generally vest over four years from the date of grant as specified in the plans or by the compensation committee of our board of directors and are exercisable for a period of up to ten years from the date of grant.

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

The following table represents the impact of stock-based compensation expense on our consolidated statements of income during the three months ended February 28, 2009, and February 29, 2008:

	2009		2008
Income from operations	$	1,479	$	1,339
Provision for income taxes		532		477
Net income	$	947	$	862

Basic net income per share	$	0.05	$	0.05
Diluted net income per share	$	0.05	$	0.04

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 $342 and $193 of stock option compensation cost as a component of the carrying cost of inventory on-hand as of February 28, 2009 and February 29, 2008, respectively.

The weighted average fair value of stock options at the date of grant during the three months ended February 28, 2009 and February 29, 2008 was $24.46 and $28.55, 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 three months ended February 28, 2009 and February 29, 2008, respectively:

	2009		2008
Expected life	6 years		6 years
Volatility		36%		34%
Risk-free interest rate		3.84%		4.47%
Dividend yield		0%		0%
Forfeitures		0.3%		1.2%

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

A summary of stock option activity for the three-months ended February 28, 2009 is presented below:

	Shares Under Option			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life	Aggregate Intrinsic Value
Outstanding at December 1, 2008		1,510		$	50.23
Granted		7			62.00
Exercised		(18	)		32.82
Cancelled		—			—

Outstanding at February 28, 2009		1,499		$	50.49	4.3 years	$	75,699

Exercisable at February 28, 2009		734		$	38.48	3.6 years	$	28,259

The total fair value of stock options that vested during the three months ended February 28, 2009 and February 29, 2008 was $1,637 and $1,356, respectively. The total intrinsic value of stock options exercised during the three months ended February 28, 2009 and February 29, 2008 was $598 and $4,540, respectively.

As of February 28, 2009, we had $14,597 of unrecognized compensation cost related to stock options that will be recorded over a weighted average period of approximately 2.6 years.

We are also authorized to grant restricted shares of common stock to employees under our stock incentive plans that have been approved by shareholders. The restricted shares under these plans meet the definition of “nonvested shares” in SFAS 123R. The restricted shares generally vest over a four year service period commencing upon the date of grant. The total fair market value of restricted shares on the date of grant is amortized to expense on a straight line basis over the four-year vesting period. The amortization expense related to restricted shares during the three months ended February 28, 2009 and February 29, 2008 was $43 and $93, respectively.

Restricted share activity under the plans during the three months ended February 28, 2009 is summarized as follows:

	Number of Shares		Weighted Average Grant Date Fair Value
Nonvested at December 1, 2008		1	$	35.37
Granted		—		—
Vested		1		35.37
Forfeited		—		—
Nonvested at February 28, 2009		—	$	—

5.	EARNINGS PER SHARE

The following table presents the computation of earnings per share for the three months ended February 28, 2009 and February 29, 2008, respectively:

	2009		2008

NET INCOME	$	19,566	$	14,873

NUMBER OF COMMON SHARES:
Weighted average outstanding		19,467		19,106
Issued upon assumed exercise of outstanding stock options		19		195
Issued upon assumed exercise of convertible notes		181		484
Effect of issuance of restricted common shares		—		3
Weighted average and potential dilutive outstanding (1)		19,667		19,788

NET INCOME PER COMMON SHARE:
Basic	$	1.01	$	.78
Diluted	$	.99	$	.75

(1) Because their effects are anti-dilutive, excludes shares issuable under stock option plans whose grant price was greater than the average market price of common shares outstanding as follows: 752 and 401 shares for the three months ended February 28, 2009 and February 29, 2008, respectively.

6.	LONG-TERM DEBT

Long-term debt consisted of the following as of February 28, 2009 and November 30, 2008:

	2009		2008
Revolving Credit Facility due 2010 at a variable rate of 6.07% as of November 30, 2008	$	—	$	19,500
2.0% Convertible Senior Notes due 2013		96,300		125,000
1.625% Convertible Senior Notes due 2014		100,000		100,000
Term Loan due 2013 at a variable rate of 2.84% and 6.57% as of February 28, 2009 and November 30, 2008, respectively		106,750		107,500
7.0% Senior Subordinated Notes due 2014		107,500		107,500

Total long-term debt		410,550		459,500
Less: current maturities		3,000		3,000
Total long-term debt, net of current maturities	$	407,550	$	456,500

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

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

Borrowings under the revolving credit facility portion of our Credit Facility bear interest at LIBOR plus applicable percentages of 0.875% to 1.500% or the higher of the federal funds rate plus 0.5% or the prime rate (the “Base Rate”). The applicable percentages are calculated based on our leverage ratio. As of February 28, 2009 and November 30, 2008, we had $0 and $19,500, respectively, of borrowings outstanding under the revolving credit facility portion of our Credit Facility. As of April 1, 2009, we had $0 of borrowings outstanding under the revolving credit facility portion of our Credit Facility and our borrowing capacity was $100,000.

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

Borrowings under the Credit Facility are secured by substantially all of our assets, except real property, and shares of capital stock of our domestic subsidiaries held by us and by the assets of the guarantors (our domestic subsidiaries). The Credit Facility contains covenants, representations, warranties and other agreements by us that are customary in credit agreements and security instruments relating to financings of this type. The significant financial covenants include fixed charge coverage ratio, leverage ratio, senior secured leverage ratio and brand value calculations. At February 28, 2009, we were in compliance with all applicable financial and restrictive covenants under the Credit Facility.

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

Interest payments on the 7.0% Subordinated Notes are due semi-annually in March and September. Our domestic subsidiaries are guarantors of the 7.0% Subordinated Notes. The guarantees of the 7.0% Subordinated Notes are unsecured senior subordinated obligations of the guarantors. At any time after March 1, 2009, we may redeem any of the 7.0% Subordinated Notes upon not less than 30 nor more than 60 days’ notice at redemption prices (expressed in percentages of principal amount), plus accrued and unpaid interest, if any, and liquidation damages, if any, to the applicable redemption rate, if redeemed during the twelve-month periods beginning March 2009 at 103.500%, March 2010 at 102.333%, March 2011 at 101.167% and March 2012 and thereafter at 100.000%. As of April 1, 2009, no such redemption has occurred.

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 November 2006, we entered into an interest rate swap (“swap”) agreement effective January 2007. The swap has decreasing notional principal amounts beginning October 2007 and a swap rate of 4.98% over the life of the agreement. During the second quarter and fourth quarter of fiscal 2008, we retired a portion of the swap for approximately $270 and $26, respectively. During the first quarter of fiscal 2009, we retired an additional portion of the swap for approximately $195, which was recorded as additional interest expense in the accompanying consolidated statements of income. As of February 28, 2009, we had $105,000 of LIBOR based borrowings hedged under the provisions of the swap. During the three months ended February 28, 2009, the decrease in fair value of the swap of $28, net of tax, was recorded to other comprehensive income. The fair value of the swap of $3,351 is included in accrued liabilities. As of February 28, 2009, the swap was deemed to be an effective cash flow hedge. The fair value of the swap agreement is valued by a third party. The swap agreement terminates in January 2010.

In November 2006, we completed a private offering of $125,000 of the 2.0% Convertible Notes to qualified institutional purchasers pursuant to Section 4(2) of the Securities Act of 1933. The 2.0% Convertible Notes bear interest at an annual rate of

2.0%, payable semi-annually in May and November of each year. The 2.0% Convertible Notes are convertible into our common stock at an initial conversion price of $58.92 per share, upon the occurrence of certain events, including the closing price of our common stock exceeding 130% of the initial conversion price per share, or $76.59 per share, for 20 of the last 30 consecutive trading days of the preceding fiscal quarter (the “prescribed measurement period”). The evaluation of the classification of the 2.0% Convertible Notes will occur each fiscal quarter.

Upon conversion, a holder will receive, in lieu of common stock, an amount of cash equal to the lesser of (i) the principal amount of the 2.0% Convertible Notes, or (ii) the conversion value, determined in the manner set forth in the indenture governing the 2.0% Convertible Notes, of a number of shares equal to the conversion rate. If the conversion value exceeds the principal amount of the 2.0% Convertible Notes on the conversion date, we will also deliver, at our election, cash or common stock or a combination of cash and common stock with respect to the conversion value upon conversion. If conversion occurs in connection with a change of control, we may be required to deliver additional shares of our common stock by increasing the conversion rate with respect to such notes. The maximum aggregate number of shares that we would be obligated to issue upon conversion of the 2.0% Convertible Notes is 2,059.

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 1,634 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.

On December 4, 2008, we issued an aggregate of 487 shares of our common stock in exchange for $28,700 in aggregate principal amount of our outstanding 2.0% Convertible Notes. Upon completion of the transaction, the balance of the remaining 2.0% Convertible Notes was reduced to $96,300 outstanding. In connection with this transaction, we retired a proportional share of the 2.0% Convertible Notes debt issuance costs and recorded the resulting loss on early extinguishment of debt of $696 in the first quarter of fiscal 2009.

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

Upon conversion, a holder will receive, in lieu of common stock, an amount of cash equal to the lesser of (i) the principal amount of the 1.625% Convertible Notes, or (ii) the conversion value, determined in the manner set forth in the indenture governing the 1.625% Convertible Notes, of a number of shares equal to the conversion rate. If the conversion value exceeds the principal amount of the 1.625% Convertible Note on the conversion date, we will also deliver, at our election, cash or common stock or a combination of cash and common stock with respect to the conversion value upon conversion. If conversion occurs in connection with a change of control, we may be required to deliver additional shares of our common stock by increasing the conversion rate with respect to such notes. The maximum aggregate number of shares that we would be obligated to issue upon conversion of the 1.625% Convertible Notes is 1,694.

Concurrently with the sale of the 1.625% Convertible Notes, we purchased a note hedge from the Counterparty, which is designed to mitigate potential dilution from the conversion of the 1.625% Convertible Notes. Under the note hedge, the Counterparty is required to deliver to us the number of shares of our common stock that we are obligated to deliver to the holders of the 1.625% Convertible Notes with respect to the conversion, calculated exclusive of shares deliverable by us by reason of any additional premium relating to the 1.625% Convertible Notes or by reason of any election by us to unilaterally increase the

conversion rate pursuant to the indenture governing the 1.625% Convertible Notes. The note hedge expires at the close of trading on May 1, 2014, which is the maturity date of the 1.625% Convertible Notes, although the Counterparty will have ongoing obligations with respect to 1.625% Convertible Notes properly converted on or prior to that date of which the Counterparty has been timely notified.

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

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

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

The scheduled future maturities of long-term debt to be funded for the next five successive fiscal years and those thereafter as of February 28, 2009 are as follows:

2009	$	2,250
2010		3,000
2011		3,000
2012		3,000
2013		191,800
Thereafter		207,500
	$	410,550

7.	FAIR VALUE MEASUREMENTS

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

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

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

The following table summarizes the interest rate swap measured at fair value in the accompanying consolidated balance sheet as of February 28, 2009:

	Fair Value Measurements as of February 28, 2009
	Level 1		Level 2		Level 3		Total

Liabilities
Interest rate swap (1)	$	—	$	3,351	$	—	$	3,351

(1)

The total fair value of the interest rate swap is classified as a current liability as of February 28, 2009 and matures in January 2010. We value this instrument using the “Income Approach” valuation technique. This method uses valuation techniques to convert future amounts to a single present value amount. The measurement is based on the value indicated by current market expectations about those future amounts.

SFAS 157 requires separate disclosure of assets and liabilities measured at fair value on a recurring basis, as documented above, from those measured at fair value on a nonrecurring basis. As of February 28, 2009, no assets or liabilities are measured at fair value on a nonrecurring basis.

At February 28, 2009 and November 30, 2008, the carrying value of the 7.0% Subordinated Notes approximated fair value based on market prices and market volume for same or similar issues. At February 28, 2009 and November 30, 2008, the fair value of the 2.0% Convertible Notes was determined to be $103,676 and $153,965, respectively, based upon consideration of our closing stock price of $63.43 and $72.57, respectively, and determination of conversion value as defined in the indenture under which the 2.0% Convertible Notes were issued. At February 28, 2009 and November 30, 2008, the fair value of the 1.625% Convertible Notes was determined to be $86,656 and $99,143, respectively, based upon consideration of our closing stock price and determination of conversion value as defined in the indenture under which the 1.625% Convertible Notes were issued.

8.	ADVERTISING EXPENSES

We incur significant expenditures on television, radio and print advertising to support our nationally branded over-the-counter (“OTC”) health care products, toiletries and dietary supplements. 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 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.

9.	SHIPPING AND HANDLING

Shipping and handling costs of $3,780 and $3,997 are included in selling, general and administrative expenses for the three months ended February 28, 2009 and February 29, 2008, respectively.

10.	PATENTS, TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS

The carrying value of trademarks, which are not subject to amortization under the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), was $613,328 as of February 28, 2009 and November 30, 2008. The gross carrying amount of intangible assets subject to amortization at February 28, 2009 and November 30, 2008, which consist primarily of non-compete agreements and distribution rights, was $7,028. The related accumulated amortization of intangible assets at February 28, 2009 and November 30, 2008 was $3,928 and $3,687, respectively. Amortization of our intangible assets subject to amortization under the provisions of SFAS 142 for the three months ended February 28, 2009 and February 29, 2008 was $241 and $205, respectively.

Estimated annual amortization expense for these assets for the next five successive fiscal years and those thereafter as of February 28, 2009 are as follows:

2009	$	704
2010		925
2011		925
2012		208
2013		75
Thereafter		263
	$	3,100

11.	INVENTORIES

Inventories consisted of the following as of February 28, 2009 and November 30, 2008:

	2009		2008

Raw materials and work in process	$	18,437	$	16,753
Finished goods		26,736		24,180
Total inventories	$	45,173	$	40,933

12.	ACCRUED LIABILITIES

Accrued liabilities consisted of the following as of February 28, 2009 and November 30, 2008:

	2009		2008

Interest	$	5,314	$	3,216
Salaries, wages and commissions		2,391		5,333
Product advertising and promotion		2,909		2,611
Litigation settlement and legal fees		1,214		799
Income taxes payable		11,183		4,636
Interest rate swap		3,351		2,602
Other		414		2,096
Total accrued liabilities	$	26,776	$	21,293

13.	ACCUMULATED OTHER COMPREHENSIVE INCOME

Accumulated other comprehensive income consisted of the following components for the three months ended February 28, 2009 and February 29, 2008, respectively:

	2009			2008

Net income	$	19,566		$	14,873
Other – interest rate hedge adjustment, net of taxes of $17 and $1,013, respectively		28			(1,573	)
Other – foreign currency translation adjustment		(114	)		186
Total	$	19,480		$	13,486

14.	STOCK REPURCHASE

On April 30, 2008, our Board of Directors increased the authorization to a total of $100,000 of our common stock under the terms of our existing stock repurchase program. In the three months ended February 28, 2009, we did not repurchase any of our common stock. Subsequent to February 28, 2009 and through April 1, 2009, we repurchased 51 shares of our common stock for $2,833 at an average price per share of $56.10. In the three months ended February 29, 2008, we repurchased 4 shares of our common stock for $240 at an average price per share of $64.93. The repurchased shares were retired and returned to unissued. As of April 1, 2009, the current amount available under the authorization from the Board of Directors was $71,080.

15.	POSTRETIREMENT BENEFIT PLANS

DEFINED BENEFIT PENSION PLAN

We have a noncontributory defined benefit pension plan (the “Pension Plan”), which covers substantially all employees as of December 31, 2000. The Pension Plan provides benefits based upon years of service and employee compensation to employees who had completed one year of service prior to December 31, 2000. On December 31, 2000, benefits and participation in the Pension Plan were frozen. Contributions to the Pension Plan are calculated by an independent actuary and have been sufficient to provide benefits to participants and meet the funding requirements of the Employee Retirement Income Security Act of 1974. Plan assets as of February 28, 2009 and November 30, 2008 were invested primarily in United States government and agency securities and corporate debt and equity securities.

Net periodic pension cost (benefit) for the three months ended February 28, 2009 and February 29, 2008 included the following components:

	2009			2008

Interest cost	$	146		$	152
Amortization of loss		46			—
Expected return on plan assets		(170	)		(234	)
Net periodic pension cost (benefit)	$	22		$	(82	)

No employer contributions were made for the three months ended February 28, 2009 and February 29, 2008, and no employer contributions are expected to be made for the Pension Plan in fiscal 2009.

DEFINED CONTRIBUTION PLAN

We sponsor a defined contribution plan that covers substantially all employees. Eligible employees are allowed to contribute their eligible compensation up to the applicable annual elective deferral and salary reduction limits as set fourth by the IRS. We make matching contributions of 25% on the first 6% of contributed compensation. The cost of the matching contribution totaled $90 and $88 for the three months ended February 28, 2009 and February 29, 2008, respectively. In addition to matching contributions, safe harbor contributions equaling 3% of eligible annual compensation are made on behalf of eligible participants. Safe harbor contributions totaled $283 and $288 for the three months ended February 28, 2009 and February 29, 2008, respectively. Total matching and safe harbor contributions for fiscal 2009 are expected to approximate amounts funded in fiscal 2008. Total matching and safe harbor contributions in fiscal 2008 were $1,172.

POSTRETIREMENT HEALTH CARE BENEFITS PLAN

We maintain a postretirement health care benefits plan (the “Retiree Health Plan”) for certain eligible employees over the age of 65. On May 31, 2006, Retiree Health Plan eligibility was restricted to current retirees and those active employees that were retirement eligible as of that date (age 55 and 10 years of service or age 65). Contributions to the Retiree Health Plan are limited to approximately $2 per participant per year and are paid monthly on a fully insured basis. Participants are required to pay any insurance premium amount in excess of the employer contribution. Employer contributions expected for fiscal 2009 are approximately $95.

Net periodic postretirement health care benefits cost (benefit) for the three months ended February 28, 2009 and February 29, 2008, included the following components:

	2009			2008

Service cost	$	2		$	5
Interest cost		14			14
Recognized net actuarial gain		(34	)		(24	)
Net periodic postretirement benefits	$	(18	)	$	(5	)

16.	INCOME TAXES

We account for income taxes using the asset and liability approach as prescribed by SFAS 109, FIN 48 and other applicable FSP’s and FASB Interpretations. This approach requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in our consolidated financial statements or tax returns. Using the enacted tax rates in effect for the year in which the differences are expected to reverse, deferred tax assets and liabilities are determined based on the differences between the financial reporting and the tax basis of an asset or liability. We record income tax expense in our consolidated financial statements based on an estimated annual effective income tax rate. Our tax rate for the three months ended February 28, 2009 was 36.0%, as compared to 35.6% for the three months ended February 29, 2008. As of February 28, 2009, there were no significant changes to our unrecognized tax benefit as reported in our Form 10-K for the fiscal year ended November 30, 2008.

17.	PRODUCT SEGMENT INFORMATION

Net sales within our single healthcare business segment for the three months ended February 28, 2009 and February 29, 2008 are as follows:


	2009		2008

Medicated skin care	$	41,457	$	37,653
Topical pain care		22,043		25,315
Oral care		18,285		15,772
Internal OTC		11,364		11,210
Medicated dandruff shampoos		9,363		10,579
Dietary supplements		4,272		5,374
Other OTC and toiletry products		4,124		5,412
Total domestic net sales		110,908		111,315
International revenues		5,184		9,458
Total revenues	$	116,092	$	120,773

18.	COMMITMENTS AND CONTINGENCIES

GENERAL LITIGATION

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

On April 13, 2004, we entered into a class action settlement agreement with representatives of the plaintiffs’ settlement class, which provided for a national class action settlement of all Dexatrim PPA claims. On November 12, 2004, Judge Barbara J. Rothstein of the United States District Court for the Western District of Washington entered a final order and judgment certifying the class and granting approval of the Dexatrim PPA settlement. The Dexatrim PPA settlement included claims against us involving alleged injuries by Dexatrim products containing PPA in which the alleged injury occurred after December 21, 1998, the date we acquired the Dexatrim brand. A total of 14 claimants with alleged injuries that occurred after December 21, 1998 elected to opt-out of the class settlement. Subsequently, we have settled twelve of the opt-out claims. The other two opt-outs have not filed lawsuits against us, and we believe the applicable statutes of limitation have run against their claims.

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

We were also named as a defendant in approximately 206 lawsuits relating to Dexatrim containing PPA which involved alleged injuries by Dexatrim products containing PPA manufactured and sold prior to our acquisition of Dexatrim on December 21, 1998. The DELACO Company (“DELACO”), successor by merger to the Thompson Medical Company, Inc., which owned the brand prior to December 21, 1998, owed us an indemnity obligation for any liabilities arising from these lawsuits. On February 12, 2004, DELACO filed a Chapter 11 bankruptcy petition in the United States Bankruptcy Court for the Southern

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

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

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

On February 8, 2008, we initiated a voluntary nationwide recall of our Icy Hot Heat Therapy products, including consumer “samples” that were included on a limited promotional basis in cartons of our 3 oz. Aspercreme product, and are no longer marketing these products. We conducted the recall to the consumer level. We recalled these products because we received some consumer reports of first, second and third degree burns, as well as skin irritation resulting from consumer use or possible misuse of the products. As of April 1, 2009, there were approximately 170 consumers with pending claims against us and three products liability lawsuits pending against us alleging burns and skin irritation from the use of the Icy Hot Heat Therapy products. We may receive additional claims and/or lawsuits in the future alleging burns and/or skin irritation from use of our Heat Therapy products. The outcome of any such potential litigation cannot be predicted.

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

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

We maintain insurance coverage for product liability claims relating to our products under claims-made policies which are subject to annual renewal. For the current annual policy period beginning September 1, 2008, we maintain product liability insurance coverage in the amount of $30,000 through our captive insurance subsidiary, of which approximately $2,638 has been funded as of April 1, 2009. We also have $25,000 of excess coverage through a third party reinsurance policy.

REGULATORY

We were notified in October 2000 that the FDA denied a citizen petition submitted by Thompson Medical Company, Inc., the previous owner of Sportscreme and Aspercreme. The petition sought a determination that 10% trolamine salicylate, the active ingredient in Sportscreme and Aspercreme, was clinically proven to be an effective active ingredient in external analgesic

OTC drug products and should be included in the FDA's yet-to-be finalized monograph for external analgesics. We are working to develop alternate formulations for Sportscreme and Aspercreme in the event that the FDA does not consider the available clinical data to conclusively demonstrate the efficacy of trolamine salicylate when the OTC external analgesic monograph is finalized. If 10% trolamine salicylate is not included in the final monograph, we would likely be required to discontinue these products as currently formulated after expiration of an anticipated grace period. If this occurred, we believe we could still market these products as homeopathic products or reformulate them using other ingredients included in the FDA monograph. We believe that the monograph is unlikely to become final and take effect before mid-2009.

Certain of our topical analgesic products are currently marketed under an FDA tentative final monograph. In 2003, the FDA proposed that the final monograph exclude external analgesic products in patch, plaster or poultice form, unless the FDA received additional data supporting the safety and efficacy of these products. On October 14, 2003, we submitted to the FDA information regarding the safety of our Icy Hot patches and arguments to support the inclusion of patch products in the final monograph. We also participated in an industry-wide effort coordinated by Consumer Healthcare Products Association (“CHPA”) requesting that patches be included in the final monograph and seeking to establish with the FDA a protocol of additional research that would allow the patches to be marketed under the final monograph even if the final monograph does not explicitly allow them. The CHPA submission to the FDA was made on October 15, 2003. The FDA has not responded to our or CHPA’s submission. The most recent Unified Agenda of Federal Regulatory and Deregulatory Actions published in the Federal Register provided a target final monograph publication date of May 2009. If the final monograph excludes products in patch, plaster or poultice form, we would have to file and obtain approval of a new drug application (“NDA”) in order to continue to market the Icy Hot, Capzasin and Aspercreme patch products, the Icy Hot Sleeve and/or similar delivery systems under our other topical analgesic brands. In such case, we would have to cease marketing the existing products likely within one year from the effective date of the final monograph, or pending FDA review and approval of an NDA. The preparation of an NDA would likely take us six to 24 months and would be expensive. It typically takes the FDA at least 12 months to rule on an NDA once it is submitted and there is no assurance that an NDA would be approved. Sales of our Icy Hot, Capzasin, and Aspercreme patches and Icy Hot Sleeve products represented approximately 8% of our consolidated total revenues in fiscal 2008.

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

We are aware of the FDA's concern about the potential toxicity due to concomitant use of OTC and prescription products that contain the analgesic ingredient acetaminophen, an ingredient found in Pamprin and Prēmsyn PMS. We are participating in an industry-wide effort to reassure the FDA that the current recommended dosing regimen is safe and effective and that proper labeling and public education by both OTC and prescription drug companies are the best policies to abate the FDA's concern. The FDA will address both issues in its effort to finalize the monograph on internal analgesic products. We believe the FDA may issue revised labeling requirements within the next year, perhaps prior to monograph closure that will cause the industry to relabel its analgesic products.

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

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

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

19.	CONSOLIDATING FINANCIAL STATEMENTS

The consolidating financial statements, for the dates or periods indicated, of Chattem, Inc. (“Chattem”), Signal Investment & Management Co. (“Signal”), SunDex, LLC (“SunDex”) and Chattem (Canada) Holdings, Inc. (“Canada”), the guarantors of the long-term debt of Chattem, and the non-guarantor direct and indirect wholly-owned subsidiaries of Chattem are presented below. Signal is 89% owned by Chattem and 11% owned by Canada. SunDex and Canada are wholly-owned subsidiaries of Chattem. The guarantees of Signal, SunDex and Canada are full and unconditional and joint and several. The guarantees of Signal, SunDex and Canada as of February 28, 2009 arose in conjunction with our Credit Facility and our issuance of the 7.0% Subordinated Notes (See Note 6). The maximum amount of future payments the guarantors would be required to make under the guarantees as of February 28, 2009 is $214,250.

Note 19

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING BALANCE SHEETS

FEBRUARY 28, 2009

(Unaudited and in thousands)

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

CURRENT ASSETS:
Cash and cash equivalents	$	19,694		$	134		$	10,521		$	—		$	30,349
Accounts receivable, less allowances of $10,174		55,776			18,319			5,192			(18,652	)		60,635
Interest receivable		118			664			(101	)		(681	)		—
Inventories, net		39,236			2,145			3,792			—			45,173
Deferred income taxes		3,854			—			35			—			3,889
Prepaid expenses and other current assets		6,124			—			275			(1,270	)		5,129
Total current assets		124,802			21,262			19,714			(20,603	)		145,175

PROPERTY, PLANT AND EQUIPMENT, NET		30,608			775			633			—			32,016

OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net		3,100			674,057			1,561			(62,290	)		616,428
Debt issuance costs, net		10,975			—			—			—			10,975
Investment in subsidiaries		595,449			64,682			97,690			(757,821	)		—
Note receivable		—			34,694			—			(34,694	)		—
Other		2,706			—			—			—			2,706
Total other noncurrent assets		612,230			773,433			99,251			(854,805	)		630,109

TOTAL ASSETS	$	767,640		$	795,470		$	119,598		$	(875,408	)	$	807,300

LIABILITIES AND SHAREHOLDERS’ EQUITY

CURRENT LIABILITIES:
Current maturities of long-term debt	$	3,000		$	—		$	—		$	—		$	3,000
Accounts payable		21,970			—			2,102			(166	)		23,906
Bank overdrafts		158			—			—			—			158
Accrued liabilities		39,283			3,265			4,664			(20,436	)		26,776
Total current liabilities		64,411			3,265			6,766			(20,602	)		53,840

LONG-TERM DEBT, less current maturities		408,966			(3,216	)		36,494			(34,694	)		407,550

DEFERRED INCOME TAXES		(21,842	)		64,700			(1,243	)		—			41,615

OTHER NONCURRENT LIABILITIES		1,309			—			—			—			1,309

INTERCOMPANY ACCOUNTS		11,810			(19,156	)		7,346			—			—

SHAREHOLDERS’ EQUITY:
Preferred shares, without par value, authorized 1,000, none issued		—			—			—			—			—
Common shares, without par value, authorized 100,000, issued and outstanding 19,484		56,574			—			—			—			56,574
Share capital of subsidiaries		—			641,659			78,999			(720,658	)		—
Dividends		—			(16,126	)		—			16,126			—
Retained earnings		250,796			122,650			(6,458	)		(116,192	)		250,796
		307,370			748,183			72,541			(820,724	)		307,370
Accumulated other comprehensive income (loss), net of tax:
Interest rate hedge adjustment		(1,759	)		—			—			—			(1,759	)
Foreign currency translation adjustment		(1,082	)		1,694			(2,306	)		612			(1,082	)
Unrealized actuarial gains and losses		(1,543	)		—			—			—			(1,543	)
Total shareholders’ equity		302,986			749,877			70,235			(820,112	)		302,986

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	767,640		$	795,470		$	119,598		$	(875,408	)	$	807,300

Note 19

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING BALANCE SHEETS

NOVEMBER 30, 2008

(In thousands)

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

CURRENT ASSETS:
Cash and cash equivalents	$	22,055		$	1,570		$	8,685		$	—		$	32,310
Accounts receivable, less allowances of $9,718		44,175			16,226			5,242			(16,226	)		49,417
Interest receivable		108			641			(91	)		(658	)		—
Inventories, net		35,795			1,811			3,327			—			40,933
Deferred income taxes		3,932			—			36			—			3,968
Prepaid expenses and other current assets		4,024			—			332			(1,905	)		2,451
Total current assets		110,089			20,248			17,531			(18,789	)		129,079

PROPERTY, PLANT AND EQUIPMENT, NET		30,792			775			676			—			32,243

OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net		3,341			674,057			1,561			(62,289	)		616,670
Debt issuance costs, net		12,253			—			—			—			12,253
Investment in subsidiaries		597,821			64,682			97,690			(760,193	)		—
Note receivable		—			34,694			—			(34,694	)		—
Other		2,727			—			—			—			2,727
Total other noncurrent assets		616,142			773,433			99,251			(857,176	)		631,650

TOTAL ASSETS	$	757,023		$	794,456		$	117,458		$	(875,965	)	$	792,972

LIABILITIES AND SHAREHOLDERS’ EQUITY

CURRENT LIABILITIES:
Current maturities of long-term debt	$	3,000		$	—		$	—		$	—		$	3,000
Accounts payable		16,463			—			1,736			(83	)		18,116
Bank overdrafts		1,184			—			—			—			1,184
Accrued liabilities		34,594			699			4,708			(18,708	)		21,293
Total current liabilities		55,241			699			6,444			(18,791	)		43,593

LONG-TERM DEBT, less current maturities		455,900			(1,200	)		36,494			(34,694	)		456,500

DEFERRED INCOME TAXES		(24,111	)		60,766			(1,243	)		—			35,412

OTHER NONCURRENT LIABILITIES		1,609			—			—			—			1,609

INTERCOMPANY ACCOUNTS		12,526			(18,962	)		6,436			—			—

SHAREHOLDERS’ EQUITY
Preferred shares, without par value, authorized 1,000, none issued		—			—			—			—			—
Common shares, without par value, authorized 100,000, issued and outstanding 18,978		28,926			—			—			—			28,926
Share capital of subsidiaries		—			641,659			77,935			(719,594	)		—
Dividends		—			(69,628	)		—			69,628			—
Retained earnings		231,230			179,428			(6,416	)		(173,012	)		231,230
		260,156			751,459			71,519			(822,978	)		260,156
Accumulated other comprehensive income (loss), net of tax:
Interest rate hedge adjustment		(1,787	)		—			—			—			(1,787	)
Foreign currency translation adjustment		(968	)		1,694			(2,192	)		498			(968	)
Unrealized actuarial gains and losses		(1,543	)		—			—			—			(1,543	)
Total shareholders’ equity		255,858			753,153			69,327			(822,480	)		255,858

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	757,023		$	794,456		$	117,458		$	(875,965	)	$	792,972

Note 19

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED FEBRUARY 28, 2009

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES				ELIMINATIONS			CONSOLIDATED

TOTAL REVENUES	$	108,012		$	22,639		$	4,672			$	(19,231	)	$	116,092

COSTS AND EXPENSES:										��
Cost of sales		32,780			1,170			2,184				(877	)		35,257
Advertising and promotion		26,365			1,157			1,067				—			28,589
Selling, general and administrative		14,374			230			822				—			15,426
Product recall expenses		(479	)		—			479				—			—
Equity in subsidiary income		(12,160	)		—			—				12,160			—
Total costs and expenses		60,880			2,557			4,552				11,283			79,272

INCOME FROM OPERATIONS		47,132			20,082			120				(30,514	)		36,820

OTHER INCOME (EXPENSE):
Interest expense		(5,677	)		—			(670	)			683			(5,664	)
Investment and other income, net		69			684			686				(1,328	)		111
Loss on extinguishment of debt		(696	)		—			—				—			(696	)
Royalties		(17,657	)		(685	)		(9	)			18,351			—
Corporate allocations		447			(407	)		(40	)			—			—
Total other income (expense)		(23,514	)		(408	)		(33	)			17,706			(6,249	)

INCOME BEFORE INCOME TAXES		23,618			19,674			87				(12,808	)		30,571

PROVISION FOR INCOME TAXES		4,052			6,824			129				—			11,005

NET INCOME (LOSS)	$	19,566		$	12,850		$	(42	)		$	(12,808	)	$	19,566

Note 19

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED FEBRUARY 29, 2008

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED

TOTAL REVENUES	$	110,464		$	23,044		$	6,071		$	(18,806	)	$	120,773

COSTS AND EXPENSES:
Cost of sales		31,876			1,431			2,502			(1,076	)		34,733
Advertising and promotion		30,760			1,822			1,914			—			34,496
Selling, general and administrative		14,741			110			615			—			15,466
Product recall expenses		5,555			—			488			—			6,043
Equity in subsidiary income		(11,994	)		—			—			11,994			—
Total costs and expenses		70,938			3,363			5,519			10,918			90,738

INCOME FROM OPERATIONS		39,526			19,681			552			(29,724	)		30,035

OTHER INCOME (EXPENSE):
Interest expense		(6,529	)		—			(642	)		619			(6,552	)
Investment and other income, net		12			646			723			(1,244	)		137
Loss on early extinguishment of debt		(526	)		—			—			—			(526	)
Royalties		(16,873	)		(858	)		—			17,731			—
Corporate allocations		509			(469	)		(40	)		—			—
Total other income (expense)		(23,407	)		(681	)		41			17,106			(6,941	)

INCOME BEFORE INCOME TAXES		16,119			19,000			593			(12,618	)		23,094

PROVISION FOR INCOME TAXES		1,246			6,764			211			—			8,221

NET INCOME (LOSS)	$	14,873		$	12,236		$	382		$	(12,618	)	$	14,873

Note 19

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED FEBRUARY 28, 2009

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED

OPERATING ACTIVITIES:
Net income (loss)	$	19,566		$	12,850		$	(42	)	$	(12,808	)	$	19,566
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		1,857			—			37			—			1,894
Deferred income taxes		230			3,933			1			—			4,164
Stock-based compensation expense		1,479			—			—			—			1,479
Loss on early extinguishment of debt		696			—			—			—			696
Tax benefit realized from stock options exercised		(135	)		—			—			—			(135	)
Other, net		108			—			14			—			122
Equity in subsidiary income		(12,808	)		—			—			12,808			—
Changes in operating assets and liabilities:
Accounts receivable		(11,600	)		(2,093	)		50			2,425			(11,218	)
Interest Receivable		(10	)		(23	)		10			23			—
Inventories		(3,284	)		(335	)		(463	)		—			(4,082	)
Prepaid expenses and other current assets		(2,099	)		—			56			(635	)		(2,678	)
Accounts payable and accrued liabilities		8,859			2,569			320			(1,813	)		9,935
Net cash provided by (used in) operating activities		2,859			16,901			(17	)		—			19,743

INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(753	)		—			(7	)		—			(760	)
Increase in other assets, net		(251	)		—			(111	)		—			(362	)
Net cash used in investing activities		(1,004	)		—			(118	)		—			(1,122	)

FINANCING ACTIVITIES:
Repayment of long-term debt		(750	)		—			—			—			(750	)
Intercompany debt proceeds (payments)		2,017			(2,017	)		—			—			—
Proceeds from borrowings under revolving credit facility		1,000			—			—			—			1,000
Repayments of revolving credit facility		(20,500	)		—			—			—			(20,500	)
Bank overdrafts		(1,026	)		—			—			—			(1,026	)
Proceeds from exercise of stock options		573			—			—			—			573
Tax benefit realized from stock options exercised		135			—			—			—			135
Changes in intercompany accounts		(1,146	)		(194	)		1,340			—			—
Dividends paid		15,481			(16,126	)		645			—			—
Net cash (used in) provided by financing activities		(4,216	)		(18,337	)		1,985			—			(20,568	)

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		—			—			(14	)		—			(14	)

CASH AND CASH EQUIVALENTS:
(Increase) decrease for the period		(2,361	)		(1,436	)		1,836			—			(1,961	)
At beginning of period		22,055			1,570			8,685			—			32,310
At end of period	$	19,694		$	134		$	10,521		$	—		$	30,349

Note 19

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED FEBRUARY 29, 2008

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED

OPERATING ACTIVITIES:
Net income (loss)	$	14,873		$	12,236		$	382		$	(12,618	)	$	14,873
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		2,090			—			29			—			2,119
Deferred income taxes		500			3,934			(1	)		—			4,433
Stock-based compensation expense		1,339			—			—			—			1,339
Loss on early extinguishment of debt		526			—			—			—			526
Tax benefit realized from stock options exercised		(1,812	)		—			—			—			(1,812	)
Other, net		109			—			3			—			112
Equity in subsidiary income		(12,618	)		—			—			12,618			—
Changes in operating assets and liabilities:
Accounts receivable		(14,629	)		(1,011	)		248			1,011			(14,381	)
Interest Receivable		10			(25	)		(10	)		25			—
Inventories		302			631			(196	)		—			737
Prepaid expenses and other current assets		(3,752	)		—			66			(60	)		(3,746	)
Accounts payable and accrued liabilities		6,542			166			315			(976	)		6,047
Net cash provided by (used in) operating activities		(6,520	)		15,931			836			—			10,247

INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(1,258	)		—			(13	)		—			(1,271	)
(Increase) decrease in other assets, net		(1,792	)		—			136			—			(1,656	)
Net cash provided by (used in) investing activities		(3,050	)		—			123			—			(2,927	)

FINANCING ACTIVITIES:
Repayment of long-term debt		(35,750	)		—			—			—			(35,750	)
Proceeds from borrowings under revolving credit facility		69,500			—			—			—			69,500
Repayments of revolving credit facility		(43,750	)		—			—			—			(43,750	)
Bank overdrafts		(4,734	)		—			—			—			(4,734	)
Repurchase of common shares		(240	)		—			—			—			(240	)
Proceeds from exercise of stock options		2,057			—			—			—			2,057
Tax benefit realized from stock options exercised		1,812			—			—			—			1,812
Changes in intercompany accounts		259			679			(938	)		—			—
Dividends paid		16,063			(16,688	)		625			—			—
Net cash (used in) provided by financing activities		5,217			(16,009	)		(313	)		—			( 11,105	)

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		—			—			(3	)		—			(3	)

CASH AND CASH EQUIVALENTS:
Increase (decrease) for the period		(4,353	)		(78	)		643			—			(3,788	)
At beginning of period		4,685			590			10,132			—			15,407
At end of period	$	332		$	512		$	10,775		$	—		$	11,619

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 2008 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 in such categories as medicated skin care, topical pain care, oral care, internal OTC, medicated dandruff shampoos, dietary supplements and other OTC and toiletry products. Our portfolio of products includes well-recognized brands such as:

•

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

•

Icy Hot, Aspercreme and Capzasin – topical pain care;

•

ACT and Herpecin-L – oral care;

•

Unisom, Pamprin and Kaopectate – internal OTC;

•

Selsun Blue – medicated dandruff shampoos;

•

Dexatrim, Garlique and New Phase – dietary supplements; and

•

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

Our products target niche markets that are often outside the focus of larger companies where we believe we can achieve and sustain significant market share through product innovation and strong advertising and promotion support. Many of our products are among the U.S. market leaders in their respective categories. For example, our portfolio of topical analgesic brands, our Cortizone-10 anti-itch ointment, and our Gold Bond medicated body powders have the leading U.S. market share in these categories. We support our brands through extensive and cost-effective advertising and promotion, the expenditures for which represented approximately 25% of our total revenues in the first quarter of fiscal 2009. We sell our products nationally through mass merchandiser, drug and food channels, principally utilizing our own sales force.

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

Developments During the First Quarter of Fiscal 2009

Products

In the first quarter of fiscal 2009, we introduced the following product line extensions: ACT Total Care, Gold Bond Ultimate Protecting Lotion, Gold Bond Anti-Itch Lotion, Gold Bond Foot Pain Cream, Cortizone-10 Cooling Gel, Cortizone-10 Easy Relief Applicator, Icy Hot No-Mess Applicator, Icy Hot Medicated Roll, Capzasin Quick Relief and Selsun Blue Itchy Dry Scalp.

2.0% Convertible Notes

On December 4, 2008 we issued an aggregate of 487,123 shares of our common stock in exchange for $28.7 million in aggregate principal amount of our outstanding 2.0% Convertible Senior Notes due 2013 (“2.0% Convertible Notes”). Upon completion of the transaction, the balance of the remaining 2.0% Convertible Notes was reduced to $96.3 million outstanding. In connection with this transaction, we retired a proportional share of the 2.0% Convertible Notes debt issuance costs and recorded the resulting loss on early extinguishment of debt of $0.7 million in the first quarter of fiscal 2009.

Results of Operations

The following table sets forth certain items from our unaudited consolidated statements of income expressed as a percentage of total revenue for the three months ended February 28, 2009 and February 29, 2008, respectively:

	2009			2008

TOTAL REVENUES		100.0	%		100.0	%

COSTS AND EXPENSES:
Cost of sales		30.4			28.8
Advertising and promotion		24.6			28.6
Selling, general and administrative		13.3			12.8
Product recall expenses		—			5.0
Total costs and expenses		68.3			75.2

INCOME FROM OPERATIONS		31.7			24.8

OTHER INCOME (EXPENSE):
Interest expense		(4.9	)		(5.4	)
Investment and other income, net		0.1			0.1
Loss on early extinguishment of debt		(0.6	)		(0.4	)
Total other income (expense)		(5.4	)		(5.7	)

INCOME BEFORE INCOME TAXES		26.3			19.1

PROVISION FOR INCOME TAXES		9.4			6.8

NET INCOME		16.9	%		12.3	%

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 February 28, 2009 unaudited consolidated financial statements:

Allowance for Doubtful Accounts

As of February 28, 2009, an estimate was made of the collectibility of the outstanding accounts receivable balances. This estimate requires the utilization of outside credit services, knowledge about the customer and the customer’s industry, new developments in the customer’s industry and operating results of the customer as well as general economic conditions and historical trends. When all these facts are compiled, a judgment as to the collectibility of the individual account is made. Many factors can impact this estimate, including those noted in this paragraph. The adequacy of the estimated allowance may be impacted by the deterioration in the financial condition of a large customer, weakness in the economic environment resulting in a higher level of customer bankruptcy filings or delinquencies and the competitive environment in which the customer operates. During the first quarter of fiscal 2009, 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 $0.5 million and $0.4 million as of February 28, 2009 and November 30, 2008, 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 returned as a percentage of sales, and estimate an allowance for potential returns based on product sold in the current period. To consider product sold in current and prior periods, an estimate of inventory held by our retail customers is calculated based on customer inventory detail. This estimate of inventory held by our customers, along with historical returns as a percentage of sales, is used to determine an estimate of potential product returns. This estimate of the allowance for seasonal and non-seasonal returns is further analyzed by considering retail customer point of sale data. We also consider specific events, such as discontinued product or product divestitures, when determining the adequacy of the allowance. Based on consideration of the sales of Icy Hot Pro Therapy performing below expectations, review of retail point of sales data and an estimate of inventory on hand at customers, our estimate of product returns of Icy Hot Pro Therapy was $0.7 million as of November 30, 2008. As of February 28, 2009, the allowance for Icy Hot Pro Therapy returns is $0.5 million.

Our estimate of product returns for seasonal and non-seasonal products as of February 28, 2009 was $1.3 million and $1.1 million, respectively, and $1.4 million and $1.3 million, respectively, as of November 30, 2008. During the three months ended February 28, 2009, we decreased our estimate of returns for seasonal and non-seasonal products by approximately $0.1 million and $0.2 million, respectively, which resulted in an increase to net sales in our consolidated financial statements. For the three months ended February 29, 2008, we increased our estimate of returns for seasonal products by $0.3 million, which resulted in a decrease to net sales in our consolidated financial statements. For the three months ended February 29, 2008, we decreased our estimate of non-seasonal returns by approximately $0.1 million, which resulted in an increase to net sales in our consolidated financial statements. Each percentage point change in the seasonal return rate would impact net sales by an insignificant amount. 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 February 28, 2009, the coupon accrual and reserve for vendor allowances were $1.9 million and $5.6 million, respectively, and $1.8 million and $4.9 million, respectively, as of November 30, 2008. Each percentage point change in promotional program participation and advertising and promotion expense would impact net sales by $0.1 million and an insignificant amount, respectively, for the three months ended February 28, 2009.

Income Taxes

We account for income taxes using the asset and liability approach as prescribed by SFAS 109, FIN 48, FSP FIN 48-1 and other applicable FSP’s and FASB Interpretations. This approach requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Using the enacted tax rates in effect for the year in which the differences are expected to reverse, deferred tax assets and liabilities are determined based on the differences between the financial reporting and the tax basis of an asset or liability. We adopted FIN 48, as amended by FSP FIN 48-1, on December 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS 109. We record income tax expense in our consolidated financial statements based on an estimated annual effective income tax rate. Our tax rate for the three months ended February 28, 2009 was 36.0%, as compared to 35.6% for the three months ended February 29, 2008.

Accounting for Acquisitions and Intangible Assets

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

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

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

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

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

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

Fair Value Measurements

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

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

Stock-Based Compensation

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

Comparison of Three Months Ended February 28, 2009 and February 29, 2008

To facilitate discussion of our operating results for the three months ended February 28, 2009 and February 29, 2008, we have included the following selected data from our unaudited consolidated statements of income:

					Increase (Decrease)
	2009		2008		Amount			Percentage
	(dollars in thousands)
Domestic net sales	$	110,908	$	111,315	$	(407	)		(0.4	)%
International revenues		5,184		9,458		(4,274	)		(45.2	)
Total revenues		116,092		120,773		(4,681	)		(3.9	)
Cost of sales		35,257		34,733		524			1.5
Advertising and promotion expense		28,589		34,496		(5,907	)		(17.1	)
Selling, general and administrative expense		15,426		15,466		(40	)		(0.3	)
Product recall expenses		—		6,043		(6,043	)		(100.0	)
Interest expense		5,664		6,552		(888	)		(13.6	)
Loss on early extinguishment of debt		696		526		170			32.3
Net income		19,566		14,873		4,693			31.6

Domestic Net Sales

Domestic net sales in the first quarter of fiscal 2009 decreased $0.4 million, or 0.4%, to $110.9 million from $111.3 million in the prior year quarter. The domestic sales decline was a result of reduced inventory carrying levels at certain retailers, utilization by retailers of promotion programs to reduce the retail price to consumers that were accounted for as a reduction of net sales rather than as advertising and promotion expense in our consolidated statements of income and the discontinuance of shipping of Icy Hot Heat Therapy in the first quarter of fiscal 2008 following the February 8, 2008 voluntary recall of the product. Excluding the sales of Icy Hot Heat Therapy in the first quarter of fiscal 2008 prior to the voluntary product recall, domestic net sales increased $1.5 million, or 1.4%, as compared to 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)
	2009		2008		Amount			Percentage
	(dollars in thousands)
Medicated skin care	$	41,457	$	37,653	$	3,804			10.1	%
Topical pain care		22,043		25,315		(3,272	)		(12.9	)
Oral care		18,285		15,772		2,513			15.9
Internal OTC		11,364		11,210		154			1.4
Medicated dandruff shampoos		9,363		10,579		(1,216	)		(11.5	)
Dietary supplements		4,272		5,374		(1,102	)		(20.5	)
Other OTC and toiletry products		4,124		5,412		(1,288	)		(23.8	)
Total	$	110,908	$	111,315	$	(407	)		(0.4	)

Net sales in the medicated skin care products category increased 10.1% for the first quarter of fiscal 2009 compared to the prior year quarter primarily due to the launch of Gold Bond Anti-Itch Lotion, Gold Bond Foot Pain Cream, and Gold Bond Ultimate Protecting Lotion during the first quarter of fiscal 2009 and the continued growth of the existing lotion business.

Net sales in the topical pain care category decreased 12.9% for the first quarter of fiscal 2009 compared to the prior year quarter primarily as a result of the discontinuance of shipments of Icy Hot Heat Therapy following the voluntary recall of the product announced on February 8, 2008 and reduced inventory carrying levels at certain of our retail customers. Excluding sales of Icy Hot Heat Therapy, sales in the category decreased 5.8% compared to the prior year period.

Net sales in the oral care products category increased 15.9% for the first quarter of fiscal 2009 compared to the prior year quarter due in part to the launch and initial sell-in of ACT Total Care in the first quarter of fiscal 2009 and the continued performance of ACT Restoring and ACT Rinse.

Net sales in the internal OTC category increased 1.4% for the first quarter of fiscal 2009 compared to the prior year quarter as a result of sales of Unisom SleepMelts which were introduced in the second quarter of fiscal 2008, and increased distribution of Pamprin, offset by declining sales of Kaopectate.

Net sales in the medicated dandruff shampoos category decreased 11.5% in the first quarter of fiscal 2009 compared to the prior year quarter as a result of a decline in sales of Selsun Salon products due to distribution changes to accommodate the launch and initial sell-in of Selsun Blue Itchy Dry Scalp in the first quarter of fiscal 2009 and reduced inventory carrying levels by certain of our retail customers.

Net sales in the dietary supplements category decreased 20.5% for the first quarter of fiscal 2009 compared to the prior year quarter primarily as a result of declines in the Dexatrim and Garlique products. Dexatrim’s reduced sales resulted from declines in Dexatrim Max and Dexatrim Max2O, partially offset by the launch of Dexatrim Max Complex 7 during the fourth quarter of fiscal 2008. Garlique’s reduced sales resulted from lower retail sales in the garlic category.

Net sales in the other OTC and toiletry products category decreased 23.8% for the first quarter of fiscal 2009 compared to the prior year quarter primarily as a result of the timing of shipments of Bullfrog.

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

International Revenues

For the first quarter of fiscal 2009, international revenues decreased $4.3 million, or 45.2%, compared to the first quarter of fiscal 2008, primarily as a result of terminating shipments to certain distributors serving the Latin American market to reduce the potential for diversion of English language packaging back to the United States market and unfavorable exchange rates that decreased net sales by approximately $0.8 million. We are seeking Latin American distributors for these markets and are converting the packaging for the major products sold in these markets to local Spanish language.

Cost of Sales

Cost of sales in the first quarter of fiscal 2009 was $35.3 million, a 1.5% increase over the same period of fiscal 2008, or 30.4% as a percentage of total revenues for the first quarter of fiscal 2009 as compared to 28.8% in the prior year quarter. Gross margin for the first quarter of fiscal 2009 was 69.6% compared to 71.2% in the prior year quarter. The decrease in gross margin was attributable to the increased cost of certain raw material input components and an increased utilization by retailers of programs to reduce prices to consumers that are recorded as a reduction of our net sales rather than advertising and promotion expense.

Advertising and Promotion Expense

Advertising and promotion expenses in the first quarter of fiscal 2009 decreased $5.9 million, or 17.1%, as compared to the same quarter of fiscal 2008 and were 24.6% of total revenues in the first quarter of fiscal 2009 compared to 28.6% for the prior year quarter. The decrease in expense was a result of greater utilization of price reduction promotion programs by retailers that are recorded as a reduction of net sales rather than advertising and promotion expense, reduced sampling programs and cost efficiencies realized in the media market.

Selling, General and Administrative Expense

Selling, general and administrative expenses in the first quarter of fiscal 2009 were consistent with amounts in the first quarter of fiscal 2008 and were 13.3% of total revenues compared to the prior year quarter of 12.8%.

Product Recall Expenses

The $6.0 million of product recall expenses in the first quarter of fiscal 2008 was related to the voluntary recall of our Icy Hot Heat Therapy product initiated in February 2008. Based in part on consideration of on-hand inventory and retail point of sales data, the $6.0 million of product recall expenses related to product returns, inventory obsolescence, destruction costs, consumer refunds, legal fees and other estimated expenses. As of February 28, 2009, we do not expect to record additional expenses related to the recall of Icy Hot Heat Therapy.

Interest Expense

Interest expense decreased $0.9 million, or 13.6%, in the first quarter of fiscal 2009 as compared to the prior year quarter, as a result of the exchange of $28.7 million in aggregate principal of our 2.0% Convertible Notes on December 4, 2008 for 487,123 shares of our common stock and the retirement of $58.8 million of our Credit Facility subsequent to the first quarter of our fiscal 2008. Until our indebtedness is reduced substantially, interest expense will continue to represent a significant percentage of our total revenues.

Loss on Early Extinguishment of Debt

On December 4, 2008, we issued an aggregate of 487,123 shares of our common stock in exchange for $28.7 million in aggregate principal of our outstanding 2.0% Convertible Notes. In connection with this transaction, we retired a proportional share of the 2.0% Convertible Notes debt issuance costs and recorded the resulting loss on early extinguishment of debt of $0.7 million in the first quarter of fiscal 2009. In January 2008, we utilized borrowings under the revolving credit facility portion of our Credit Facility to repay $35.0 million of the term loan under the Credit Facility. In connection with the term loan repayment, we retired a proportional share of the term loan debt issuance costs and recorded the resulting loss on extinguishment of debt of $0.5 million in the first quarter of fiscal 2008.

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 $19.7 million and $10.2 million was provided by operations in the first quarter of fiscal 2009 and fiscal 2008, respectively. The increase in cash flow from operations in the first quarter of fiscal 2009 as compared to the same prior year period was primarily the result of higher net income, and an increase in accounts payable and accrued liabilities, partially offset by an increase in inventory as the carrying amount of inventory was increased in support of the launch of the new products for fiscal 2009.

Investing activities used cash of $1.1 million and $2.9 million in the first quarter of fiscal 2009 and fiscal 2008, respectively. Cash flow used in investing activities was primarily a result of purchases of manufacturing equipment.

Financing activities used cash of $20.6 million and $11.1 million in the first quarter of fiscal 2009 and 2008, respectively. Cash flow used in financing activities in each period was a result of the repayment of amounts outstanding under the revolving credit facility portion of our Credit Facility and the term loan portion of our Credit Facility.

As of February 28, 2009, our total debt was $410.6 million, consisting of the 7.0% Subordinated Notes of $107.5 million, the 2.0% Convertible Notes of $96.3 million, the 1.625% Convertible Notes of $100.0 million and $106.8 million outstanding under the term loan portion of our Credit Facility. As of February 28, 2009, no amounts were outstanding under the revolving credit facility portion of our Credit Facility and we were in compliance with all applicable financial and restrictive covenants under the Credit Facility.

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

Foreign Operations

Historically, our primary foreign operations have been through our Canadian and United Kingdom (“U.K.”) subsidiaries. Since November 1, 2004, our European business has been conducted through Chattem Global Consumer Products Limited, a wholly-owned subsidiary located in Limerick, Ireland. In connection with the acquisition of ACT in Western Europe in May 2007, we established Chattem Greece, a wholly-owned subsidiary located in Alimos Attica, Greece. In November 2008, we established Chattem Peru SRL (“Chattem Peru”), a wholly-owned subsidiary located in Lima, Peru. Chattem Peru utilizes third party distributors to sell certain of our Selsun Blue products throughout Peru. The functional currencies of these subsidiaries are Canadian dollars, British pounds, Euros and Peruvian Sol, respectively. Fluctuations in exchange rates can impact operating results, including total revenues and expenses, when translations of the subsidiary financial statements are made in accordance with SFAS No. 52, “Foreign Currency Translation”. For the three months ended February 28, 2009 and February 29, 2008, these subsidiaries accounted for 4% and 8% of total revenues, respectively, and 2% and 2% of total assets, respectively. It has not been our practice to hedge our assets and liabilities or our intercompany transactions due to the inherent risks associated with foreign currency hedging transactions and the timing of payments between us and our foreign subsidiaries. Historically, gains or losses from foreign currency transactions have not had a material impact on our operating results. Losses of $0.2 million and gains of $0.1 million, respectively, resulting from foreign currency transactions for the three months ended February 28, 2009 and February 29, 2008 are included in selling, general and administrative expenses in the unaudited consolidated statements of income.

Recent Accounting Pronouncements

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

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

In May 2008, the FASB issued FSP Accounting Principles Board Opinion No. 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP 14-1”). FSP 14-1 specifies that issuers of convertible debt instruments should separately account for the liability and equity components of the instrument in a manner that will reflect the entity’s non-convertible debt borrowing rate on the instrument’s issuance date when interest is recognized in subsequent periods. Upon adoption of FSP 14-1, the proceeds received from the issuance of the 2.0% Convertible Notes and the 1.625% Convertible Notes (collectively, the “Convertible Notes”) will be allocated between the liability and equity component by determining the fair value of the liability component using our non-convertible debt borrowing rate at the time the Convertible Notes were issued. The difference between the proceeds of the Convertible Notes and the calculated fair value of the liability component will be recorded as a debt discount with a corresponding increase to common shares in our consolidated balance sheet. The debt discount will be amortized as additional non-cash interest expense over the remaining life of the Convertible Notes using the effective interest rate method. Although FSP 14-1 will have no impact on our cash flows, FSP 14-1 will result in additional non-cash interest expense until maturity or early extinguishment of the Convertible Notes. The provisions of FSP 14-1 are to be applied retrospectively to all periods presented upon adoption and are effective for fiscal years beginning after December 15, 2008, or our fiscal 2010, and interim periods within those fiscal years. Upon adoption of FSP 14-1, we estimate non-cash interest expense for the fiscal years ended November 30, 2009 and 2008 will increase approximately $6.9 million and $7.2 million, respectively. The additional non-cash interest expense is expected to increase as the Convertible Notes approach their respective maturity dates and accrete to their face values.

Forward Looking Statements

We may from time to time make written and oral forward-looking statements. Forward-looking statements may appear in writing in documents filed with the Securities and Exchange Commission, in press releases and in reports to shareholders or be made orally in publicly accessible conferences or conference calls. The Private Securities Litigation Reform Act of 1995 contains a safe harbor for forward-looking statements. We rely on this safe harbor in making such disclosures. These forward-looking statements generally can be identified by use of phrases such as “believe,” “plan,” “expect,” “anticipate,” “intend,” “forecast” or other similar words or phrases. These forward-looking statements relate to, among other things, our strategic and business initiatives and plans for growth or operating changes; our financial condition and results of operation; future events, developments or performance; and management’s expectations, beliefs, plans, estimates and projections. The forward-looking statements are based on management’s current beliefs and assumptions about expectations, estimates, strategies and

projections. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. We undertake no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise. Factors that could cause our actual results to differ materially from those anticipated in the forward-looking statements in this Form 10-Q and the documents incorporated herein by reference include the following:

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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-10 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 or defend claims of infringement by others;

•

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

•

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

•

we are subject to the risk of doing business internationally;

•

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

•

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

•

our operations are subject to significant environmental laws and regulations;

•

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

•

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

•

the trading price of our common stock may be volatile;

•

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

•

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

•

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

•

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

•

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

•

virtually all of our assets consists of intangibles; and

•

other risks described in our Securities and Exchange Commission filings.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

Our exposure to interest rate risk currently relates to amounts outstanding under our Credit Facility. Loans under the revolving credit facility portion of our Credit Facility bear interest at LIBOR plus applicable percentages of 0.875% to 1.50% or the higher of the federal funds rate plus 0.50% or the prime rate (the “Base Rate”). The applicable percentages are calculated based on our leverage ratio. The term loan under our Credit Facility bears interest at either LIBOR plus 1.75% or the Base Rate plus 0.75%. As of February 28, 2009, we had no borrowings outstanding under the revolving credit facility portion of our Credit Facility and $106.8 million was outstanding under the term loan portion of our Credit Facility. The variable rate for the term loan was LIBOR plus 1.75%, or 2.84%, as of February 28, 2009. The 7.0% Subordinated Notes, the 1.625% Convertible Notes and the 2.0% Convertible Notes are fixed interest rate obligations.

In November 2006, we entered into an interest rate swap (“swap”) agreement effective January 2007. The swap has decreasing notional principal amounts beginning in October 2007 and a swap rate of 4.98% over the life of the agreement. As of February 28, 2009, the decrease in fair value of an insignificant amount was recorded to accumulated other comprehensive income and the swap was deemed to be an effective cash flow hedge. The swap agreement terminates in January 2010.

The impact on our results of operations of a one-point rate change on the April 1, 2009 outstanding $106.0 million term loan balance of our Credit Facility for the next twelve months would be approximately $0.5 million, net of tax. As of April 1, 2009, we had no borrowings outstanding under the revolving credit facility portion of our Credit Facility.

We are subject to risk from changes in the foreign exchange rates relating to our Canadian, U.K., Irish, Grecian and Peruvian subsidiaries. Assets and liabilities of these subsidiaries are translated to U.S. dollars at period-end exchange rates. Income and expense items are translated at average rates of exchange prevailing during the year. Translation adjustments are accumulated as a separate component of shareholders' equity. Gains and losses, which result from foreign currency transactions, are included in selling, general and administrative expenses in our consolidated statements of income. The potential loss resulting from a hypothetical 10.0% adverse change in the quoted foreign currency exchange rate amounts to approximately $1.3 million as of February 28, 2009.

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

Item 4. Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we have evaluated the effectiveness of our disclosure controls and procedures (as such terms are defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of February 28, 2009 (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 18 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 fiscal year ended November 30, 2008.

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

A summary of the common stock repurchase activity for our first quarter of fiscal 2009 is as follows:

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

December 1 – December 31		—	$	—		—		73,913,336
January 1 – January 31		—		—		—		73,913,336
February 1 – February 28		—		—		—		73,913,336
Total First Quarter		—	$	—		—		73,913,336

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

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

Item 3. Defaults Upon Senior Securities

None.

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

None.

Item 5. Other Information

At the annual meeting of shareholders held on April 8, 2009, our shareholders approved the Chattem, Inc. 2009 Equity Incentive Plan (the “2009 Plan”) and the related performance goals (“Performance Goals”) which are a part of the 2009 Plan. Our Board of Directors had previously adopted the 2009 Plan and the Performance Goals on January 28, 2009, subject to shareholder approval in accordance with Nasdaq rules and Section 162(m) of the Internal Revenue Code of 1986, as amended (the “Code”). The primary purpose of the 2009 Plan is to attract and retain eligible employees and outside directors, provide an incentive to eligible employees and outside directors to work to increase the value of our common stock, and provide eligible employees and outside directors with a stake in our future which corresponds to the stake of each of our shareholders.

The 2009 Plan, which is administered by the Compensation Committee of our Board of Directors (the “Committee”), provides for the grant of stock options (“Options”) and stock appreciation rights (“SARs”) and for stock grants (“Stock Grants”) and grants of restricted stock units (“RSU Grants”) to eligible employees and to outside directors. The maximum number of shares of common stock that may be issued under the 2009 Plan is 1,750,000, provided that no more than 1,000,000 shares of common stock may be issued pursuant to Stock Grants and RSU Grants. In addition, no eligible employee in any calendar year may (i) be granted an Option to purchase more than 200,000 shares of common stock or an SAR based on the appreciation with respect to more than 200,000 shares of common stock, or (ii) be awarded Stock Grants or RSU Grants that are intended to satisfy the requirements of Section 162(m) of the Code for more than 200,000 shares of common stock. The Committee has the discretion to increase each such grant limit to 400,000 shares of common stock if deemed necessary or appropriate in connection with hiring any individual who would when hired be an eligible employee. The foregoing grant limits are subject to adjustment in the event of any equity restructuring or change in capitalization or any other transaction under Section 424 of the Code that does not constitute a change in control of our company. The number of Options, SARs, Stock Grants and RSU Grants that will be awarded to our executive officers pursuant to the 2009 Plan is within the discretion of the Committee and is therefore not currently determinable. The 2009 Plan has a term of ten years.

For a more detailed description of the 2009 Plan and the Performance Goals, refer to the information set forth under the heading “Item 2—Approval of the Chattem, Inc. 2009 Equity Incentive Plan” on pages 6 through 13 of our Definitive Proxy Statement on Schedule 14A, filed with the Securities and Exchange Commission on February 27, 2009 (the “2009 Proxy Statement”). The foregoing summary description of the 2009 Plan and the Performance Goals is qualified in its entirety by reference to the full text of the 2009 Plan, which was included as Appendix A to the 2009 Proxy Statement and is incorporated by reference herein.

Item 6. Exhibits

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

	Exhibit Number		Description

	10.1		Chattem, Inc. 2009 Equity Incentive Plan (incorporated by reference to Appendix A to the registrant’s Definitive Proxy Statement on Schedule 14A filed on February 27, 2009 (File No. 000-05905))
	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: April 9, 2009		/s/ Zan Guerry
		Zan Guerry
		Chairman and Chief Executive Officer


Dated: April 9, 2009		/s/ Robert B. Long
		Robert B. Long
		Vice President and Chief Financial Officer

Chattem, Inc. and Subsidiaries

Exhibit Index

Exhibit Number		Description of Exhibit
10.1		Chattem, Inc. 2009 Equity Incentive Plan (incorporated by reference to Appendix A to the registrant’s Definitive Proxy Statement on Schedule 14A filed on February 27, 2009 (File No. 000-05905))

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. sophomore Avg

Chattem (CHTT) Inactive 10-Q2009 Q1 Quarterly report

Content analysis