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 August 31, 2007

Commission file number 0-5905

CHATTEM, INC.

A TENNESSEE CORPORATION

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

1715 WEST 38TH STREET

CHATTANOOGA, TENNESSEE 37409

TELEPHONE:  423-821-4571

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) for 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.

      YESþ NO

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

Large accelerated filer  þ  Accelerated filer   Non-accelerated filer  

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

      YES      NOþ

As of October 2, 2007, 18,985,098 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 August 31, 2007 and
November 30, 2006	3
Consolidated Statements of Income for the Three and Nine
Months Ended August 31, 2007 and August 31, 2006	5
Consolidated Statements of Cash Flows for the Nine Months
Ended August 31, 2007 and August 31, 2006	6
Notes to Consolidated Financial Statements	7
Item 2.  Management's Discussion and Analysis of Financial Condition
and Results of Operations	28
Item 3.  Quantitative and Qualitative Disclosures About Market Risk	38
Item 4.  Controls and Procedures	39
PART II.  OTHER INFORMATION
Item 1. Legal Proceedings	40
Item 1A. Risk Factors	40
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	40
Item 3. Defaults Upon Senior Securities	40
Item 4. Submission of Matters to a Vote of Security Holders	40
Item 5. Other Information	40
Item 6. Exhibits	40
SIGNATURES	41

2

PART 1. FINANCIAL INFORMATION

Item 1. Financial Statements

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands)

ASSETS	August 31,    2007		NOVEMBER 30,  2006
	(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents	$	13,069	$	90,527
Accounts receivable, less allowances of $13,899 at August 31, 2007 and $10,907 at November 30, 2006		42,755		29,852
Inventories		35,270		31,389
Deferred income taxes		4,496		4,341
Prepaid expenses and other current assets		4,002		5,857
Total current assets		99,592		161,966
PROPERTY, PLANT AND EQUIPMENT, NET		31,222		30,353
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net		617,541		206,149
Debt issuance costs, net		16,145		11,399
Other		4,912		5,446
Total other noncurrent assets		638,598		222,994
TOTAL ASSETS	$	769,412	$	415,313

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

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CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands)

LIABILITIES AND SHAREHOLDERS’ EQUITY	AUGUST 31,  2007			NOVEMBER 30,  2006
	(Unaudited)
CURRENT LIABILITIES:
Current maturities of long-term debt	$	3,000		$	—
Accounts payable and other		15,240			9,948
Bank overdraft		9,660			5,824
Accrued liabilities		22,391			11,805
Total current liabilities		50,291			27,577
LONG-TERM DEBT, less current maturities		520,750			232,500
DEFERRED INCOME TAXES		17,997			17,668
OTHER NONCURRENT LIABILITIES		1,747			1,987
COMMITMENTS AND CONTINGENCIES (Note 19)
SHAREHOLDERS’ EQUITY:
Preferred shares, without par value, authorized 1,000, none issued		—			—
Common shares, without par value, authorized 100,000, issued and outstanding 18,908 at August 31, 2007 and 18,669 at November 30, 2006		27,820			30,452
Retained earnings		150,835			105,965
		178,655			136,417
Cumulative other comprehensive income, net of tax:
Interest rate hedge adjustment		(347	)		(597	)
Foreign currency translation adjustment		319			(239	)
Total shareholders’ equity		178,627			135,581
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	769,412		$	415,313

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

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CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited and in thousands, except per share amounts)

	FOR THE THREE MONTHS  ENDED AUGUST 31,						FOR THE NINE MONTHS  ENDED AUGUST 31,
	2007			2006			2007			2006
REVENUES:
Net Sales	$	108,880		$	71,947		$	322,574		$	235,276
Royalties		85			58			186			164
Total Revenues		108,965			72,005			322,760			235,440
COSTS AND EXPENSES:
Cost of sales		32,793			22,238			98,868			73,312
Advertising and promotion		27,760			23,607			86,211			75,575
Selling, general and administrative		15,619			10,855			42,516			33,974
Acquisition expenses		—			—			2,057			—
Litigation settlement		—			(10,800	)		—			(19,305	)
Total costs and expenses		76,172			45,900			229,652			163,556
INCOME FROM OPERATIONS		32,793			26,105			93,108			71,884
OTHER INCOME (EXPENSE):
Interest expense		(7,147	)		(3,018	)		(22,702	)		(8,318	)
Investment and other income, net		199			188			1,258			616
Loss on early extinguishment of debt		(414	)		—			(2,633	)		(2,805	)
Total other income (expense)		(7,362	)		(2,830	)		(24,077	)		(10,507	)
INCOME BEFORE INCOME TAXES		25,431			23,275			69,031			61,377
PROVISION FOR INCOME TAXES		9,119			8,046			24,161			21,175
NET INCOME	$	16,312		$	15,229		$	44,870		$	40,202
NUMBER OF COMMON SHARES:
Weighted average outstanding-basic		19,026			18,749			18,903			19,195
Weighted average and potential dilutive outstanding		19,409			18,912			19,273			19,468
NET INCOME PER COMMON SHARE:
Basic	$	.86		$	.81		$	2.37		$	2.09
Diluted	$	.84		$	.81		$	2.33		$	2.07

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

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CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited and in thousands, except per share amount)

FOR THE NINE MONTHS ENDED           

	AUGUST 31,  2007			AUGUST 31, 2006
OPERATING ACTIVITIES:
Net income	$	44,870		$	40,202
Adjustments to reconcile net income to net cash provided by     operating activities:
Depreciation and amortization		6,461			4,339
Deferred income taxes		11,126			3,554
Tax benefit realized from stock options exercised		(4,747	)		(744	)
Stock-based compensation		4,122			3,322
Loss on early extinguishment of debt		2,633			2,805
Other, net		13			255
Changes in operating assets and liabilities, net of effects from acquisitions:
Accounts receivable		(12,903	)		13,483
Inventories		2,172			(5,099	)
Refundable income taxes		—			1,951
Prepaid expenses and other current assets		833			(1,125	)
Accounts payable and accrued liabilities		18,741			(11,244	)
Net cash provided by operating activities		73,321			51,699
INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(3,793	)		(3,557	)
Acquisition of brands		(416,184	)		—
Decrease (increase) in other assets, net		1,796			(2,078	)
Net cash used in investing activities		(418,181	)		(5,635	)
FINANCING ACTIVITIES:
Repayment of long-term debt		(153,750	)		(75,000	)
Proceeds from long-term debt		400,000			—
Proceeds from borrowings under revolving credit facility		147,500			75,500
Repayments of revolving credit facility		(102,500	)		(22,000	)
Proceeds from exercise of stock options		11,130			911
Change in bank overdraft		3,836			2,140
Repurchase of common shares		(22,260	)		(39,332	)
Purchase of note hedge		(29,500	)		—
Proceeds from issuance of warrant		17,430			—
Increase in debt issuance costs		(9,374	)		(5,634	)
Debt retirement costs		—			(1,501	)
Tax benefit realized from stock options exercised		4,747			744
Net cash provided by (used in) financing activities		267,259			(64,172	)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		143			(176	)
CASH AND CASH EQUIVALENTS:
Decrease for the period		(77,458	)		(18,284	)
At beginning of period		90,527			47,327
At end of period	$	13,069		$	29,043
PAYMENTS FOR:
Interest	$	16,678		$	6,452
Taxes	$	6,680		$	14,706

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

6

CHATTEM, INC.  AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

1. BASIS OF PRESENTATION

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

2. CASH AND CASH EQUIVALENTS

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

3. RECLASSIFICATIONS

Certain prior year amounts have been reclassified to conform to the current period’s presentation.  The accrual for vendor allowances of $4,187 for the period ended August 31, 2006, which was included as a component of accrued liabilities, has been reclassified as a reduction of accounts receivable.  The bank overdraft of $2,140 for the period ended August 31, 2006, which was included in cash and cash equivalents, has been reclassified as an increase to total current liabilities.

4. RECENT ACCOUNTING PRONOUNCEMENTS

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”.  SFAS 123R supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and amends SFAS No. 95, “Statement of Cash Flows”.  SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions and requires all share-based payments to employees, including grants of employee stock options, to be recognized as additional compensation expense in the financial statements based on the calculated fair value of the awards.  SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation costs to be reported as a financing cash flow.  This requirement has reduced net operating cash flows and increased net financing cash flows in periods after adoption.  We adopted SFAS 123R effective for our fiscal year beginning December 1, 2005.

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

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”).  SFAS 157 provides guidance for using fair value to measure assets and liabilities and is intended to respond to investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings.  SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances.  SFAS 157 also requires expanded disclosure of the effect on earnings for items measured using unobservable data, establishes a fair value hierarchy that prioritizes the information used to develop those assumptions and requires separate disclosure by level within the fair value hierarchy.  The provisions of SFAS 157 are effective for interim financial statements issued for fiscal years beginning after November 15, 2007, or our fiscal year beginning December 1, 2007.  We are evaluating the impact of adopting SFAS 157 on our consolidated financial statements.

7

In September 2006, the FASB issued SFAS No. 158, “Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans -- An Amendment of FASB Statements No. 87, 88, 106, and 132R” (“SFAS 158”).  SFAS 158 requires an employer to recognize in its balance sheet an asset or liability for a plan’s funded status, measure a plan’s assets and obligations as of the end of the employer’s fiscal year and recognize changes in the funded status in the year in which the changes occur.  SFAS 158 also enhances the current disclosure requirements for pension and other postretirement plans to include disclosure related to certain effects on net periodic benefit cost.  The requirement to recognize the funded status of a benefit plan and the disclosure requirements are effective as of the end of the fiscal year ending after December 15, 2006, or our fiscal 2007.  The requirement to measure plan assets and benefit obligations as of the employer’s fiscal year-end is effective for fiscal years ending after December 15, 2008, or our fiscal year beginning December 1, 2008.  We are evaluating the impact of adopting SFAS 158 on our consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”).  SFAS 159 permits entities to choose to measure certain financial assets and liabilities at fair value.  Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings.  SFAS 159 is effective for fiscal years beginning after November 15, 2007, or our fiscal year beginning December 1, 2007.  We are evaluating the impact of adopting SFAS 159 on our consolidated financial statements.

5. STOCK-BASED COMPENSATION

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

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

For the three and nine months ended August 31, 2007, we recorded compensation expense related to stock options that reduced income from operations by $1,490 and $4,122, provision for income taxes by $534 and $1,443, net income by $956 and $2,679 and basic and diluted net income per share by $0.05 and $0.14, respectively.  The stock option compensation expense was included partly in cost of sales, advertising and promotion expenses and selling, general and administrative expenses in the accompanying consolidated statements of income.  We capitalized $180 of stock option compensation cost as a component of the carrying cost of inventory on-hand as of August 31, 2007.

The weighted average grant-date fair value of stock options granted during the three months ended August 31, 2007 and 2006 was $24.50 and $16.44, respectively, and for the nine months ended August 31, 2007 and 2006 was $24.50 and $16.81, respectively.  For options granted subsequent to our SFAS 123R adoption date of December 1, 2005, the fair value of each stock option grant was estimated on the date of grant using a Flex Lattice Model.  For options granted prior to our adoption date of SFAS 123R, we used the Black-Scholes option pricing model.  The following assumptions were used to determine the fair value of stock option grants during the nine months ended August 31, 2007 and 2006:

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

8

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

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

	For the Nine Months Ended August 31, 2007
	Shares Under  Option			Weighted Average   Exercise  Price		Weighted Average Remaining Contractual        Life	Aggregate Intrinsic Value
Outstanding at December 1, 2006		1,936		$	27.63
Granted		414			59.75
Exercised		(619	)		18.00
Cancelled		(30	)		36.74
Outstanding at August 31, 2007		1,701		$	38.78	5.3 years	$	37,901
Exercisable at August 31, 2007		872		$	30.38	5.1 years	$	26,764

The total fair value of stock options that vested during the three and nine months ended August 31, 2007 and 2006 was $1,475 and $1,169 and $4,139 and $3,549, respectively.  The total intrinsic value of stock options exercised during the three and nine months ended August 31, 2007 and 2006 was $6,580 and $231 and $24,485 and $2,067, respectively.

As of August 31, 2007, we had $14,005 of unrecognized compensation cost related to stock options that will be recorded over a weighted average period of approximately 2.8 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 and nine months ended August 31, 2007 and 2006 was $115 and $184 and $473 and $551, respectively.

Restricted share activity under the plans is summarized as follows:

	Number of Shares			Weighted Average Grant Date Fair Value
Nonvested at December 1, 2006		37		$	26.45
Granted		—			—
Vested		(21	)	$	22.19
Forfeited		(1	)	$	35.37
Nonvested at August 31, 2007		15		$	31.62

As of August 31, 2007, we had $474 of unrecognized compensation cost related to restricted shares that will be recorded over a weighted average period of approximately 1.3 years.

9

6. EARNINGS PER SHARE

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

	For the Three Months    Ended August 31,				For the Nine Months  Ended August 31,
	2007		2006		2007		2006
NET INCOME	$	16,312	$	15,229	$	44,870	$	40,202
NUMBER OF COMMON SHARES:
Weighted average outstanding		19,026		18,749		18,903		19,195
Issued upon assumed exercise of outstanding stock options		283		126		359		237
Issued upon assumed conversion of convertible notes		87		—		—		—
Effect of issuance of restricted common shares		13		37		11		36
Weighted average and potential dilutive outstanding (1)		19,409		18,912		19,273		19,468
NET INCOME PER COMMON SHARE:
Basic	$	.86	$	.81	$	2.37	$	2.09
Diluted	$	.84	$	.81	$	2.33	$	2.07

(1)  Because their effects are anti-dilutive, excludes shares issuable under stock option plans and restricted stock issuance whose grant price was greater than the average market price of common shares outstanding as follows: 412 and 937 shares for the three months ended August 31, 2007 and 2006, respectively, and 195 and 830 shares for the nine months ended August 31, 2007 and 2006, respectively.

7. LONG-TERM DEBT

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

	2007			2006
Revolving Credit Facility due 2010 at a variable rate of 7.04% and 8.25% as of August 31, 2007 and November 30, 2006, respectively	$	45,000		$	—
2.0% Convertible Senior Notes due 2013		125,000			125,000
1.625% Convertible Senior Notes due 2014		100,000			—
Term Loan due 2013 at a variable rate of 7.11% as of August 31, 2007		146,250			—
7.0% Senior Subordinated Notes due 2014		107,500			107,500
Total long-term debt		523,750			232,500
Less:  current maturities		(3,000	)		—
Total long-term debt, net of current maturities	$	520,750		$	232,500

In February 2004, we entered into a Senior Secured Revolving Credit Facility with a maturity date of February 26, 2009 (the “Revolving Credit Facility”) with Bank of America, N.A. that provided an initial borrowing capacity of $25,000 and an additional $25,000, subject to successful syndication.  In March 2004, we entered into a commitment agreement with a syndicate of commercial banks led by Bank of America, N.A., as agent, that enabled us to borrow up to a total of $50,000 under the Revolving Credit Facility and an additional $50,000, subject to successful syndication.  In November 2005, we entered into an amendment to our Revolving Credit Facility (the “Amended Revolving Credit Facility”) that, among other things, increased our borrowing capacity under the facility from $50,000 to $100,000, increased our flexibility to repurchase shares of our stock, improved our borrowing rate under the facility and extended the maturity date to November 15, 2010.  Upon successful syndication, we were able to increase the borrowing capacity under the Amended Revolving Credit Facility by $50,000 to an aggregate of $150,000.  In November 2006, we entered into an amendment to our Amended Revolving Credit Facility that, among other things, permitted the sale of the 2.0% Convertible Senior Notes due 2013 (the “2.0% Convertible Notes”).  In

10

January 2007, we completed an amendment to the Amended Revolving Credit Facility providing for up to a $100,000 revolving credit facility and a $300,000 term loan (the “Credit Facility”).  The proceeds from the term loan under the Credit Facility were used to finance in part the acquisition of the five consumer and over-the-counter (“OTC”) brands from Johnson & Johnson.  The Credit Facility includes an “accordion” feature that permits us under certain circumstances to increase our borrowings under the revolving credit facility by $50,000 and to borrow an additional $50,000 as a term loan.  In April 2007, we entered into an amendment to our Credit Facility that, among other things, permitted the sale of the 1.625% Convertible Senior Notes due 2014  (the “1.625% Convertible Notes”) and reduced the applicable interest rates on the revolving credit facility portion of our Credit Facility.

Borrowings under the revolving credit facility portion of our Credit Facility bear interest at LIBOR plus applicable percentages of 0.875% to 1.500% or the higher of the federal funds rate plus 0.5% or the prime rate (the “Base Rate”).  The applicable percentages are calculated based on our leverage ratio.  As of August 31, 2007 and November 30, 2006, we had $45,000 and $0, respectively, of borrowings outstanding under the revolving credit facility portion of our Credit Facility.  As of October 2, 2007, we had $45,000 of borrowings outstanding under the revolving credit facility portion of our Credit Facility and our borrowing capacity was $55,000.

The term loan under the Credit Facility bears interest at either LIBOR plus 1.75% or the Base Rate plus 0.75%.  The term loan borrowings are to be repaid in increments of $750 each calendar quarter, with the first principal payment paid on June 30, 2007.  The principal outstanding after scheduled repayment and any unscheduled prepayments matures and is payable on January 2, 2013.  In April 2007, we utilized the net proceeds from the 1.625% Convertible Notes and borrowings under the revolving credit facility portion of our Credit Facility to repay $128,000 of the term loan under the Credit Facility.   In July 2007, we utilized borrowings under the revolving credit facility portion of our Credit Facility to repay an additional $25,000 of the term loan under the Credit Facility.  In connection with the term loan repayments during April 2007 and July 2007, we retired a proportional share of the term loan debt issuance costs and recorded the resulting loss on early extinguishment of debt of $2,219 in the second quarter of fiscal 2007 and $414 in the third quarter of fiscal 2007.

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

In February 2004, we issued and sold $75,000 of Floating Rate Senior Notes due March 1, 2010 (the “Floating Rate Senior Notes”) and $125,000 of 7.0% Senior Subordinated Notes due 2014 (the “7.0% Subordinated Notes”).  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.  In November 2005, we called our $75,000 of Floating Rate Senior Notes for full redemption on December 30, 2005 at a price of 102% of par plus accrued interest to December 30, 2005.  We utilized borrowings of $38,000 under our Amended Revolving Credit Facility and $38,948 of our cash on hand to fund the redemption of the Floating Rate Senior Notes.  As a result of the redemption, we retired associated debt issuance costs of $1,303 and incurred other related call fees, which resulted in a loss on early extinguishment of debt of $2,805 during the first quarter of fiscal 2006.

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

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

In March 2004, we entered into an interest rate cap agreement effective June 1, 2004 with decreasing annual notional principal amounts of $15,000 beginning March 1, 2006 and cap rates ranging from 4.0% to 5.0% over the life of the agreement.  We paid a premium of $1,375 to enter into the interest rate cap agreement.  During the second quarter of fiscal 2007, the interest

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

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

In November 2006, we completed a private offering of $125,000 of the 2.0% Convertible Notes to qualified institutional purchasers pursuant to Section 4(2) of the Securities Act of 1933.  The 2.0% Convertible Notes bear interest at an annual rate of 2.0%, payable semi-annually on May 15 and November 15 of each year.  The 2.0% Convertible Notes are convertible into our common stock at an initial conversion price of $58.92 per share, upon the occurrence of certain events, including the closing price of our common stock exceeding 130% of the conversion price per share for 20 of the last 30 trading days of the conversion reference period.  The stock price at which the notes would be convertible is $76.59 and as of August 31, 2007 our closing stock price was $61.71. Upon conversion, a holder will receive, in lieu of common stock, an amount of cash equal to the lesser of (i) the principal amount of the 2.0% Convertible Notes, or (ii) the conversion value, determined in the manner set forth in the indenture governing the 2.0% Convertible Notes, of a number of shares equal to the conversion rate. If the conversion value exceeds the principal amount of the 2.0% Convertible Note on the conversion date, we will also deliver, at our election, cash or common stock or a combination of cash and common stock with respect to the conversion value upon conversion. If conversion occurs in connection with a change of control, we may be required to deliver additional shares of our common stock by increasing the conversion rate with respect to such notes. The maximum aggregate number of shares that we would be obligated to issue upon conversion of the 2.0% Convertible Notes is 2,673.

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

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

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

In November 2006, we entered into an interest rate swap (“swap”) agreement effective January 15, 2007.  The swap has decreasing notional principal amounts beginning October 15, 2007 and a swap rate of 4.98% over the life of the agreement.  As of August 31, 2007, we had $175,500 of LIBOR based borrowings hedged under the provisions of the swap.  During the three months ended August 31, 2007, the decrease in fair value of the swap of $830, net of tax, was recorded to other comprehensive income.  The current portion of the fair value of the swap of $198 is included in accrued liabilities, and the long-term portion of $272 is included in noncurrent liabilities.  As of August 31, 2007, 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 on January 15, 2010.

In November 2006, we entered into an interest rate cap agreement effective January 15, 2007.  The interest rate cap had decreasing notional principal amounts beginning October 15, 2007 and a cap rate of 5.0% over the life of the agreement.  We paid a premium of $687 to enter into the interest rate cap agreement.  During the second fiscal quarter of 2007, the interest rate cap was sold for $555.  As a result, $50 was recorded as additional interest expense in the accompanying consolidated statement of income.

In April 2007, we entered into an interest rate cap agreement.  The cap has decreasing notional principal amounts beginning May 15, 2007 and a cap rate of 5.0% over the life of the agreement.  We paid a $114 premium to enter into the cap agreement, which is being amortized over the life of the agreement.  As of August 31, 2007, we had $15,000 of LIBOR based borrowings hedged under the provisions of the cap.  During the three months ended August 31, 2007, the value of the cap premium was compared to the fair value of the cap and the decrease in the market value of the premium of $21, net of tax, was recorded to other comprehensive income.  The current portion of the premium on the cap agreement of $69 is included in

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prepaid expenses and other current assets, and the long-term portion of $3 is included in other noncurrent assets.   As of August 31, 2007, a portion of the interest rate cap was deemed an ineffective cash flow hedge due to the reduction of variable rate debt resulting in an insignificant charge recorded as additional interest expense in the accompanying consolidated statement of income for the third quarter of fiscal 2007.  The balance of the cash flow hedge was deemed to be effective.  The fair value of the cap agreement is valued by a third party.  The cap agreement terminates on September 15, 2008.

In April 2007, we completed a private offering of $100,000 of the 1.625% Convertible Notes to qualified institutional investors pursuant to Section 144A of the Securities Act of 1933.  The 1.625% Convertible Notes bear interest at an annual rate of 1.625%, payable semi-annually on May 1 and November 1 of each year, with the first interest payment due on November 1, 2007.  The 1.625% Convertible Notes are convertible into our common stock at an initial conversion price of $73.20 per share, upon the occurrence of certain events, including the closing price of our common stock exceeding 130% of the conversion price per share for 20 of the last 30 trading days of the conversion reference period.  The stock price at which the notes would be convertible is $95.16. Upon conversion, a holder will receive, in lieu of common stock, an amount of cash equal to the lesser of (i) the principal amount of the 1.625% Convertible Notes, or (ii) the conversion value, determined in the manner set forth in the indenture governing the 1.625%  Convertible Notes, of a number of shares equal to the conversion rate. If the conversion value exceeds the principal amount of the 1.625% Convertible Note on the conversion date, we will also deliver, at our election, cash or common stock or a combination of cash and common stock with respect to the conversion value upon conversion. If conversion occurs in connection with a change of control, we may be required to deliver additional shares of our common stock by increasing the conversion rate with respect to such notes. The maximum aggregate number of shares that we would be obligated to issue upon conversion of the 1.625% Convertible Notes is 1,694.

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

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

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

Pursuant to EITF 90-19,“Convertible Bonds with Issuer Option to Settle for Cash upon Conversion”, (“EITF 90-19”), 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.

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

2007	$	750
2008		3,000
2009		3,000
2010		48,000
2011		3,000
Thereafter		466,000
	$	523,750

8. ACQUISITION AND SALES OF BRANDS

On January 2, 2007, we acquired the U.S. rights to five consumer and OTC brands from Johnson & Johnson (“J&J Acquisition”).  The acquired brands were: ACT, an anti-cavity mouthwash/mouth rinse; Unisom, an OTC sleep-aid; Cortizone-10, a hydrocortisone anti-itch product; Kaopectate, an anti-diarrhea product; and Balmex, a diaper rash product.  The J&J Acquisition was funded with the proceeds from a $300,000 term loan provided under our Credit Facility, borrowings under the revolving credit facility of the Credit Facility and through the use of a portion of the proceeds derived from the 2.0% Convertible Notes.  The purchase price of the J&J Acquisition was $410,000 plus $2,264 of costs directly related to the acquisition, of which $469 was incurred and funded during our fiscal year ended November 30, 2006.  The purchase price related to $5,916 of inventory, $1,884 of assumed liabilities, $463 of equipment, $403,855 of trademarks, which were assigned an indefinite life, and $3,914 of distribution rights, which was assigned a useful life of five years.  This was a preliminary assignment of values that will be completed during fiscal 2007.  Johnson & Johnson will continue to manufacture and supply certain of the products to us for a period of up to 18 months from the close of the acquisition, or such earlier date as we are able to move production to our facilities.  The price we pay Johnson & Johnson for these products is equivalent to the manufacturing cost, which includes all costs associated with the manufacturing and delivery of the product.  Certain of the products are manufactured and supplied under assumed agreements with third party manufacturers.  For a period of up to six months from the close of the acquisition, Johnson & Johnson provided transition services consisting of consumer affairs, distribution and collection services (including related financial, accounting and reporting services).  We terminated the distribution and collections services effective April 2, 2007 and the consumer affairs services effective June 21, 2007.  The costs charged for these transition services approximated the actual costs incurred by Johnson & Johnson.  During the nine months ended August 31, 2007, we incurred $2,057, of expenses related to these transition services.

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

PRO FORMA CONSOLIDATED RESULTS OF OPERATIONS (Unaudited)

	Three Months Ended		Nine Months Ended August 31,
	August 31,2006		2007		2006
Total revenue	$	100,864	$	331,942	$	326,292
Net income		18,750		45,653		50,886
Earnings per share – basic:		1.00		2.42		2.65
Earnings per share – diluted:		0.99		2.37		2.61

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

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

9. ADVERTISING EXPENSES

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

10. SHIPPING AND HANDLING

Shipping and handling costs of $3,358 and $2,038 were included in selling expenses for the three months ended August 31, 2007 and 2006, respectively, and $8,923 and $6,623 for the nine months ended August 31, 2007 and 2006, respectively.

11. PATENT, TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS

The carrying value of trademarks, which are not subject to amortization under the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), was $614,079 and $205,983 as of August 31, 2007 and November 30, 2006, respectively.  The gross carrying amount of intangible assets subject to amortization at August 31, 2007 and November 30, 2006, which consist primarily of non-compete agreements and distribution rights, was $6,053 and $2,139, respectively.  The related accumulated amortization of intangible assets at August 31, 2007 and November 30, 2006 was $2,591 and $1,973, respectively.  Amortization of our intangible assets subject to amortization under the provisions of SFAS 142 for the three months ended August 31, 2007 and 2006 was $206 and $59, respectively, and for the nine months ended August 31, 2007 and 2006 was $618 and $178, respectively.   Estimated annual amortization expense for these assets for the years ending November 30, 2008, 2009, 2010, 2011 and 2012 is $823, $803, $783, $783 and $65, respectively.

12. INVENTORIES

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

	2007		2006
Raw materials and work in process	$	11,554	$	15,495
Finished goods		23,716		15,894
Total inventories	$	35,270	$	31,389

13. ACCRUED LIABILITIES

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

	2007		2006
Interest	$	6,869	$	2,599
Salaries, wages and commissions		4,943		3,878
Product advertising and promotion		2,715		1,936
Litigation settlement and legal fees		956		1,162
Income taxes payable		2,001		635
Transition services and acquisition costs		2,920		—
Other		1,987		1,595
Total accrued liabilities	$	22,391	$	11,805

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14. COMPREHENSIVE INCOME

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

	For the Three Months Ended August 31,						For the Nine Months Ended August 31,
	2007			2006			2007		2006
Net income	$	16,312		$	15,229		$	44,870	$	40,202
Other – interest rate hedge adjustment		(832	)		122			250		65
Other – foreign currency translation adjustment		347			(151	)		558		(140	)
Total	$	15,827		$	15,200		$	45,678	$	40,127

15. STOCK REPURCHASE

 In the three and nine months ended August 31, 2007, we repurchased 380,129 shares of our common stock for $22,260 at an average price per share of $58.56.  All repurchased shares were retired and returned to unissued.  We, however, are limited in our ability to repurchase shares due to restrictions under the terms of our Amended Revolving Credit Facility and the indenture pursuant to which the 7.0% Subordinated Notes were issued.  We have not repurchased any shares of our common stock subsequent to August 31, 2007.

On July 25, 2006 our Board of Directors authorized the repurchase of up to an additional $100,000 of our common stock under the terms of our existing stock repurchase program.  As of October 2, 2007, the current amount available under the authorization from the Board of Directors was $65,887.

16. RETIREMENT PLANS AND POSTRETIREMENT HEALTH CARE BENEFITS

RETIREMENT PLANS

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

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

	For the Three Months Ended August 31,						For the Nine Months Ended August 31,
	2007			2006			2007			2006
Service cost	$	—		$	—		$	—		$	—
Interest cost on projected benefit obligation		153			156			459			467
Actual return on plan assets		(220	)		(226	)		(660	)		(677	)
Net amortization and deferral		—			—			—			—
Net pension benefit	$	(67	)	$	(70	)	$	(201	)	$	(210	)

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

POSTRETIREMENT HEALTH CARE BENEFITS

We maintain certain postretirement health care benefits for eligible employees.  Employees become eligible for these benefits if they meet certain age and service requirements.  We pay a portion of the cost of medical benefits for certain retired employees over the age of 65.    Effective May 31, 2006, we adopted an amendment to change the eligibility requirements for employee participation and limit the annual benefit to be paid.  This action resulted in a curtailment gain of $496 in the nine

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 months ended August 31, 2006 and is included as a component of selling, general and administrative expenses in the accompanying consolidated statements of income.    Employer contributions expected for fiscal 2007 are approximately $78.

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

	For the Three Months Ended August 31,						For the Nine Months Ended August 31,
	2007			2006			2007			2006
Service cost	$	14		$	20		$	42		$	60
Interest cost on accumulated postretirement benefit obligation		18			22			54			66
Amortization of prior service cost		4			4			12			11
Amortization of net gain		(4	)		(4	)		(12	)		(12	)
Curtailment gain		—			—			—			(496	)
Net periodic postretirement benefits cost (benefit)	$	32		$	42		$	96		$	(371	)

17. INCOME TAXES

We account for income taxes using the asset and liability approach as prescribed by SFAS 109.  This approach requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns.  Using the enacted tax rates in effect for the year in which the differences are expected to reverse, deferred tax assets and liabilities are determined based on the differences between the financial reporting and the tax basis of an asset or liability.  We record income tax expense in our consolidated financial statements based on an estimated annual effective income tax rate.  Our effective tax rate for the three and nine months ended August 31, 2007 was 35.9% and 35.0%, as compared to 34.6% and 34.5% in the three and nine months ended August 31, 2006.  The increase in the effective tax rate for the three and nine month periods ending August 31, 2007 as compared to the same periods of 2006 resulted from a greater proportion of U.S. taxable income in 2007.

Undistributed earnings of Chattem Canada, our Canadian subsidiary, amounted to approximately $606 and $1,410 for the three and nine months ended August 31, 2007, respectively.  These earnings are considered to be reinvested indefinitely and, accordingly, no provision for U.S. federal and state income taxes has been provided thereon.  Upon distribution of those earnings in the form of dividends or otherwise, those earnings would be subject to U.S. income taxes (subject to an adjustment for foreign tax credits).

18. PRODUCT SEGMENT INFORMATION

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

	For the Three Months Ended August 31,				For the Nine Months Ended August 31,
	2007		2006		2007		2006
Topical pain care	$	23,548	$	21,767	$	75,700	$	82,605
Medicated skin care		32,678		17,340		92,105		49,620
Oral care		13,042		1,601		35,260		4,919
Internal OTC		12,967		3,550		33,430		9,143
Dietary supplements		6,710		9,934		21,564		27,696
Medicated dandruff shampoos		8,770		7,798		27,406		28,075
Other OTC and toiletry products		3,046		4,321		16,136		14,849
Total	$	100,761	$	66,311	$	301,601	$	216,907

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19. COMMITMENT 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. Consequently, we are not currently defending any PPA products liability claims.

In accordance with the terms of the class action settlement, approximately $70,885 was initially funded into a settlement trust.  Over the past two years, we have resolved all of the claims submitted in the Dexatrim PPA settlement. All claims in the settlement and expenses of the trust have been paid.  On June 14, 2006, we filed a motion to dissolve the settlement trust.  The court granted this motion on July 14, 2006.  On August 31, 2006, the settlement trust paid us $10,720, which is included as a component of litigation settlement in our condensed consolidated statement of income for 2006.  The settlement trust currently has a balance of approximately $2,500.

We were also named as a defendant in approximately 206 lawsuits relating to Dexatrim containing PPA which 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 is included in our condensed consolidated statement 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.  Although we discontinued the manufacturing and shipment of Dexatrim containing ephedrine after September 2002, the FDA's final rule may result in lawsuits being filed against us alleging damages related to the use or purchase of Dexatrim containing ephedrine.

There is currently one Dexatrim with ephedrine products liability lawsuit pending against us.  That lawsuit is styled Grace Gunduz v. Herbalife International of America, Inc., et al., Superior Court of the State of California, County of Los Angeles.  In the case, the plaintiff seeks compensation for primary pulmonary hypertension, a condition she allegedly developed after ingesting ephedrine containing products manufactured by Herbalife, EAS and Chattem.  The case is set for trial in Santa Monica, California on December 3, 2007.  We plan to vigorously defend this case.

We maintain insurance coverage for product liability claims relating to our products, including Dexatrim products containing ephedrine, under claims-made policies which are subject to annual renewal.   For the current annual policy period beginning June 1, 2007, we maintain product liability insurance coverage in the amount of $30,000 through our captive insurance subsidiary, of which approximately $4,218 has been funded as of October 2, 2007.  We also have $25,000 of excess coverage through a third party reinsurance policy, which excludes coverage for our Dexatrim products containing ephedrine.

18

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

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

REGULATORY

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

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

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

19

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

In early 2005, infrequent, but serious, adverse cardiovascular events were reported to the FDA associated with patients who were prescribed a subclass of COX-2 inhibitor non-steroidal anti-inflammatory drugs (“NSAID’s”) for long periods to relieve pain of chronic diseases such as arthritis.  These products include Vioxx®, Bextra®, and Celebrex®.  In February 2005, the FDA held a joint advisory committee meeting to seek external counsel on the extent to which manufacturers might further warn patients of these cardiovascular risks on prescription product labeling, or prohibit sale of these prescription products.  As part of its response on this issue, the FDA has recommended labeling changes for both the prescription and OTC NSAID’s. Well-known OTC NSAID’s such as ibuprofen and naproxen, which have been sold in vast quantities since the 1970s, were affected by this regulatory action.   Manufacturers of OTC NSAID’s were asked to revise their labeling to provide more specific information about the potential cardiovascular and gastrointestinal risks recognizing the limited dose and duration of treatment of these products.  Our Pamprin All Day product, which contains naproxen sodium, is subject to these new labeling requirements.  Pamprin All Day is manufactured for us by The Perrigo Company (“Perrigo”), holder of an abbreviated NDA for naproxen sodium.  As holder of the abbreviated NDA, Perrigo made the mandated labeling changes within the time frame required by the FDA. Product with revised labeling compliant with new FDA regulations began shipping in February 2006.  We are also aware of the FDA's concern about the potential toxicity due to concomitant use of OTC and prescription products that contain the analgesic ingredient acetaminophen, an ingredient also found in Pamprin and Prēmsyn PMS.  We are also aware that the FDA will revise acetaminophen labeling to reflect the concerns similar to NSAID analgesics such as naproxen.  We are participating in an industry-wide effort to reassure the FDA that the current recommended dosing regimen is safe and effective and that proper labeling and public education by both OTC and prescription drug companies are the best policies to abate the FDA's concern.   The FDA will address both issues in its effort to finalize the monograph on internal analgesic products.  We believe the FDA may issue revised labeling requirements within the next year, perhaps prior to monograph closure that will cause the industry to relabel its analgesic products to better inform consumers.

During the finalization of the monograph on sunscreen products, the FDA chose to hold in abeyance specific requirements relating to the characterization of a product’s ability to reduce UVA radiation.  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.

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

On September 22, 2007, the FDA published a final rule establishing regulations requiring current good manufacturing practices for dietary supplements.  This final rule becomes effective June 2008.

20

20. CONOLIDATING 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 August 31, 2007 arose in conjunction with Chattem’s Credit Facility and Chattem’s issuance of the 7.0% Subordinated Notes (See Note 7).  The maximum amount of future payments the guarantors would be required to make under the guarantees as of August 31, 2007 is $298,750.

21

Note 20

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING BALANCE SHEETS

AUGUST 31, 2007

(Unaudited and in thousands)

	CHATTEM			GUARANTOR  SUBSIDIARY  COMPANIES			NON-GUARANTOR  SUBSIDIARY  COMPANIES		ELIMINATIONS			CONSOLIDATED
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	3,354		$	519		$	9,196	$	—		$	13,069
Accounts receivable, less allowances of $13,899		36,732			16,176			6,023		(16,176	)		42,755
Interest receivable		50			653			294		(997	)		—
Inventories		28,584			3,885			2,801		—			35,270
Refundable income taxes		—			—			—		—			—
Deferred income taxes		4,459			—			37		—			4,496
Prepaid expenses and other current assets		2,842			—			1,400		(240	)		4,002
Total current assets		76,021			21,233			19,751		(17,413	)		99,592
PROPERTY, PLANT AND EQUIPMENT, NET		29,805			775			642		—			31,222
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net		3,462			674,805			1,564		(62,290	)		617,541
Debt issuance costs, net		16,145			—			—		—			16,145
Investment in subsidiaries		349,825			33,000			66,860		(449,685	)		—
Note receivable		—			33,000			—		(33,000	)		—
Other		4,407			—			505		—			4,912
Total other noncurrent assets		373,839			740,805			68,929		(544,975	)		638,598
TOTAL ASSETS	$	479,665		$	762,813		$	89,322	$	(562,388	)	$	769,412
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt	$	3,000		$	—		$	—	$	—		$	3,000
Accounts payable and other		13,862			—			1,378		—			15,240
Bank overdraft		9,660			—			—		—			9,660
Accrued liabilities		35,262			1,046			3,496		(17,413	)		22,391
Total current liabilities		61,784			1,046			4,874		(17,413	)		50,291
LONG-TERM DEBT, less current maturities		527,150			(1,200	)		27,800		(33,000	)		520,750
DEFERRED INCOME TAXES		(21,792	)		39,789			—		—			17,997
OTHER NONCURRENT LIABILITIES		1,747			—			—		—			1,747
INTERCOMPANY ACCOUNTS		(267,851	)		260,143			7,708		—			—
SHAREHOLDERS’ EQUITY:
Preferred shares, without par value, authorized 1,000, none issued		—			—			—		—			—
Common shares, without par value, authorized 50,000, issued and outstanding 18,908		27,820			—			—		—			27,820
Shares of subsidiaries		—			329,705			39,803		(369,508	)		—
Retained earnings		150,835			133,330			8,336		(141,666	)		150,835
Total		178,655			463,035			48,139		(511,174	)		178,655
Unamortized value of restricted common shares issued		—			—			—		—			—
Cumulative other comprehensive income, net of tax:
Interest rate cap adjustment		(347	)		—			—		—			(347	)
Foreign currency translation adjustment		319			—			801		(801	)		319
Total shareholders’ equity		178,627			463,035			48,940		(511,975	)		178,627
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	479,665		$	762,813		$	89,322	$	(562,388	)	$	769,412

22

Note 20

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING BALANCE SHEETS

NOVEMBER 30, 2006

(In thousands)

	CHATTEM			GUARANTOR SUBSIDIARY  COMPANIES			NON-GUARANTOR  SUBSIDIARY  COMPANIES		ELIMINATIONS			CONSOLIDATED
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	80,198		$	1,967		$	8,362	$	—		$	90,527
Accounts receivable, less allowances of $10,907		25,203			9,407			4,649		(9,407	)		29,852
Interest receivable		17			625			—		(642	)		—
Inventories		24,444			4,160			2,785		—			31,389
Deferred income taxes		4,304			—			37		—			4,341
Prepaid expenses and other current assets		3,666			—			2,191		—			5,857
Total current assets		137,832			16,159			18,024		(10,049	)		161,966
PROPERTY, PLANT AND EQUIPMENT, NET		28,985			775			593		—			30,353
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net		166			268,273			—		(62,290	)		206,149
Debt issuance costs, net		11,399			—			—		—			11,399
Investment in subsidiaries		313,922			33,000			66,860		(413,782	)		—
Note receivable		—			33,000			—		(33,000	)		—
Other		4,978			468			—		—			5,446
Total other noncurrent assets		330,465			334,741			66,860		(509,072	)		222,994
TOTAL ASSETS	$	497,282		$	351,675		$	85,477	$	(519,121	)	$	415,313
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable and other	$	10,473		$	—		$	1,580	$	(2,105	)	$	9,948
Bank overdraft		5,824			—			—		—			5,824
Accrued liabilities		17,869			1,132			748		(7,944	)		11,805
Total current liabilities		34,166			1,132			2,328		(10,049	)		27,577
LONG-TERM DEBT, less current maturities		232,500			—			33,000		(33,000	)		232,500
DEFERRED INCOME TAXES		(16,517	)		34,185			—		—			17,668
OTHER NONCURRENT LIABILITIES		1,987			—			—		—			1,987
INTERCOMPANY ACCOUNTS		109,564			(114,014	)		4,450		—			—
SHAREHOLDERS’ EQUITY:
Preferred shares, without par value, authorized 1,000, none issued		—			—			—		—			—
Common shares, without par value, authorized 100,000, issued 18,669		30,452			—			—		—			30,452
Share capital of subsidiaries		—			329,705			39,803		(369,508	)		—
Retained earnings		105,965			100,667			5,679		(106,346	)		105,965
Total		136,417			430,372			45,482		(475,854	)		136,417
Cumulative other comprehensive income, net of     taxes:
Interest rate swap/cap adjustment		(597	)		—			—		—			(597	)
Foreign currency translation adjustment		(238	)		—			217		(218	)		(239	)
Total shareholders’ equity		135,582			430,372			45,699		(476,072	)		135,581
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	497,282		$	351,675		$	85,477	$	(519,121	)	$	415,313

23

Note 20

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF INCOME

FOR THE NINE MONTHS ENDED AUGUST 31, 2007

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY  COMPANIES			NON-GUARANTOR  SUBSIDIARY   COMPANIES			ELIMINATIONS			CONSOLIDATED
TOTAL REVENUES	$	286,359		$	70,374		$	16,727		$	(50,700	)	$	322,760
COSTS AND EXPENSES:
Cost of sales		87,617			5,724			7,758			(2,231	)		98,868
Advertising and promotion		73,748			8,194			4,269			—			86,211
Selling, general and administrative		41,535			(220	)		1,201			—			42,516
Acquisition expenses		2,057			—			—			—			2,057
Equity in subsidiary income		(35,319	)		—			—			35,319			—
Total costs and expenses		169,638			13,698			13,228			33,088			229,652
INCOME FROM OPERATIONS		116,721			56,676			3,499			(83,788	)		93,108
OTHER INCOME (EXPENSE):
Interest expense		(22,923	)		—			(1,989	)		2,210			(22,702	)
Investment and other income, net		795			1,923			2,626			(4,086	)		1,258
Loss on early extinguishment of debt		(2,633	)		—			—			—			(2,633	)
Royalties		(44,983	)		(3,486	)		—			48,469			—
Corporate allocations		2,026			(1,978	)		(48	)		—			—
Total other income (expense)		(67,718	)		(3,541	)		589			46,593			(24,077	)
INCOME BEFORE INCOME TAXES		49,003			53,135			4,088			(37,195	)		69,031
PROVISION FOR INCOME TAXES		4,133			18,597			1,431			—			24,161
NET INCOME	$	44,870		$	34,538		$	2,657		$	(37,195	)	$	44,870

24

Note 20

CHATTEM, INC. AND SUBSIDIARIES 

CONSOLIDATING STATEMENTS OF INCOME

FOR THE NINE MONTHS ENDED AUGUST 31, 2006

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY  COMPANIES			NON-GUARANTOR  SUBSIDIARY   COMPANIES			ELIMINATIONS			CONSOLIDATED
TOTAL REVENUES	$	194,859		$	63,036		$	14,736		$	(37,191	)	$	235,440
COSTS AND EXPENSES:
Cost of sales		60,764			7,730			6,789			(1,971	)		73,312
Advertising and promotion		63,346			8,371			3,858			—			75,575
Selling, general and administrative		33,800			(167	)		341			—			33,974
Litigation settlement		(19,305	)		—			—			—			(19,305	)
Equity in subsidiary income		(28,211	)		—			—			28,211			—
Total costs and expenses		110,394			15,934			10,988			26,240			163,556
INCOME FROM OPERATIONS		84,465			47,102			3,748			(63,431	)		71,884
OTHER INCOME (EXPENSE):
Interest expense		(8,328	)		—			(1,846	)		1,856			(8,318	)
Investment and other income, net		316			1,897			2,134			(3,731	)		616
Loss on early extinguishment of debt		(2,805	)		—			—			—			(2,805	)
Royalties		(30,743	)		(4,477	)		—			35,220			—
Corporate allocations		2,625			(2,578	)		(47	)		—			—
Total other income (expense)		(38,935	)		(5,158	)		241			33,345			(10,507	)
INCOME BEFORE INCOME TAXES		45,530			41,944			3,989			(30,086	)		61,377
PROVISION FOR INCOME TAXES		5,328			14,471			1,376			—			21,175
NET INCOME	$	40,202		$	27,473		$	2,613		$	(30,086	)	$	40,202

25

Note 20

CHATTEM, INC. AND SUBSIDIARIES 

CONSOLIDATING STATEMENTS OF CASH FLOWS 

FOR THE NINE MONTHS ENDED AUGUST 31, 2007 

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY  COMPANIES			NON-GUARANTOR  SUBSIDIARY   COMPANIES			ELIMINATIONS			CONSOLIDATED
OPERATING ACTIVITIES:
Net income	$	44,870		$	34,538		$	2,657		$	(37,195	)	$	44,870
Adjustments to reconcile net income to net cash     provided by (used in) operating activities:
Depreciation and amortization		6,307			—			154			—			6,461
Deferred income taxes		5,524			5,603			(1	)		—			11,126
Tax benefit realized from stock options exercised		(4,747	)		—			—			—			(4,747	)
Stock-based compensation		4,122			—			—			—			4,122
Loss on early extinguishment of debt		2,633			—			—			—			2,633
Other, net		156			—			(143	)		—			13
Equity in subsidiary income		(37,195	)		—			—			37,195			—
Changes in operating assets and liabilities, net of effects from acquisitions:
Accounts receivable and other		(11,528	)		(6,770	)		(1,375	)		6,770			(12,903	)
Accounts receivable		(33	)		(27	)		(295	)		355			—
Inventories		1,912			275			(15	)		—			2,172
Prepaid expenses and other current assets		825			—			(232	)		240			833
Accounts payable and accrued liabilities		23,644			(85	)		2,547			(7,365	)		18,741
Net cash provided by operating activities		36,490			33,534			3,297			—			73,321
INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(3,590	)		—			(203	)		—			(3,793	)
Acquisition of brands		(8,091	)		(406,531	)		(1,562	)		—			(416,184	)
Decrease in other assets, net		229			467			1,100			—			1,796
Net cash used in investing activities		(11,452	)		(406,064	)		(665	)		—			(418,181	)
FINANCING ACTIVITIES:
Repayment of long-term debt		(153,750	)		—			—			—			(153,750	)
Intercompany debt proceeds (payments)		6,400			(1,200	)		(5,200	)		—			—
Proceeds from long-term debt		400,000			—			—			—			400,000
Proceeds from borrowings under revolving credit facility		147,500			—			—			—			147,500
Repayments of revolving credit facility		(102,500	)		—			—			—			(102,500	)
Proceeds from exercise of stock options		11,130			—			—			—			11,130
Change in bank overdraft		3,836			—			—			—			3,836
Repurchase of common shares		(22,260	)		—			—			—			(22,260	)
Purchase of note hedge		(29,500	)		—			—			—			(29,500	)
Proceeds from issuance of warrant		17,430			—			—			—			17,430
Increase in debt issuance costs		(9,374	)		—			—			—			(9,374	)
Debt retirement costs		—			—			—			—			—
Tax benefit realized from stock options exercised		4,747			—			—			—			4,747
Changes in intercompany accounts		(375,541	)		374,157			1,384			—			—
Dividends paid		—			(1,875	)		1,875			—			—
Net cash (used in) provided by financing activities		(101,882	)		371,082			(1,941	)		—			267,259
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		—			—			143			—			143
CASH AND CASH EQUIVALENTS:
(Decrease) increase for the period		(76,844	)		(1,448	)		834			—			(77,458	)
At beginning of period		80,198			1,967			8,362			—			90,527
At end of period	$	3,354		$	519		$	9,196		$	—		$	13,069

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Note 20

CHATTEM, INC. AND SUBSIDIARIES 

CONSOLIDATING STATEMENTS OF CASH FLOWS 

FOR THE NINE MONTHS ENDED AUGUST 31, 2006 

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY  COMPANIES			NON-GUARANTOR  SUBSIDIARY   COMPANIES			ELIMINATIONS			CONSOLIDATED
OPERATING ACTIVITIES:
Net income	$	40,202		$	27,473		$	2,613		$	(30,086	)	$	40,202
Adjustments to reconcile net income to net cash     provided by (used in) operating activities:
Depreciation and amortization		4,124			—			215			—			4,339
Deferred income taxes		(2,064	)		5,653			(35	)		—			3,554
Tax benefit realized from stock options exercised		(744	)		—			—			—			(744	)
Stock-based compensation		3,322			—			—			—			3,322
Loss on early extinguishment of debt		2,805			—			—			—			2,805
Other, net		78			—			177			—			255
Equity in subsidiary income		(30,086	)		—			—			30,086			—
Changes in operating assets and liabilities:
Accounts receivable		14,093			235			(610	)		(235	)		13,483
Inventories		(4,826	)		(447	)		174			—			(5,099	)
Refundable income taxes		1,951			—			—			—			1,951
Prepaid expenses and other current assets		23			—			403			(1,551	)		(1,125	)
Accounts payable and accrued liabilities		(9,589	)		621			(4,062	)		1,786			(11,244	)
Net cash provided by (used in) operating activities		19,289			33,535			(1,125	)		—			51,699
INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(3,350	)		—			(207	)		—			(3,557	)
Increase in other assets, net		(949	)		—			(1,129	)		—			(2,078	)
Net cash used in investing activities		(4,299	)		—			(1,336	)		—			(5,635	)
FINANCING ACTIVITIES:
Repayment of long-term debt		(75,000	)		—			—			—			(75,000	)
Proceeds from borrowings under revolving credit facility		75,500			—			—			—			75,500
Repayments of revolving credit facility		(22,000	)		—			—			—			(22,000	)
Proceeds from exercise of stock options		911			—			—			—			911
Change in bank overdraft		2,140			—			—			—			2,140
Repurchase of common shares		(39,332	)		—			—			—			(39,332	)
Increase in debt issuance costs		(5,634	)		—			—			—			(5,634	)
Debt retirement costs		(1,501	)		—			—			—			(1,501	)
Tax benefit realized from stock options exercised		744			—			—			—			744
Changes in intercompany accounts		31,859			(31,658	)		(201	)		—			—
Dividends paid		—			(1,875	)		1,875			—			—
Net cash (used in) provided by financing activities		(32,313	)		(33,533	)		1,674			—			(64,172	)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		—			—			(176	)		—			(176	)
CASH AND CASH EQUIVALENTS:
(Decrease) increase for the period		(17,323	)		2			(963	)		—			(18,284	)
At beginning of period		36,647			1,982			8,698			—			47,327
At end of period	$	19,324		$	1,984		$	7,735		$	—		$	29,043

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Item 2. Management’s Discussion and Analysis of Financial Condition and

Results of Operations

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

Overview

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

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

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

• Selsun Blue and Selsun Salon– medicated dandruff shampoos;

• ACT and Herpecin-L – oral care;

• Unisom,Pamprin and Kaopectate  – internal OTC;

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

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

Our products target niche markets that are often outside the focus of larger companies where we believe we can achieve and sustain significant market share through innovation and strong advertising and promotion support. Many of our products are among the U.S. market leaders in their respective categories. For example, our portfolio of topical analgesic brands and our Gold Bond medicated body powders have the leading U.S. market share in these categories. We support our brands through extensive and cost-effective advertising and promotion, the expenditures for which represented approximately 27% of our total revenues for the nine months ended August 31, 2007. We sell our products nationally through mass merchandiser, drug and food channels, principally utilizing our own sales force.

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

Developments During Fiscal 2007

Acquisition of Brands

On January 2, 2007, we acquired the U.S. rights to five consumer and OTC brands from Johnson & Johnson (“J&J Acquisition”).  The acquired brands were: ACT, an anti-cavity mouthwash/mouth rinse; Unisom, an OTC sleep-aid; Cortizone-10, a hydrocortisone anti-itch product; Kaopectate, an anti-diarrhea product; and Balmex, a diaper rash product.  The J&J Acquisition was funded with the proceeds from a $300.0 million term loan provided under our Credit Facility, borrowings under the revolving credit facility portion of the Credit Facility and through the use of a portion of the proceeds derived from the 2.0% Convertible Notes.  The purchase price of the J&J Acquisition was $410.0 million plus $2.3 million of costs directly related to the acquisition, of which $0.5 million was incurred and funded during our fiscal year ended November 30, 2006.  The purchase price related to $5.9 million of inventory, $1.9 million of assumed liabilities, $0.5 million of equipment, $403.9 million of trademarks, which were assigned an indefinite life, and $3.9 million of distribution rights, which was assigned a useful life of five years.  This was a preliminary assignment of values that will be completed during fiscal 2007.  Johnson & Johnson will continue to manufacture and supply certain of the products to us for a period of up to 18 months from the close of the acquisition, or such earlier date as we are able to move production to our facilities.  The price we pay Johnson & Johnson for these products is equivalent to the manufacturing cost, which includes all costs associated with the manufacturing and delivery of the product.  Certain of the products are manufactured and supplied under assumed agreements with third party manufacturers.  For a period of up to six months from the close of the acquisition, Johnson & Johnson provided transition services consisting of consumer affairs, distribution and collection services (including related financial, accounting and reporting services).  We terminated the distribution

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and collections services effective April 2, 2007 and the consumer affairs services effective June 21, 2007.  The costs charged for these transition services approximated the actual costs incurred by Johnson & Johnson.

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

Products

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

Debt

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

Borrowings under the revolving credit facility portion of our Credit Facility bear interest at LIBOR plus applicable percentages of 0.875% to 1.5% or the higher of the federal funds rate plus 0.5% or the prime rate (the “Base Rate”).  The applicable percentages are calculated based on our leverage ratio.  As of August 31, 2007 and November 30, 2006, we had $45.0 million and $0, respectively, of borrowings outstanding under the revolving credit facility portion of our Credit Facility.  As of October 2, 2007, we had $45.0 million of borrowings outstanding under the revolving credit facility portion of our Credit Facility and our borrowing capacity was $55.0 million.

The term loan under the Credit Facility bears interest of either LIBOR plus 1.75% or the Base Rate plus 0.75%.  The term loan borrowings are to be repaid in increments of $0.8 million each calendar quarter, with the first principal paid on June 30, 2007.  The principal outstanding after scheduled repayment and any unscheduled prepayments is due January 2, 2013.  In April 2007, we utilized the net proceeds from the 1.625% Convertible Notes and borrowings under the revolving credit facility portion of our Credit Facility to repay $128.0 million of the term loan under the Credit Facility.  In July 2007, we utilized borrowings under the revolving credit facility portion of our Credit Facility to repay an additional $25.0 million of the term loan under the Credit Facility.  In connection with the term loan repayments during April 2007 and July 2007, we retired a proportional share of the term loan debt issuance costs and recorded the resulting loss on early extinguishment of debt of $2.6 million in the nine months ended August 31, 2007.

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

In April 2007, we completed a private offering of $100.0 million of the 1.625% Convertible Notes, the proceeds of which were used to repay a portion of the amount outstanding under the Credit Facility term loan, pay for a note hedge and pay approximately $2.5 million in debt issuance costs.  The 1.625% Convertible Notes bear interest at an annual rate of 1.625%, payable semi-annually on May 1 and November 1 of each year, with the first interest payment due on November 1, 2007.  Concurrently with the sale of the 1.625% Convertible Notes, we purchased a note hedge for $29.5 million and issued warrants for proceeds of $17.4 million with an affiliate of Merrill Lynch (the “Counterparty”).  The note hedge and warrants are separate and legally distinct instruments that bind us and the Counterparty and have no binding effect on the holders of the 1.625% Convertible Notes.

Stock Repurchase

During the first nine months of fiscal 2007, we repurchased 380,129 shares of our common stock under our stock repurchase program for $22.3 million at an average price per share of $58.56.

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Results of Operations

The following table sets forth, for the periods indicated, certain items from our Consolidated Statements of Income expressed as a percentage of total revenues:

	For the Three Months Ended						For the Nine Months Ended
	August 31, 2007			August 31, 2006			August 31, 2007			August 31, 2006
TOTAL REVENUES		100.0	%		100.0	%		100.0	%		100.0	%
COSTS AND EXPENSES:
Cost of sales		30.1			30.9			30.6			31.2
Advertising and promotion		25.5			32.8			26.7			32.1
Selling, general and administrative		14.3			15.1			13.3			14.4
Acquisition expenses		—			—			0.6			—
Litigation settlement		—			(15.0	)		—			(8.2	)
Total costs and expenses		69.9			63.8			71.2			69.5
INCOME FROM OPERATIONS		30.1			36.2			28.8			30.5
OTHER INCOME (EXPENSE):
Interest expense		(6.6	)		(4.2	)		(7.0	)		(3.5	)
Investment and other income, net		0.2			0.3			0.4			0.3
Loss on early extinguishment of debt		(0.4	)		—			(0.8	)		(1.2	)
Total other income (expense)		(6.8	)		(3.9	)		(7.4	)		(4.4	)
INCOME BEFORE INCOME TAXES		23.3			32.3			21.4			26.1
PROVISION FOR INCOME TAXES		8.4			11.2			7.5			9.0
NET INCOME		14.9	%		21.1	%		13.9	%		17.1	%

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 consolidated financial statements for the three and nine months ended August 31, 2007.

Allowance for Doubtful Accounts

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

Revenue Recognition

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

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and retail point of sale data on existing and newly introduced products.  The level of returns may fluctuate from our estimates due to several factors including weather conditions, customer inventory levels and competitive conditions.  We charge the allowance account for product returns when the customer provides appropriate supporting documentation that the product is properly destroyed or upon receipt of the product.

We separate returns into the two categories of seasonal and non-seasonal products.  We use the historical return detail of seasonal and non-seasonal products for at least the most recent three fiscal years on generally all products, which is normalized for any specific occurrence that is not reasonably likely to recur, to determine the amount of product return as a percentage of sales, and estimate an allowance for potential returns based on product sold in the current period.  To consider product sold in current and prior periods, an estimate of inventory held by our retail customers is calculated based on customer inventory detail.  This estimate of inventory held by our customers, along with historical returns as a percentage of sales, is used to determine an estimate of potential product returns.  This estimate of the allowance for seasonal and non-seasonal returns is further analyzed by considering retail customer point of sale data.  We also consider specific events, such as discontinued product or product divestitures, when determining the adequacy of the allowance.  Based on consideration of the sales of Icy Hot Pro-Therapy performing below expectations, review of retail point of sales data and an estimate of inventory on hand at customers, an allowance for returns of $3.3 million was recorded as of November 30, 2006.  As of August 31, 2007, the allowance remaining for Icy Hot Pro-Therapy  returns after fiscal 2007 returns activity through August 31, 2007 is $1.5 million.

Our estimate of product returns for seasonal and non-seasonal products as of August 31, 2007 was $2.5 million and $1.4 million, respectively, and $1.2 million and $1.3 million, respectively, as of November 30, 2006.  For the nine months ended August 31, 2007, we increased our estimate of returns for seasonal and non-seasonal products by approximately $1.3 million and $0.1 million, respectively, which resulted in a decrease to net sales in our consolidated financial statements.  During the nine months ended August 31, 2006, we increased our estimate of returns for seasonal products and non-seasonal returns by approximately $2.1 million and $0.1 million, respectively, which resulted in a decrease to net sales in our consolidated financial statements.  Each percentage point change in the seasonal and non-seasonal return rate would impact net sales by approximately $0.2 million and $0.7 million, respectively.

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 August 31, 2007, the coupon and vendor allowances accruals were $2.1 million and $7.1 million, respectively, and $1.2 million and $3.7 million, respectively, as of November 30, 2006.  Each percentage point change in promotional program participation would impact net sales by $0.2 million and advertising and promotion expense by an insignificant amount for the nine months ended August 31, 2007.

Income Taxes

We account for income taxes using the asset and liability approach as prescribed by Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes”.  This approach requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in 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

31

liability.  We record income tax expense in our consolidated financial statements based on an estimated annual effective income tax rate.  Our effective tax rate for the nine months ended August 31, 2007 and 2006 was 35.0% and 34.5%, respectively.  The increase in the effective tax rate for the three and nine month periods ending August 31, 2007 as compared to the same periods of 2006 results from a greater proportion of U.S. taxable income in 2007.

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

Comparison of Three Months Ended August 31, 2007 and 2006

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

						Increase (Decrease)
	2007		2006			Amount		Percentage
	(dollars in thousands)
Domestic net sales	$	100,761	$	66,311		$	34,450		52.0	%
International revenues (including royalties)		8,204		5,694			2,510		44.1
Total revenues		108,965		72,005			36,960		51.3
Cost of sales		32,793		22,238			10,555		47.5
Advertising and promotion expense		27,760		23,607			4,153		17.6
Selling, general and administrative expense		15,619		10,855			4,764		43.9
Litigation settlement		—		(10,800	)		10,800		100.0
Interest expense		7,147		3,018			4,129		136.8
Loss on early extinguishment of debt		414		—			414		100.0
Net  income		16,312		15,229			1,083		7.1

Domestic Net Sales

Domestic net sales for the three months ended August 31, 2007 increased $34.5 million, or 52.0%, to $100.8 million from $66.3 million in the prior year quarter.   A comparison of domestic net sales for the categories of products included in our portfolio of OTC healthcare products is as follows:

					Increase (Decrease)
	2007		2006		Amount			Percentage
	(dollars in thousands)
Topical pain care	$	23,548	$	21,767	$	1,781			8.2	%
Medicated skin care		32,678		17,340		15,338			88.5
Oral care		13,042		1,601		11,441			714.6
Internal OTC		12,967		3,550		9,417			265.3
Dietary supplements		6,710		9,934		(3,224	)		(32.5	)
Medicated dandruff shampoos		8,770		7,798		972			12.5
Other OTC and toiletry products		3,046		4,321		(1,275	)		(29.5	)
Total	$	100,761	$	66,311	$	34,450			52.0

Net sales in the topical pain care category increased $1.8 million, or 8.2%, in the third quarter of fiscal 2007 compared to the prior year quarter due to the launch of Icy Hot Heat Therapy and Icy Hot Vanishing Scent Cream.

Net sales in the medicated skin care products category increased $15.3 million, or 88.5%, in the third quarter of fiscal 2007 compared to the prior year quarter.  The category increase was primarily attributable to the Cortizone-10 and Balmex brands acquired in the J&J acquisition.  Net sales of Gold Bond in the third quarter of fiscal 2007 increased 13.9% compared to the prior year quarter led by sales of Gold Bond Ultimate Softening Lotion launched in the fourth quarter of fiscal 2006 and the Gold Bond Foot line of products.

Net sales in the oral care category increased $11.4 million, or 715%, in the third quarter of fiscal 2007 compared to the prior year quarter.  This increase was led by ACT, which was acquired in the J&J Acquisition.

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Net sales in the internal OTC category increased $9.4 million, or 265%, in the third quarter of fiscal 2007 compared to the prior year quarter.  This increase was led by Unisom and Kaopectate, which were acquired in the J&J Acquisition.

Net sales in the dietary supplements category decreased $3.3 million, or 32.5%, in the third quarter of fiscal 2007 compared to the prior year quarter.  Net sales of Dexatrim decreased 43.3% as a result of initial sales of Dexatrim Max2o in fiscal 2006 and increased competitive pressures.  Partially offsetting the decline was Dexatrim Max Evening Control launched in fiscal 2007.

Net sales in the medicated dandruff shampoos category increased $0.9 million, or 12.5%, in the third quarter of fiscal 2007 compared to the prior year quarter.  The increase was primarily attributable to the introduction of Selsun Naturals in fiscal 2007.

Net sales in the other OTC and toiletry products category decreased $1.3 million, or 29.5%, in the third quarter of fiscal 2007 compared to the prior year quarter as a result of a 24.2% decrease in Bullfrog sales due to the timing of shipments for certain retailers in the second fiscal quarter of 2007 versus the third quarter of fiscal 2007.

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

International Revenues

For the third quarter of fiscal 2007, international revenues increased $2.5 million, or 44.1%, as compared to the prior year quarter of fiscal 2006, primarily due to the brands acquired in the J&J Acquisition and the ACT Acquisition and the timing of sales to certain customers in the quarter compared to the prior year quarter.  Sales variances for our international operations were principally the result of changes in unit sales volume.

Cost of Sales

Cost of sales as a percentage of total revenues was 30.1% for the third quarter of fiscal 2007 as compared to 30.9% in the prior year quarter.  Gross margin for the third quarter of fiscal 2006 was 69.9% compared to 69.1% in the prior year quarter.  The gross margin increase was attributable to the sales of products with lower gross margins in fiscal 2006 as compared to fiscal 2007, including Icy Hot Pro-Therapy which was launched in February 2006.

Advertising and Promotion Expense

Advertising and promotion expenses in the third quarter of fiscal 2007 increased $4.2 million, or 17.6%, as compared to the prior year quarter and were 25.5% of total revenues for third quarter of fiscal 2007 compared to 32.8% for the prior year quarter.  The decrease in advertising and promotion expense as a percentage of revenue for the current period reflected higher advertising and promotion spending for Icy Hot Pro-Therapy during the fiscal 2006 launch period.

Selling, General and Administrative Expense

Selling, general and administrative expenses increased $4.8 million, or 43.9%, in the third quarter of fiscal 2007 compared to the prior year quarter.  Selling, general and administrative expenses were 14.3% and 15.1% of total revenues for the third quarter of fiscal 2007 and 2006, respectively.  The decrease as a percentage of revenue was attributable to increased revenue without commensurate increases in selling, general and administrative expenses.

Litigation Settlement

Litigation settlement for the third quarter of fiscal 2006 reflected a $10.7 million recovery of proceeds from the settlement trust in the Dexatrim litigation settlement and net recoveries related to the Dexatrim litigation of $0.1 million.  No corresponding benefit was recorded in the third quarter of fiscal 2007.

Interest Expense

Interest expense increased $4.1 million, or 137%, in the third quarter of fiscal 2007 as compared to the prior year quarter as a result of additional indebtedness incurred to finance the J&J Acquisition.  Until our indebtedness is reduced substantially, interest expense will continue to represent a significant percentage of our total revenues.

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Loss on Early Extinguishment of Debt

During the third quarter of fiscal 2007, we utilized borrowings under the revolving credit facility portion of our Credit Facility to repay $25.0 million of the term loan under the Credit Facility.  In connection with the repayment, we retired a proportional share of the term loan debt issuance costs, which resulted in a loss on early extinguishment of debt of $0.4 million.

Comparison of Nine Months Ended August 31, 2007 and 2006

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

						Increase (Decrease)
	2007		2006			Amount			Percentage
	(dollars in thousands)
Domestic net sales	$	301,601	$	216,907		$	84,694			39.0	%
International revenues (including royalties)		21,159		18,533			2,626			14.2
Total revenues		322,760		235,440			87,320			37.1
Cost of sales		98,868		73,312			25,556			34.9
Advertising and promotion expense		86,211		75,575			10,636			14.1
Selling, general and administrative expense		42,516		33,974			8,542			25.1
Acquisition expenses		2,057		—			2,057			100.0
Litigation settlement		—		(19,305	)		19,305			100.0
Interest expense		22,702		8,318			14,384			172.9
Loss on early extinguishment of debt		2,633		2,805			(172	)		(6.1	)
Net income		44,870		40,202			4,668			11.6

Domestic Net Sales

Domestic net sales for the nine months ended August 31, 2007 increased $84.7 million, or 39.0%, as compared to the corresponding period of 2006.   A comparison of domestic net sales for the categories of products included in our portfolio of OTC healthcare products is as follows:

					Increase (Decrease)
	2007		2006		Amount			Percentage
	(dollars in thousands)
Topical pain care	$	75,700	$	82,605	$	(6,905	)		(8.4	)%
Medicated skin care		92,105		49,620		42,485			85.6
Oral care		35,260		4,919		30,341			616.8
Internal OTC		33,430		9,143		24,287			265.6
Dietary supplements		21,564		27,696		(6,132	)		(22.1	)
Medicated dandruff shampoos		27,406		28,075		(669	)		(2.4	)
Other OTC and toiletry products		16,136		14,849		1,287			8.7
Total	$	301,601	$	216,907	$	84,694			39.0

Net sales in the topical pain care products category decreased $6.9 million, or 8.4%, for the first nine months of fiscal 2007 compared to the same period in fiscal 2006, due to the initial introduction of Icy Hot Pro-Therapy in fiscal 2006, partially offset by the launch of Icy Hot Heat Therapy and Icy Hot Vanishing Scent Cream in fiscal 2007.

Net sales in the medicated skin care products category increased $42.5 million, or 85.6%, for the first nine months of fiscal 2007 compared to the same period in fiscal 2006 as a result of the acquisition of Cortizone-10 and Balmex in the first fiscal quarter of fiscal 2007 and sales of Gold Bond Ultimate Softening Lotion launched in the fourth quarter of fiscal 2006.  The Gold Bond franchise had sales increases of 21.0% for the first nine months of fiscal 2007 compared to the same prior year period.

Net sales in the oral care category increased $30.3 million, or 617%, for the first nine months of fiscal 2007 compared to the same period in 2006.  This increase was led by ACT, which was acquired in the J&J Acquisition.

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Net sales in the internal OTC category increased $24.3 million, or 266%, for the first nine months of fiscal 2007 compared to the same period in 2006.  This increase was led by Unisom and Kaopectate, which were acquired in the J&J Acquisition.

Net sales in the dietary supplements category decreased $6.1 million, or 22.1%, for the first nine months of fiscal 2007 as compared to the same period in 2006.  Net sales of Dexatrim decreased 17.2% as a result of initial sales of Dexatrim Max2o in fiscal 2006 and increased competitive pressures.  Net sales of Garlique decreased 27.7% compared to the prior year period as a result of the initial product introduction of Garlique Cardio Assist in the same period of fiscal 2006.

Net sales in the medicated dandruff shampoos category decreased $0.7 million, or 2.4%, for the first nine months of fiscal 2007 compared to the same period in fiscal 2006 primarily due to the launch and initial sell-in of Selsun Salon in the first quarter of fiscal 2006, partially offset by the introduction of Selsun Naturals in fiscal 2007.

Net sales in the other OTC and toiletry products category increased $1.3 million, or 8.7%, for the first nine months of fiscal 2007 compared to the same period in fiscal 2006 due principally to the introduction of Bullfrog Marathon Mist.

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

International Revenues

For the nine months ended August 31, 2007, international revenues increased $2.6 million, or 14.2%, as compared to the same period in fiscal 2006, primarily due to the brands acquired in the J&J Acquisition and the ACT Acquisition.  Sales variances for international operations were principally the result of changes in unit sales volumes.

Cost of Sales

Cost of sales as a percentage of total revenues was 30.6% for the nine months ended August 31, 2007 as compared to 31.2% for the comparable period of fiscal 2006.  Gross margin for the nine months ended August 31, 2007 was 69.4% compared to 68.8% for the same period in fiscal 2006. The gross margin increase was attributable to the sales of products with lower gross margins in fiscal 2006 as compared to fiscal 2007, including Icy Hot Pro-Therapy which was launched in February 2006.

Advertising and Promotion Expense

Advertising and promotion expenses for the nine months ended August 31, 2007 increased $10.6 million, or 14.1%, as compared to the same period in fiscal 2006 and were 26.7% of total revenues for the nine months ended August 31, 2007 compared to 32.1% for the comparable period of fiscal 2006.  The decrease in advertising and promotion expense as a percentage of revenue for the current period reflected higher advertising and promotion spending for Icy Hot Pro-Therapy and Selsun Salon during the fiscal 2006 launch period.

Selling, General and Administrative Expense

Selling, general and administrative expenses for the nine months ended August 31, 2007 increased $8.6 million, or 25.1%, as compared to the same period of fiscal 2006.  Selling, general and administrative expenses were 13.3% and 14.4% of total revenues for the nine months ended August 31, 2007 and 2006, respectively.  The decrease as a percentage of revenue was attributable to increased revenue without commensurate increases in selling, general and administrative expenses.

Litigation Settlement

Litigation settlement for the nine months ended August 31, 2006 reflected the $8.8 million recovery from the DELACO settlement trust in the first quarter of 2006, the $10.7 million recovery from the litigation settlement trust on August 31, 2006 in the Dexatrim litigation settlement and net legal expenses related to the Dexatrim litigation of $0.2 million.  No corresponding benefit was recorded in fiscal 2007.

Interest Expense

Interest expense increased $14.4 million, or 173%, in the nine months ended August 31, 2007 as compared to the same period in fiscal 2006 as a result of additional indebtedness incurred to finance the J&J Acquisition.  Until our indebtedness is reduced substantially, interest expense will continue to represent a significant percentage of our total revenues.

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Loss on Early Extinguishment of Debt

In April 2007, we utilized the net proceeds from the 1.625% Convertible Notes and borrowings under the revolving credit facility portion of our Credit Facility to repay $128.0 million of the term loan under the Credit Facility.   In July 2007, we utilized borrowings under the revolving credit facility portion of our Credit Facility to repay an additional $25.0 million of the term loan under the Credit Facility.  In connection with the term loan repayments, we retired a proportional share of the term loan debt issuance costs and recorded the resulting loss on early extinguishment of debt of $2.6 million during the nine months ended August 31, 2007.  Our $75.0 million of Floating Rate Senior Notes were fully redeemed in the first quarter of fiscal 2006.  As a result of the redemption, a loss on early extinguishment of debt of $2.8 million was recorded in the nine months ended August 31, 2006.

Liquidity and Capital Resources

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

Cash of $73.3 million and $51.7 million was provided by operating activities for the nine months ended August 31, 2007 and 2006, respectively.  The increase in cash flows from operating activities over the prior year period was primarily attributable to increased net income, increased accounts payable and accrued liabilities (net of acquisitions) and decreased inventories (net of acquisitions) offset by increased accounts receivable.

Investing activities used cash of $418.2 million and $5.6 million in the nine months ended August 31, 2007 and 2006, respectively.  The increase in cash used in 2007 is primarily related to amounts used to fund the J&J Acquisition and the ACT Acquisition.

Financing activities provided cash of $267.3 million and used cash of $64.2 in the nine months ended August 31, 2007 and 2006, respectively.  The increase was primarily attributable to amounts borrowed to fund the J&J Acquisition.

As of August 31, 2007, we had $45.0 million of borrowings outstanding under the revolving credit facility portion of our Credit Facility.  As of October 2, 2007, we had $45.0 of borrowings outstanding under the revolving credit facility portion of our Credit Facility and our borrowing capacity was $55.0.

Foreign Operations

Historically, our primary foreign operations have been conducted through our Canadian and United Kingdom (“U.K.”) subsidiaries.  Effective November 1, 2004, we transitioned our European business to Chattem Global Consumer Products Limited, a wholly-owned subsidiary located in Limerick, Ireland.  The functional currencies of these subsidiaries are Canadian dollars and Euros, respectively.  Fluctuations in exchange rates can impact operating results, including total revenues and expenses, when translations of the subsidiary financial statements are made in accordance with SFAS No. 52, “Foreign Currency Translation”.  For the nine months ended August 31, 2007 and 2006 these subsidiaries accounted for 5% and 6% of total revenues, respectively and 2% and 3% of total assets, respectively.  It has not been our practice to hedge our assets and liabilities in Canada, the U.K. and Ireland or our intercompany transactions due to the inherent risks associated with foreign currency hedging transactions and the timing of payments between us and our foreign subsidiaries.  Historically, gains or losses from foreign currency transactions have not had a material impact on our operating results.  Gains and losses from foreign currency transactions for the nine months ended August 31, 2007 and 2006 were insignificant and are included in selling, general and administrative expenses in the Consolidated Statements of Income.

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Account Standard (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”.  SFAS 123R supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and amends SFAS No. 95, “Statement of Cash Flows”.  SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions and requires all share-based payments to employees, including grants of employee stock options, to be recognized as additional compensation expense in the financial statements based on the calculated fair value of the awards.  SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation costs to be reported as a financing cash flow.  This requirement has reduced net operating cash flows and increased net financing cash flows in periods after adoption.  We adopted SFAS 123R effective for our fiscal year beginning December 1, 2005.

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

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”).  SFAS 157 provides guidance for using fair value to measure assets and liabilities and is intended to respond to investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings.  SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances.  SFAS 157 also requires expanded disclosure of the effect on earnings for items measured using unobservable data, establishes a fair value hierarchy that prioritizes the information used to develop those assumptions and requires separate disclosure by level within the fair value hierarchy.  The provisions of SFAS 157 are effective for interim financial statements issued for fiscal years beginning after November 15, 2007, or our fiscal year beginning December 1, 2007.  We are evaluating the impact of adopting SFAS 157 on our consolidated financial statements.

In September 2006, the FASB issued SFAS No. 158, “Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans -- An Amendment of FASB Statements No. 87, 88, 106, and 132R” (“SFAS 158”).  SFAS 158 requires an employer to recognize in its balance sheet an asset or liability for a plan’s funded status, measure a plan’s assets and obligations as of the end of the employer’s fiscal year and recognize changes in the funded status in the year in which the changes occur.  SFAS 158 also enhances the current disclosure requirements for pension and other postretirement plans to include disclosure related to certain effects on net periodic benefit cost.  The requirement to recognize the funded status of a benefit plan and the disclosure requirements are effective as of the end of the fiscal year ending after December 15, 2006, or our fiscal 2007.  The requirement to measure plan assets and benefit obligations as of the employer’s fiscal year-end is effective for fiscal years ending after December 15, 2008, or our fiscal year beginning December 1, 2008.  We are evaluating the impact of adopting SFAS 158 on our consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”).  SFAS 159 permits entities to choose to measure certain financial assets and liabilities at fair value.  Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings.  SFAS 159 is effective for fiscal years beginning after November 15, 2007, or our fiscal year beginning December 1, 2007.  We are evaluating the impact of adopting SFAS 159 on our consolidated financial statements.

Forward Looking Statements

We may from time to time make written and oral forward-looking statements. Written forward-looking statements may appear in documents filed with the Securities and Exchange Commission, in press releases and in reports to shareholders. Oral forward-looking statements may be made 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; forecasts of financial performance; future events, developments or performance; and management’s expectations, beliefs, plans, estimates and projections.  The forward-looking statements are based on management’s current beliefs and assumptions about expectations, estimates, strategies and projections. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. We undertake no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise. Factors that could cause our actual results to differ materially from those anticipated in the forward-looking statements in this Form 10-Q and the documents incorporated herein by reference include the following:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Item 3. Quantitative and Qualitative Disclosures About Market Risks

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

Our exposure to interest rate risk currently relates to amounts outstanding under our Credit Facility.  Loans under the revolving credit facility portion of our Credit Facility bear interest at LIBOR plus applicable percentages of 0.875% to 1.5% or the higher of the federal funds rate plus 0.5% or the prime rate (the “Base Rate”).  The applicable percentages are calculated based on our leverage ratio.  The term loan under our Credit Facility bears interest at either LIBOR plus 1.75% or the Base Rate plus 0.75%.  As of August 31, 2007, $45.0 million was outstanding under the revolving credit facility and $146.3 million was outstanding under the term loan portion of our Credit Facility.  The variable rate for the revolving credit facility was LIBOR plus 1.5%, or 7.04% as of August 31, 2007, and the variable rate for the term loan portion was LIBOR plus 1.75%, or 7.11%, as of August 31, 2007.  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 15, 2007.  The swap has decreasing notional principal amounts beginning October 15, 2007 and a swap rate of 4.98% over the life of the agreement.  As of August 31, 2007, the decrease in fair value of $0.8 million, net of tax, was recorded to other comprehensive income.  The swap was deemed to be an effective cash flow hedge.  The swap agreement terminates on January 15, 2010.

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

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The impact on our results of operations of a one-point rate change on the October 2, 2007 outstanding revolving credit facility balance of $45.0 million and $145.5 million term loan balance of our Credit Facility for the next twelve months would be approximately $1.2 million, net of tax.

We are subject to risk from changes in the foreign exchange rates relating to our Canadian, U.K. and Irish subsidiaries. Assets and liabilities of these subsidiaries are translated to U.S. dollars at year-end exchange rates. Income and expense items are translated at average rates of exchange prevailing during the year.  Translation adjustments are accumulated as a separate component of shareholders' equity. Gains and losses, which result from foreign currency transactions, are included in the consolidated statements of income.  The potential loss resulting from a hypothetical 10.0% adverse change in the quoted foreign currency exchange rate amounts to approximately $1.2 million as of August 31, 2007.

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

Item 4. Controls and Procedures

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

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PART II.  OTHER INFORMATION

Item 1.  Legal Proceedings

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

Item 1A.  Risk Factors

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

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

(a) Not applicable.

(b) Not applicable.

(c) A summary of the common stock repurchase activity for our third quarter of fiscal 2007 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)
June 1– June 30		—	$	—		—	$	88,147,224
July 1 – July 31		250,000	$	59.29		250,000	$	73,325,939
August 1 – August 31		130,129	$	57.17		130,129	$	65,887,142
Total Third Quarter		380,129	$	58.56		380,129	$	65,887,142

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

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

Item 3.  Defaults Upon Senior Securities

None.

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

None.

Item 5.  Other Information

None.

Item 6. Exhibits

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

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

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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: October 9, 2007		/s/ Zan Guerry
		Zan Guerry
		Chairman and Chief Executive Officer

Dated: October 9, 2007	/s/ Robert B. Long
	Robert B. Long
	Vice President, Finance

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Chattem, Inc. and Subsidiaries

Exhibit Index

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

42