10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT

PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended May 31, 2009

Commission file number 0-5905

CHATTEM, INC.

A TENNESSEE CORPORATION

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

1715 WEST 38TH STREET

CHATTANOOGA, TENNESSEE 37409

TELEPHONE:  423-821-4571

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

YESþ      NO 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files)

YES      NO 

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

Large accelerated filer  þ                                                                                     Accelerated filer 

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

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

YES      NO þ

As of July 1, 2009, 19,016,960 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 May 31, 2009 and November 30, 2008	3
Consolidated Statements of Income for the Three and Six Months Ended May 31, 2009 and May 31, 2008	5
Consolidated Statements of Cash Flows for the Six Months Ended May 31, 2009 and May 31, 2008	6
Notes to Consolidated Financial Statements	7
Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations	27
Item 3.    Quantitative and Qualitative Disclosures About Market Risk	38
Item 4.    Controls and Procedures	38
PART II.  OTHER INFORMATION
Item 1.    Legal Proceedings	39
Item 1A. Risk Factors	39
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds	39
Item 3.    Defaults Upon Senior Securities	39
Item 4.    Submission of Matters to a Vote of Security Holders	39
Item 5.    Other Information	39
Item 6.    Exhibits	39
SIGNATURES	41

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PART 1. FINANCIAL INFORMATION

Item 1. Financial Statements

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands)

ASSETS	MAY 31,    2009		NOVEMBER 30,  2008
	(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents	$	28,734	$	32,310
Accounts receivable, less allowances of $11,220 at     May 31, 2009 and $9,718 at November 30, 2008		59,876		49,417
Inventories		45,398		40,933
Deferred income taxes		3,874		3,968
Prepaid expenses and other current assets		2,588		2,451
Total current assets		140,470		129,079
PROPERTY, PLANT AND EQUIPMENT, NET		32,534		32,243
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net		616,187		616,670
Debt issuance costs, net		10,349		12,253
Other		2,653		2,727
Total other noncurrent assets		629,189		631,650
TOTAL ASSETS	$	802,193	$	792,972

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	MAY 31,  2009			NOVEMBER 30,  2008
	(Unaudited)
CURRENT LIABILITIES:
Current maturities of long-term debt	$	3,000		$	3,000
Accounts payable and other		14,758			18,116
Bank overdraft		838			1,184
Accrued liabilities		24,352			21,293
Total current liabilities		42,948			43,593
LONG-TERM DEBT, less current maturities		406,800			456,500
DEFERRED INCOME TAXES		45,923			35,412
OTHER NONCURRENT LIABILITIES		1,329			1,609
COMMITMENTS AND CONTINGENCIES (Note 18)
SHAREHOLDERS’ EQUITY:
Preferred shares, without par value, authorized 1,000,     none issued		—			—
Common shares, without par value, authorized 100,000,     issued and outstanding 19,004 at May 31, 2009 and    18,978  at November 30, 2008		32,845			28,926
Retained earnings		275,026			231,230
		307,871			260,156
Cumulative other comprehensive income (loss), net of tax:
Interest rate hedge adjustment		(1,308	)		(1,787	)
Foreign currency translation adjustment		173			(968	)
Unrealized actuarial gains and losses		(1,543	)		(1,543	)
Total shareholders’ equity		305,193			255,858
TOTAL LIABILITIES AND SHAREHOLDERS’           EQUITY	$	802,193		$	792,972

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 MAY 31,						FOR THE SIX MONTHS   ENDED MAY 31,
	2009			2008			2009			2008
TOTAL REVENUES	$	121,830		$	116,716		$	237,922		$	237,489
COSTS AND EXPENSES:
Cost of sales		37,131			32,641			72,388			67,374
Advertising and promotion		26,969			30,247			55,558			64,743
Selling, general and administrative		14,330			15,186			29,756			30,652
Product recall expenses		—			—			—			6,043
Total costs and expenses		78,430			78,074			157,702			168,812
INCOME FROM OPERATIONS		43,400			38,642			80,220			68,677
OTHER INCOME (EXPENSE):
Interest expense		(5,285	)		(6,565	)		(10,949	)		(13,117	)
Investment and other income, net		67			116			178			253
Loss on early extinguishment of debt		—			—			(696	)		(526	)
Total other income (expense)		(5,218	)		(6,449	)		(11,467	)		(13,390	)
INCOME BEFORE INCOME TAXES		38,182			32,193			68,753			55,287
PROVISION FOR INCOME TAXES		13,952			11,461			24,957			19,682
NET INCOME	$	24,230		$	20,732		$	43,796		$	35,605
NUMBER OF COMMON SHARES:
Weighted average outstanding-basic		19,219			19,118			19,342			19,112
Weighted average and potential dilutive outstanding		19,219			19,518			19,403			19,592
NET INCOME PER COMMON SHARE:
Basic	$	1.26		$	1.08		$	2.26		$	1.86
Diluted	$	1.26		$	1.06		$	2.26		$	1.82

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)

	FOR THE SIX MONTHS ENDED MAY 31,
	2009			2008
OPERATING ACTIVITIES:
Net income	$	43,796		$	35,605
Adjustments to reconcile net income to net cash provided by     operating activities:
Depreciation and amortization		3,785			4,216
Deferred income taxes		8,487			8,898
Tax benefit realized from stock options exercised		(147	)		(1,855	)
Stock-based compensation		3,543			2,580
Loss on early extinguishment of debt		696			526
Other, net		(21	)		135
Changes in operating assets and liabilities, net of effects from acquisitions:
Accounts receivable and other		(10,459	)		(11,692	)
Inventories		(4,429	)		906
Prepaid expenses and other current assets		(137	)		(180	)
Accounts payable and accrued liabilities		(1,625	)		(7,850	)
Net cash provided by operating activities		43,489			31,289
INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(2,234	)		(2,466	)
(Increase) decrease in other assets, net		1,349			(1,140	)
Net cash used in investing activities		(885	)		(3,606	)
FINANCING ACTIVITIES:
Repayment of long-term debt		(1,500	)		(36,500	)
Proceeds from borrowings under revolving credit facility		1,000			109,500
Repayments of revolving credit facility		(20,500	)		(94,312	)
Change in bank overdraft		(346	)		(1,246	)
Repurchase of common shares		(26,107	)		(12,554	)
Proceeds from exercise of stock options		995			2,165
Tax benefit realized from stock options exercised		147			1,855
Net cash used in financing activities		(46,311	)		(31,092	)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		131			(23	)
CASH AND CASH EQUIVALENTS:
Decrease for the period		(3,576	)		(3,432	)
At beginning of period		32,310			15,407
At end of period	$	28,734		$	11,975
PAYMENTS FOR:
Interest	$	9,548		$	11,489
Taxes	$	12,969		$	9,931

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

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

2. CASH AND CASH EQUIVALENTS

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

3. RECENT ACCOUNTING PRONOUNCEMENTS

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

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

In May 2008, the FASB issued FSP Accounting Principles Board (“APB”) Opinion No. 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP 14-1”).  FSP 14-1 specifies that issuers of convertible debt instruments should separately account for the liability and equity components of the instrument in a manner that will reflect the entity’s non-convertible debt borrowing rate on the instrument’s issuance date when interest is recognized in subsequent periods.  Upon adoption of FSP 14-1, the proceeds received from the issuance of the 2.0% Convertible Notes and the 1.625% Convertible Notes (collectively, the “Convertible Notes”) will be allocated between the liability and equity component by determining the fair value of the liability component using our non-convertible debt borrowing rate at the time the Convertible Notes were issued.  The difference between the proceeds of the Convertible Notes and the calculated fair value of the liability component will be recorded as a debt discount with a corresponding increase to common shares in our consolidated balance sheet.  The debt discount will be amortized as additional non-cash interest expense over the remaining life of the Convertible Notes using the effective interest rate method.  Although FSP 14-1 will have no impact on our cash flows, FSP 14-1 will result in additional non-cash interest expense until maturity or early extinguishment of the Convertible Notes.  The provisions of FSP 14-1 are to be applied retrospectively to all periods presented upon adoption and are effective for fiscal years beginning after December 15, 2008, or our fiscal 2010, and interim periods within those fiscal years.  Upon adoption of FSP 14-1, we estimate non-cash interest expense will increase approximately $6,600 and $7,200 (or $0.22 and $0.25 per share) for the fiscal years ended November 30, 2009 and 2008, respectively.  The additional non-cash interest expense is expected to increase as the Convertible Notes approach their respective maturity dates and accrete to their face values.

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

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162” (“SFAS 168”).  SFAS 168 eliminates the previous levels of U.S. GAAP. It does not include any guidance or interpretations of GAAP beyond what is already reflected in the FASB literature. It merely takes previously issued FASB standards and other authoritative pronouncements, changes the nomenclature previously used to refer to FASB standards, in the past, and includes them in specific topic areas.  SFAS 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009.  We are currently evaluating the impact, if any, of SFAS 168.

4. STOCK-BASED COMPENSATION

We currently provide stock-based compensation under five stock incentive plans that have been approved by our shareholders.  Our 1999 Non-Statutory Stock Option Plan for Non-Employee Directors allows for the issuance of up to 200 shares of common stock.  The 2000 Non-Statutory Stock Option Plan provides for the issuance of up to 1,500 shares of common stock.  The 2003 and 2005 Stock Incentive Plans both provide for the issuance of up to 1,500 shares of common stock.   The 2009 Equity Incentive Plan, which was adopted by our board of directors on January 28, 2009 and was approved by our shareholders at the April 8, 2009 annual shareholders’ meeting, provides for the issuance of up to 1,750 shares of common stock.  Stock options granted under all of these plans generally vest over four years from the date of grant as specified in the plans or by the compensation committee of our board of directors and are exercisable for a period of up to ten years from the date of grant.

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

The following table represents the impact of stock-based compensation expense on our consolidated statements of income during the three and six months ended May 31, 2009 and 2008, respectively:

	Three Months Ended May 31,				Six Months Ended May 31,
	2009		2008		2009		2008
Income from operations	$	2,064	$	1,241	$	3,543	$	2,580
Provision for income taxes		754		442		1,286		918
Net income	$	1,310	$	799	$	2,257	$	1,662
Basic net income per share	$	0.07	$	0.04	$	0.12	$	0.09
Diluted net income per share	$	0.07	$	0.04	$	0.12	$	0.08

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 $219 and $209 of stock option compensation cost as a component of the carrying cost of inventory on-hand as of May 31, 2009 and 2008, respectively.

The weighted average grant-date fair value of stock options granted during the three and six months ended May 31, 2009 was $20.93 and $20.99, respectively, and for stock options granted during the three and six months ended May 31, 2008 was $27.99.  The fair value of each stock option grant was estimated on the date of grant using a Flex Lattice Model.  The following assumptions were used to determine the fair value of stock option grants during the six months ended May 31, 2009 and 2008:

8

	Six Months Ended   May 31,
	2009		2008
Expected life	6.0 years		6.0 years
Volatility		37%		36%
Risk-free interest rate		2.61%		3.84%
Dividend yield		0%		0%
Forfeitures		0.4%		0.3%

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

A summary of stock option activity for the six months ended May 31, 2009 is presented below:

	Shares Under Option			Weighted Average Exercise Price		Weighted Average Remaining Contractual        Life	Aggregate Intrinsic Value
Outstanding at December 1, 2008		1,510		$	50.23
Granted		386			55.53
Exercised		(29	)		34.23
Cancelled		(11	)		59.91
Outstanding at May 31, 2009		1,856		$	51.53	4.4 years	$	18,568
Exercisable at May 31, 2009		913		$	43.85	3.6 years	$	15,112

The total fair value of stock options that vested during the three months ended May 31, 2009 and 2008 was $1,946 and $1,249, respectively, and during the six months ended May 31, 2009 and 2008 was $3,580 and $2,605, respectively.  The total intrinsic value of stock options exercised during the three months ended May 31, 2009 and 2008 was $208 and $163, respectively, and during the six months ended May 31, 2009 and 2008 was $807 and $4,703, respectively.

As of May 31, 2009, we had $20,124 of unrecognized compensation cost related to stock options that will be recorded over a weighted average period of approximately 2.9 years.

We are also authorized to grant restricted shares of common stock to employees under our stock incentive plans that have been approved by shareholders.  The restricted shares under these plans meet the definition of “nonvested shares” in SFAS 123R.  The restricted shares generally vest over a four year service period commencing upon the date of grant.  The total fair market value of restricted shares on the date of grant is amortized to expense on a straight line basis over the four-year vesting period.  The amortization expense related to restricted shares during the three months ended May 31, 2009 and 2008 was $0 and $64, respectively, and was $43 and $157 for the six months ended May 31, 2009 and 2008, respectively.  All grants of restricted shares were fully vested effective February 28, 2009.

Restricted share activity for the six months ended May 31, 2009 under the plans is summarized as follows:

	Number of Shares			Weighted Average Grant Date Fair Value
Nonvested at December 1, 2008		1		$	35.37
Granted		—			—
Vested		(1	)		35.37
Forfeited		—			—
Nonvested at May 31, 2009		—		$	—

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5. EARNINGS PER SHARE

The following table presents the computation of earnings per share for the three and six months ended May 31, 2009 and 2008, respectively:

	For the Three Months     Ended May 31,				For the Six Months  Ended May 31,
	2009		2008		2009		2008
NET INCOME	$	24,230	$	20,732	$	43,796	$	35,605
NUMBER OF COMMON SHARES:
Weighted average outstanding		19,219		19,118		19,342		19,112
Issued upon assumed exercise of outstanding stock options		—		101		—		101
Issued upon assumed exercise of convertible notes		—		296		61		376
Effect of issuance of restricted common shares		—		3		—		3
Weighted average and potential dilutive outstanding (1)		19,219		19,518		19,403		19,592
NET INCOME PER COMMON   SHARE:
Basic	$	1.26	$	1.08	$	2.26	$	1.86
Diluted	$	1.26	$	1.06	$	2.26	$	1.82

(1)  Because their effects are anti-dilutive, excludes shares issuable under stock option plans whose grant price was greater than the weighted-average market price of common shares outstanding as follows: 898 and 528 shares for the three months ended May 31, 2009 and 2008, respectively, and 825 and 465 shares for the six months ended May 31, 2009 and 2008, respectively.

6. LONG-TERM DEBT

Long-term debt consisted of the following as of May 31, 2009 and November 30, 2008:

	2009		2008
Revolving Credit Facility due 2010 at a variable rate of  6.07% as of November 30, 2008	$	—	$	19,500
2.0% Convertible Senior Notes due 2013		96,300		125,000
1.625% Convertible Senior Notes due 2014		100,000		100,000
Term Loan due 2013 at a variable rate of 6.70% and 6.57% as of May 31, 2009 and November 30, 2008, respectively		106,000		107,500
7.0% Senior Subordinated Notes due 2014		107,500		107,500

Total long-term debt		409,800		459,500
Less:  current maturities		3,000		3,000
Total long-term debt, net of current maturities	$	406,800	$	456,500

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

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completed an amendment to the Amended Revolving Credit Facility providing for up to a $100,000 revolving credit facility and a $300,000 term loan (the “Credit Facility”).  The Credit Facility includes “accordion” features that permit us under certain circumstances to increase our borrowings under the revolving credit facility by $50,000 and to borrow an additional $50,000 as a term loan, subject to successful syndication.  In April 2007, we entered into an amendment to our Credit Facility that, among other things, permitted the sale of the 1.625% Convertible Senior Notes due 2014  (the “1.625% Convertible Notes”) and reduced the applicable interest rates on the revolving credit facility portion of our Credit Facility.

Borrowings under the revolving credit facility portion of our Credit Facility bear interest at LIBOR plus applicable percentages of 0.875% to 1.500% or the higher of the federal funds rate plus 0.50% or the prime rate (the “Base Rate”).  The applicable percentages are calculated based on our leverage ratio.  As of May 31, 2009 and November 30, 2008, we had $0 and $19,500, respectively, of borrowings outstanding under the revolving credit facility portion of our Credit Facility.  As of July 1, 2009, we had $0 of borrowings outstanding under the revolving credit facility portion of our Credit Facility and our borrowing capacity was $100,000.

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

Borrowings under the Credit Facility are secured by substantially all of our assets, except real property, and shares of capital stock of our domestic subsidiaries held by us and by the assets of the guarantors (our domestic subsidiaries).  The Credit Facility contains covenants, representations, warranties and other agreements by us that are customary in credit agreements and security instruments relating to financings of this type.  The significant financial covenants include fixed charge coverage ratio, leverage ratio, senior secured leverage ratio and brand value calculations.  At May 31, 2009, we were in compliance with all applicable financial and restrictive covenants under the Credit Facility.

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

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

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

In November 2006, we entered into an interest rate swap (“swap”) agreement effective January 2007.  The swap has decreasing notional principal amounts beginning October 2007 and a swap rate of 4.98% over the life of the agreement.  During the second quarter of fiscal 2008 we retired a portion of the swap for approximately $270, and during the first quarter of fiscal 2009, we retired an additional portion of the swap for approximately $195, which were recorded as additional interest expense in the accompanying consolidated statements of income.  As of May 31, 2009, we had $105,000 of LIBOR based borrowings hedged under the provisions of the swap.  During the six months ended May 31, 2009, the decrease in fair value of the swap of $479, net of tax, was recorded to other comprehensive income.  The fair value of the swap of $2,638 is included in accrued liabilities.  As of May 31, 2009, the swap was deemed to be an effective cash flow hedge.  The fair value of the swap is valued by a third party.  The agreement governing the swap terminates in January 2010.

In November 2006, we completed a private offering of $125,000 of the 2.0% Convertible Notes to qualified institutional purchasers pursuant to Section 4(2) of the Securities Act of 1933.  The 2.0% Convertible Notes bear interest at an annual rate of 2.0%, payable semi-annually in May and November of each year.  The 2.0% Convertible Notes are convertible into our common

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stock at an initial conversion price of $58.92 per share, upon the occurrence of certain events, including the closing price of our common stock exceeding 130% of the initial conversion price per share, or $76.59 per share, for 20 of the last 30 consecutive trading days of the preceding fiscal quarter (the “prescribed measurement period”).  The evaluation of the classification of the 2.0% Convertible Notes occurs each fiscal quarter.

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

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

In addition, we issued warrants to the Counterparty that could require us to issue up to approximately 1,634 shares of our common stock on November 15, 2013 upon notice of exercise by the Counterparty. The exercise price is $74.82 per share, which represented a 60.0% premium over the closing price of our shares of common stock on November 16, 2006. If the Counterparty exercises the warrant, we will have the option to settle in cash or shares the excess of the price of our shares on that date over the initially established exercise price.

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

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

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

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

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

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trading on May 1, 2014, which is the maturity date of the 1.625% Convertible Notes, although the Counterparty will have ongoing obligations with respect to 1.625% Convertible Notes properly converted on or prior to that date of which the Counterparty has been timely notified.

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

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

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

The scheduled future maturities of long-term debt to be funded for the next five successive fiscal years and those thereafter as of May 31, 2009 are as follows:

2009	$	1,500
2010		3,000
2011		3,000
2012		3,000
2013		191,800
Thereafter		207,500
	$	409,800

7. FAIR VALUE MEASUREMENTS

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

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

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

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The following table summarizes the financial instruments measured at fair value in the accompanying consolidated balance sheet as of May 31, 2009:

	Fair Value Measurements as of May 31, 2009
	Level 1		Level 2		Level 3		Total
Liabilities
Interest rate swap (1)	$	—	$	2,638	$	—	$	2,638

(1)   The total fair value of the interest rate swap is classified as a current liability as of May 31, 2009 and matures January 2010. We value this financial instrument using the “Income Approach” valuation technique.  This method uses valuation techniques to convert future amounts to a single present value amount.  The measurement is based on the value indicated by current market expectations about those future amounts.

SFAS 157 requires separate disclosure of assets and liabilities measured at fair value on a recurring basis, as documented above, from those measured at fair value on a nonrecurring basis.  As of May 31, 2009, no assets or liabilities are measured at fair value on a nonrecurring basis.

At May 31, 2009 and November 30, 2008, the carrying value of the 7.0% Subordinated Notes approximated fair value based on market prices and market volume for same or similar issues.  At May 31, 2009 and November 30, 2008, the fair value of the 2.0% Convertible Notes was determined to be $97,628 and $153,965, respectively, based upon consideration of our closing stock price of $59.73 and $72.57, respectively, and determination of conversion value as defined in the indenture under which the 2.0% Convertible Notes were issued.  At May 31, 2009 and November 30, 2008, the fair value of the 1.625% Convertible Notes was determined to be $81,601 and $99,143, respectively, based upon consideration of our closing stock price and determination of conversion value as defined in the indenture under which the 1.625% Convertible Notes were issued.

8. ADVERTISING EXPENSES

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

9. SHIPPING AND HANDLING

Shipping and handling costs of $3,638 and $3,986 are included in selling, general and administrative expenses for the three months ended May 31, 2009 and 2008, respectively, and $7,418 and $7,983 for the six months ended May 31, 2009 and 2008, respectively.

10. PATENT, TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS

The carrying value of trademarks, which are not subject to amortization under the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), was $613,329 as of May 31, 2009 and November 30, 2008.  The gross carrying amount of intangible assets subject to amortization at May 31, 2009 and November 30, 2008, which consist primarily of non-compete agreements and distribution rights, was $7,028.  The related accumulated amortization of intangible assets at May 31, 2009 and November 30, 2008 was $4,170 and $3,687, respectively.  Amortization of our intangible assets subject to amortization under the provisions of SFAS 142 for the three months ended May 31, 2009 and 2008 was $241 and $228, respectively, and for the six months ended May 31, 2009 and 2008 was $483 and $434, respectively.

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Estimated annual amortization expense for these assets for the next five successive fiscal years and those thereafter as of May 31, 2009 are as follows:

2009	$	462
2010		925
2011		925
2012		208
2013		75
Thereafter		263
	$	2,858

11. INVENTORIES

Inventories consisted of the following as of May 31, 2009 and November 30, 2008:

	2009		2008
Raw materials and work in process	$	18,522	$	16,753
Finished goods		26,876		24,180
Total inventories	$	45,398	$	40,933

12. ACCRUED LIABILITIES

Accrued liabilities consisted of the following as of May 31, 2009 and November 30, 2008:

	2009		2008
Interest	$	2,540	$	3,216
Salaries, wages and commissions		2,917		5,333
Product advertising and promotion		5,437		2,611
Litigation settlement and legal fees		1,076		799
Income taxes payable		9,340		4,636
Interest rate swap		2,638		2,602
Other		404		2,096
Total accrued liabilities	$	24,352	$	21,293

13. ACCUMULATED OTHER COMPREHENSIVE INCOME

Accumulated other comprehensive income consisted of the following components for the three and six months ended May 31, 2009 and 2008, respectively:

	For the Three Months Ended  May 31,					For the Six Months Ended  May 31,
	2009		2008			2009		2008
Net income	$	24,230	$	20,732		$	43,796	$	35,605
Other – interest rate hedge adjustment, net of tax of $278, $838, $295, and $(183), respectively		451		1,361			479		(212	)
Other – foreign currency translation adjustment		1,256		(26	)		1,141		160
Total	$	25,937	$	22,067		$	45,416	$	35,553

14. STOCK REPURCHASE

 On April 30, 2008, our Board of Directors increased the authorization to repurchase our common stock to a total of $100,000 under the terms of our existing stock repurchase program.  In the three and six months ended May 31, 2009, we repurchased 491 shares of our common stock for $26,107 at an average price per share of $53.13.  In the three and six months ended May 31, 2008, we repurchased 183 and 187 shares of our common stock, respectively, for $12,314 and $12,554, respectively, at an average price per share of $67.04 and $67.00, respectively.  The repurchased shares were retired and returned to unissued.  As of July 1, 2009, the current amount available under the authorization from the Board of Directors was $47,806.

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15.      POST RETIREMENT BENEFIT PLANS

DEFINED BENEFIT PENSION PLAN

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

Net periodic pension benefit for the three and six months ended May 31, 2009 and 2008 included the following components:

	For the Three Months  Ended May 31,						For the Six Months  Ended May 31,
	2009			2008			2009			2008
Interest cost	$	145		$	152		$	291		$	304
Amortization of loss		47			—			93			—
Expected return on plan assets		(170	)		(234	)		(340	)		(468	)
Net periodic pension benefit	$	22		$	(82	)	$	44		$	(164	)

No employer contributions were made for the six months ended May 31, 2009 and 2008, and no employer contributions are expected to be made for the Pension Plan in fiscal 2009.

DEFINED CONTRIBUTION PLAN

We sponsor a defined contribution plan that covers substantially all employees.  Eligible employees are allowed to contribute their eligible compensation up to the applicable annual elective deferral and salary reduction limits as set forth by the IRS.  We make matching contributions of 25% on the first 6% of contributed compensation.  The cost of the matching contribution totaled $71 and $62 for the three months ended May 31, 2009 and 2008, respectively, and $160 and $150 for the six months ended May 31, 2009 and 2008, respectively.  In addition to matching contributions, safe harbor contributions equaling 3% of eligible annual compensation are made on behalf of eligible participants.  Safe harbor contributions totaled $192 and $169 for the three months ended May 31, 2009 and 2008, respectively and $475 and $457 for the six months ended May 31, 2009 and 2008, respectively.  Total matching and safe harbor contributions for fiscal 2009 are expected to approximate amounts funded in fiscal 2008.  Total matching and safe harbor contributions in fiscal 2008 were $1,172.

POSTRETIREMENT HEALTH CARE BENEFITS PLAN

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

Net periodic postretirement health benefit for the three and six months ended May 31, 2009 and 2008, included the following components:

	For the Three Months     Ended May 31,						For the Six Months     Ended May 31,
	2009			2008			2009			2008
Service cost	$	1		$	5		$	3		$	10
Interest cost		14			14			28			28
Recognized net actuarial gain		(34	)		(24	)		(68	)		(48	)
Net periodic postretirement health benefit	$	(19	)	$	(5	)	$	(37	)	$	(10	)

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16.      INCOME TAXES

We account for income taxes using the asset and liability approach as prescribed by SFAS 109, FIN 48 and other applicable FSP’s and FASB Interpretations.  This approach requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in our consolidated financial statements or tax returns.  Using the enacted tax rates in effect for the year in which the differences are expected to reverse, deferred tax assets and liabilities are determined based on the differences between the financial reporting and the tax basis of an asset or liability.  We record income tax expense in our consolidated financial statements based on an estimated annual effective income tax rate.  Our tax rate for the six months ended May 31, 2009 and 2008 was 36.3% and 35.6%, respectively.  As of May 31, 2009, there were no significant changes to our unrecognized tax benefit as reported in our Form 10-K for the fiscal year ended November 30, 2008.

17.      PRODUCT SEGMENT INFORMATION

Net sales within our single healthcare business segment for the three and six months ended May 31, 2009 and 2008 are as follows:

	For the Three Months Ended May 31,				For the Six Months Ended May 31,
	2009		2008		2009		2008
Medicated skin care	$	37,970	$	34,471	$	79,427	$	72,124
Topical pain care		24,314		24,772		46,357		50,087
Oral care		18,466		15,415		36,751		31,187
Internal OTC		11,686		13,274		23,050		24,484
Medicated dandruff shampoos		9,724		8,707		19,087		19,286
Dietary supplements		5,569		5,133		9,841		10,507
Other OTC and toiletry products		8,369		6,919		12,493		12,331
Total domestic net sales		116,098		108,691		227,006		220,006
International revenues		5,732		8,025		10,916		17,483
Total revenues	$	121,830	$	116,716	$	237,922	$	237,489

18.      COMMITMENTS AND CONTINGENCIES

GENERAL LITIGATION

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

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

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

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We were also named as a defendant in approximately 206 lawsuits relating to Dexatrim containing PPA which involved alleged injuries by Dexatrim products containing PPA manufactured and sold prior to our acquisition of Dexatrim on December 21, 1998.  The DELACO Company (“DELACO”), successor by merger to the Thompson Medical Company, Inc., which owned the brand prior to December 21, 1998, owed us an indemnity obligation for any liabilities arising from these lawsuits.  On February 12, 2004, DELACO filed a Chapter 11 bankruptcy petition in the United States Bankruptcy Court for the Southern District of New York.  We filed a claim for indemnification in DELACO’s bankruptcy.  We entered into a settlement agreement with DELACO dated June 30, 2005 that resolved DELACO’s indemnity obligations to us (“the DELACO Agreement”).  The DELACO Agreement was approved by the DELACO bankruptcy court on July 28, 2005.  In accordance with the DELACO bankruptcy plan, a settlement trust established under the plan paid us $8,750 on March 17, 2006, which was included in our consolidated statements of income, net of legal expenses, as litigation settlement for 2006.  The payment to us by the DELACO settlement trust of $8,750 has conclusively compromised and settled our indemnity claim filed in the DELACO bankruptcy. The confirmation of the DELACO bankruptcy plan effectively released us from liability for all PPA products liability cases with injury dates prior to December 21, 1998.

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

We were previously named as a defendant in a putative class action lawsuit filed by California consumer Robert O. Wilkinson in the United States District Court for the Southern District of California relating to the labeling, advertising, promotion and sale of Chattem’s Garlique product.  We were served with this lawsuit on July 5, 2007.  On May 21, 2009, this case was dismissed with prejudice to Wilkinson but without prejudice to any potential class.

We have been named as a defendant in a putative class action lawsuit filed by Florida consumer James A. Wilson in the United States District Court for the Southern District of Florida relating to the labeling, advertising, promotion and sale of our Garlique product.  We were served with this lawsuit on May 27, 2009.  The plaintiff seeks injunctive relief, compensatory and punitive damages, and attorney fees.  The plaintiff alleges that we mislabeled our product and made false advertising claims.  The plaintiff seeks certification of a national class.  We are vigorously defending the case.

On February 8, 2008, we initiated a voluntary nationwide recall of our Icy Hot Heat Therapy products, including consumer “samples” that were included on a limited promotional basis in cartons of our 3 oz. Aspercreme product, and are no longer marketing these products.  We conducted the recall to the consumer level.  We recalled these products because we received some consumer reports of first, second and third degree burns, as well as skin irritation resulting from consumer use or possible misuse of the products.  As of July 1, 2009, there were approximately 160 consumers with pending claims against us and four products liability lawsuits pending against us alleging burns and skin irritation from the use of the Icy Hot Heat Therapy products.  We may receive additional claims and/or lawsuits in the future alleging burns and/or skin irritation from use of our Heat Therapy products.  The outcome of any such potential litigation cannot be predicted.

On July 25, 2008, LecTec Corporation filed a complaint against us in the U.S. District Court for the Eastern District of Texas, which alleges that our Icy Hot and Capzasin patch products infringe LecTec’s patents.  In the same lawsuit, LecTec has asserted patent infringement claims against Endo Pharmaceuticals, Inc.; Johnson & Johnson Consumer Products Company, Inc.; The Mentholatum Company, Inc.; and Prince of Peace Enterprises, Inc.  LecTec seeks injunctive relief, and compensatory and enhanced damages for the alleged infringement, and attorneys’ fees and expenses.  LecTec filed a motion for preliminary injunction against us and the other defendants in February 2009 seeking an order preventing us and the other defendants from selling the specified patch products while the litigation is pending.  Our response opposing the motion is due August 30, 2009 and LecTec’s reply is due September 30, 2009.  The trial date is currently scheduled for January 4, 2011.  We are vigorously defending this lawsuit.

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

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We maintain insurance coverage for product liability claims relating to our products under claims-made policies which are subject to annual renewal.  For the current annual policy period beginning September 1, 2008, we maintain product liability insurance coverage in the amount of $30,000 through our captive insurance subsidiary, of which approximately $2,539 has been funded as of July 1, 2009.  We also have $25,000 of excess coverage through a third party reinsurance policy.

REGULATORY

We were notified in October 2000 that the FDA denied a citizen petition submitted by Thompson Medical Company, Inc., the previous owner of Sportscreme and Aspercreme.  The petition sought a determination that 10% trolamine salicylate, the active ingredient in Sportscreme and Aspercreme, was clinically proven to be an effective active ingredient in external analgesic OTC drug products and should be included in the FDA's yet-to-be finalized monograph for external analgesics. We are working to develop alternate formulations for Sportscreme and Aspercreme in the event that the FDA does not consider the available clinical data to conclusively demonstrate the efficacy of trolamine salicylate when the OTC external analgesic monograph is finalized. If 10% trolamine salicylate is not included in the final monograph, we would likely be required to discontinue these products as currently formulated after expiration of an anticipated grace period. If this occurred, we believe we could still market these products as homeopathic products or reformulate them using other ingredients included in the FDA monograph.  We believe that the monograph is unlikely to become final and take effect before the end of 2009.

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

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

We are aware of the FDA’s concern about the potential toxicity due to taking more than the recommended amount of the analgesic ingredient acetaminophen, an ingredient found in Pamprin and Premsyn PMS.  We are participating in an industry-wide effort to reassure the FDA that the current recommended dosing regimens are 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.

On April 29, 2009, FDA finalized one part of the monograph on internal analgesic products that directly affects Pamprin and Premsyn PMS. The final rule requires that acetaminophen-containing OTC products include on their labeling new liver warnings and directions for use.  In addition, the ingredient name “acetaminophen” must be made more prominent on the products’ labeling.  The final rule’s compliance date for all affected products is April 29, 2010.  We will be revising our product labels to comply with this FDA final rule.  FDA has not yet determined a final action date for the remaining parts of the monograph on internal analgesics.

19

More recently, on June 29-30, 2009, FDA convened a meeting of the appropriate FDA Advisory Committees to discuss potential steps to reduce acetaminophen-related liver injury.  The joint Advisory Committee generally agreed that clearer labeling and better public education are necessary but recommended that FDA take certain administrative actions to further protect the public, such as changing the directions for use of OTC products to reduce the maximum milligrams per dose and the maximum total daily dosage.  If FDA agrees with the Advisory Committee and implements these changes, it could affect the labeling and formulation of certain maximum-strength (500 mg) versions of Pamprin and Premsyn PMS.  After citing a lack of data and urging FDA to conduct further research, a majority of the joint Advisory Committee voted against removing OTC combination acetaminophen products from the market or limiting package sizes.  We believe that FDA will address these issues in its future efforts to finalize the monograph on internal analgesic products and, prior to monograph closure, may issue revised labeling requirements within the next year that will cause the OTC industry to relabel its analgesic products.

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

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

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

19.      CONSOLIDATING FINANCIAL STATEMENTS

The consolidating financial statements, for the dates or periods indicated, of Chattem, Inc.  (“Chattem”), Signal Investment & Management Co. (“Signal”), SunDex, LLC (“SunDex”) and Chattem (Canada) Holdings, Inc. (“Canada”), the guarantors of the long-term debt of Chattem, and the non-guarantor direct and indirect wholly-owned subsidiaries of Chattem are presented below.  Signal is 89% owned by Chattem and 11% owned by Canada.  SunDex and Canada are wholly-owned subsidiaries of Chattem.  The guarantees of Signal, SunDex and Canada are full and unconditional and joint and several.  The guarantees of Signal, SunDex and Canada as of May 31, 2009 arose in conjunction with Chattem’s Credit Facility and Chattem’s issuance of the 7.0% Subordinated Notes (See Note 6).  The maximum amount of future payments the guarantors would be required to make under the guarantees as of May 31, 2009 is $213,500.

20

Note 19

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING BALANCE SHEETS

MAY 31, 2009

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	18,361		$	315		$	10,058		$	—		$	28,734
Accounts receivable, less allowances of $11,220		54,676			19,144			5,532			(19,476	)		59,876
Interest receivable		101			654			(84	)		(671	)		—
Inventories		39,611			1,634			4,153			—			45,398
Deferred income taxes		3,836			—			38			—			3,874
Prepaid expenses and other current assets		3,031			—			192			(635	)		2,588
Total current assets		119,616			21,747			19,889			(20,782	)		140,470
PROPERTY, PLANT AND EQUIPMENT, NET		31,101			775			658			—			32,534
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net		2,859			674,057			1,561			(62,290	)		616,187
Debt issuance costs, net		10,349			—			—			—			10,349
Investment in subsidiaries		602,740			64,682			97,690			(765,112	)		—
Note receivable		—			34,694			—			(34,694	)		—
Other		2,653			—			—			—			2,653
Total other noncurrent assets		618,601			773,433			99,251			(862,096	)		629,189
TOTAL ASSETS	$	769,318		$	795,955		$	119,798		$	(882,878	)	$	802,193
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt	$	3,000		$	—		$	—		$	—		$	3,000
Accounts payable and other		13,139			—			1,869			(250	)		14,758
Bank overdraft		838			—			—			—			838
Accrued liabilities		39,409			1,525			3,950			(20,532	)		24,352
Total current liabilities		56,386			1,525			5,819			(20,782	)		42,948
LONG-TERM DEBT, less current maturities		412,555			(7,555	)		36,494			(34,694	)		406,800
DEFERRED INCOME TAXES		(21,468	)		68,634			(1,243	)		—			45,923
OTHER NONCURRENT LIABILITIES		1,329			—			—			—			1,329
INTERCOMPANY ACCOUNTS		15,323			(21,606	)		6,283			—			—
SHAREHOLDERS’ EQUITY:
Preferred shares, without par value, authorized 1,000, none issued		—			—			—			—			—
Common shares, without par value, authorized 100,000, issued and outstanding 19,004		32,845			—			—			—			32,845
Shares of subsidiaries		—			641,659			78,999			(720,658	)		—
Dividends		—			(24,876	)		—			24,876			—
Retained earnings		275,026			136,480			(5,505	)		(130,975	)		275,026
		307,871			753,263			73,494			(826,757	)		307,871
Cumulative other comprehensive income (loss), net of tax:
Interest rate hedge adjustment		(1,308	)		—			—			—			(1,308	)
Foreign currency translation adjustment		173			1,694			(1,049	)		(645	)		173
Unrealized actuarial gains and losses		(1,543	)		—			—			—			(1,543	)
Total shareholders’ equity		305,193			754,957			72,445			(827,402	)		305,193
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	769,318		$	795,955		$	119,798		$	(882,878	)	$	802,193

21

Note 19

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING BALANCE SHEETS

NOVEMBER 30, 2008

(In thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	22,055		$	1,570		$	8,685		$	—		$	32,310
Accounts receivable, less allowances of $9,718		44,175			16,226			5,242			(16,226	)		49,417
Interest receivable		108			641			(91	)		(658	)		—
Inventories, net		35,795			1,811			3,327			—			40,933
Deferred income taxes		3,932			—			36			—			3,968
Prepaid expenses and other current assets		4,024			—			332			(1,905	)		2,451
Total current assets		110,089			20,248			17,531			(18,789	)		129,079
PROPERTY, PLANT AND EQUIPMENT, NET		30,792			775			676			—			32,243
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net		3,341			674,057			1,561			(62,289	)		616,670
Debt issuance costs, net		12,253			—			—			—			12,253
Investment in subsidiaries		597,821			64,682			97,690			(760,193	)		—
Note receivable		—			34,694			—			(34,694	)		—
Other		2,727			—			—			—			2,727
Total other noncurrent assets		616,142			773,433			99,251			(857,176	)		631,650
TOTAL ASSETS	$	757,023		$	794,456		$	117,458		$	(875,965	)	$	792,972
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt	$	3,000		$	—		$	—		$	—		$	3,000
Accounts payable		16,463			—			1,736			(83	)		18,116
Bank overdrafts		1,184			—			—			—			1,184
Accrued liabilities		34,594			699			4,708			(18,708	)		21,293
Total current liabilities		55,241			699			6,444			(18,791	)		43,593
LONG-TERM DEBT, less current maturities		455,900			(1,200	)		36,494			(34,694	)		456,500
DEFERRED INCOME TAXES		(24,111	)		60,766			(1,243	)		—			35,412
OTHER NONCURRENT LIABILITIES		1,609			—			—			—			1,609
INTERCOMPANY ACCOUNTS		12,526			(18,962	)		6,436			—			—
SHAREHOLDERS’ EQUITY
Preferred shares, without par value, authorized 1,000, none issued		—			—			—			—			—
Common shares, without par value, authorized 100,000, issued and outstanding 18,978		28,926			—			—			—			28,926
Share capital of subsidiaries		—			641,659			77,935			(719,594	)		—
Dividends		—			(69,628	)		—			69,628			—
Retained earnings		231,230			179,428			(6,416	)		(173,012	)		231,230
		260,156			751,459			71,519			(822,978	)		260,156
Accumulated other comprehensive income (loss), net of tax:
Interest rate hedge adjustment		(1,787	)		—			—			—			(1,787	)
Foreign currency translation adjustment		(968	)		1,694			(2,192	)		498			(968	)
Unrealized actuarial gains and losses		(1,543	)		—			—			—			(1,543	)
Total shareholders’ equity		255,858			753,153			69,327			(822,480	)		255,858
TOTAL LIABILITIES AND  SHAREHOLDERS’ EQUITY	$	757,023		$	794,456		$	117,458		$	(875,965	)	$	792,972

22

Note 19

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF INCOME

FOR THE SIX MONTHS ENDED MAY 31, 2009

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED
TOTAL REVENUES	$	220,113		$	47,396		$	9,512		$	(39,099	)	$	237,922
COSTS AND EXPENSES:
Cost of sales		66,623			2,598			4,745			(1,578	)		72,388
Advertising and promotion		51,348			2,079			2,131			—			55,558
Selling, general and administrative		28,524			606			626			—			29,756
Product recall expenses		(509	)		—			509			—			—
Equity in subsidiary income		(26,329	)		—			—			26,329			—
Total costs and expenses		119,657			5,283			8,011			24,751			157,702
INCOME FROM OPERATIONS		100,456			42,113			1,501			(63,850	)		80,220
OTHER INCOME (EXPENSE):
Interest expense		(10,974	)		—			(1,284	)		1,309			(10,949	)
Investment and other income, net		129			1,309			1,311			(2,571	)		178
Loss on early extinguishment of debt		(696	)		—			—			—			(696	)
Royalties		(35,950	)		(1,562	)		(9	)		37,521			—
Corporate allocations		1,035			(936	)		(99	)		—			—
Total other income (expense)		(46,456	)		(1,189	)		(81	)		36,259			(11,467	)
INCOME BEFORE INCOME TAXES		54,000			40,924			1,420			(27,591	)		68,753
PROVISION FOR INCOME TAXES		10,204			14,244			509			—			24,957
NET INCOME (LOSS)	$	43,796		$	26,680		$	911		$	(27,591	)	$	43,796

23

Note 19

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF INCOME

FOR THE SIX MONTHS ENDED MAY 31, 2008

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED
TOTAL REVENUES	$	216,390		$	46,210		$	12,435		$	(37,546	)	$	237,489
COSTS AND EXPENSES:
Cost of sales		61,020			2,387			5,638			(1,671	)		67,374
Advertising and promotion		57,984			3,611			3,148			—			64,743
Selling, general and administrative		29,114			226			1,312			—			30,652
Product recall expenses		5,555			—			488			—			6,043
Equity in subsidiary income		(24,908	)		—			—			24,908			—
Total costs and expenses		128,765			6,224			10,586			23,237			168,812
INCOME FROM OPERATIONS		87,625			39,986			1,849			(60,783	)		68,677
OTHER INCOME (EXPENSE):
Interest expense		(13,112	)		—			(1,285	)		1,280			(13,117	)
Investment and other income, net		58			1,285			1,440			(2,530	)		253
Loss on early extinguishment of debt		(526	)		—			—			—			(526	)
Royalties		(34,224	)		(1,652	)		—			35,876			—
Corporate allocations		1,006			(926	)		(80	)		—			—
Total other income (expense)		(46,798	)		(1,293	)		75			34,626			(13,390	)
INCOME BEFORE INCOME TAXES		40,827			38,693			1,924			(26,157	)		55,287
PROVISION FOR INCOME TAXES		5,222			13,775			685			—			19,682
NET INCOME (LOSS)	$	35,605		$	24,918		$	1,239		$	(26,157	)	$	35,605

24

Note 19

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED MAY 31, 2009

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED
OPERATING ACTIVITIES:
Net income (loss)	$	43,796		$	26,680		$	911		$	(27,591	)	$	43,796
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		3,710			—			75			—			3,785
Deferred income taxes		623			7,867			(3	)		—			8,487
Tax benefit realized from stock options exercised		(147	)		—			—			—			(147	)
Stock-based compensation expense		3,543			—			—			—			3,543
Loss on early extinguishment of debt		696			—			—			—			696
Other, net		110			—			(131	)		—			(21	)
Equity in subsidiary income		(27,591	)		—			—			27,591			—
Changes in operating assets and liabilities:
Accounts receivable		(10,502	)		(2,917	)		(290	)		3,250			(10,459	)
Interest Receivable		7			(13	)		(7	)		13			—
Inventories		(3,781	)		177			(825	)		—			(4,429	)
Prepaid expenses and other current assets		993			—			140			(1,270	)		(137	)
Accounts payable and accrued liabilities		166			828			(626	)		(1,993	)		(1,625	)
Net cash provided by (used in) operating activities		11,623			32,622			(756	)		—			43,489
INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(2,257	)		—			23			—			(2,234	)
Change in other assets, net		272			—			1,077			—			1,349
Net cash (used in) provided by investing activities		(1,985	)		—			1,100			—			(885	)
FINANCING ACTIVITIES:
Repayment of long-term debt		(1,500	)		—			—			—			(1,500	)
Proceeds from borrowings under revolving credit facility		1,000			—			—			—			1,000
Repayments of revolving credit facility		(20,500	)		—			—			—			(20,500	)
Change in bank overdraft		(346	)		—			—			—			(346	)
Repurchase of common shares		(26,107	)		—			—			—			(26,107	)
Proceeds from exercise of stock options		995			—			—			—			995
Tax benefit realized from stock options exercised		147			—			—			—			147
Intercompany debt proceeds (payments)		6,355			(6,355	)		—			—			—
Changes in intercompany accounts		3,010			(2,646	)		(364	)		—			—
Dividends paid		23,614			(24,876	)		1,262			—			—
Net cash (used in) provided by financing activities		(13,332	)		(33,877	)		898			—			(46,311	)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		—			—			131			—			131
CASH AND CASH EQUIVALENTS:
(Decrease) increase for the period		(3,694	)		(1,255	)		1,373			—			(3,576	)
At beginning of period		22,055			1,570			8,685			—			32,310
At end of period	$	18,361		$	315		$	10,058		$	—		$	28,734

25

Note 19

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED MAY 31, 2008

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED
OPERATING ACTIVITIES:
Net income (loss)	$	35,605		$	24,918		$	1,239		$	(26,157	)	$	35,605
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		4,152			—			64			—			4,216
Deferred income taxes		1,033			7,867			(2	)		—			8,898
Tax benefit realized from stock options exercised		(1,855	)		—			—			—			(1,855	)
Stock-based compensation expense		2,580			—			—			—			2,580
Loss on early extinguishment of debt		526			—			—			—			526
Other, net		112			—			23			—			135
Equity in subsidiary income		(26,157	)		—			—			26,157			—
Changes in operating assets and liabilities:
Accounts receivable		(11,393	)		(911	)		(299	)		911			(11,692	)
Interest Receivable		16			(16	)		(16	)		16			—
Inventories		(412	)		1,389			(71	)		—			906
Prepaid expenses and other current assets		(125	)		—			95			(150	)		(180	)
Accounts payable and accrued liabilities		(5,701	)		103			(1,475	)		(777	)		(7,850	)
Net cash (used in) provided by operating activities		(1,619	)		33,350			(442	)		—			31,289
INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(2,388	)		—			(78	)		—			(2,466	)
(Increase) decrease in other assets, net		(1,271	)		—			131			—			(1,140	)
Net cash (used in) provided by investing activities		(3,659	)		—			53			—			(3,606	)
FINANCING ACTIVITIES:
Repayment of long-term debt		(36,500	)		—			—			—			(36,500	)
Proceeds from borrowings under revolving credit facility		109,500			—			—			—			109,500
Repayments of revolving credit facility		(94,312	)		—			—			—			(94,312	)
Change in bank overdraft		(1,246	)		—			—			—			(1,246	)
Repurchase of common shares		(12,554	)		—			—			—			(12,554	)
Proceeds from exercise of stock options		2,165			—			—			—			2,165
Tax benefit realized from stock options exercised		1,855			—			—			—			1,855
Changes in intercompany accounts		(1,071	)		1,463			(392	)		—			—
Dividends paid		33,649			(34,899	)		1,250			—			—
Net cash (used in) provided by financing activities		1,486			(33,436	)		858			—			(31,092	)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND   CASH EQUIVALENTS		—			—			(23	)		—			(23	)
CASH AND CASH EQUIVALENTS:
(Decrease) increase for the period		(3,792	)		(86	)		446			—			(3,432	)
At beginning of period		4,685			590			10,132			—			15,407
At end of period	$	893		$	504		$	10,578		$	—		$	11,975

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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 2008 Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”).  This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions.  The actual results may differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including, but not limited to, those described in our filings with the SEC.

Overview

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

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

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

• ACT and Herpecin-L – oral care;

• Unisom, Pamprin and Kaopectate – internal OTC;

• Selsun Blue – medicated dandruff shampoos;

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

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

Our products target niche markets that are often outside the focus of larger companies where we believe we can achieve and sustain significant market share through product innovation and strong advertising and promotion support. Many of our products are among the U.S. market leaders in their respective categories. For example, our portfolio of topical pain care brands, our Cortizone-10 anti-itch ointment and our Gold Bond medicated body powders have the leading U.S. market share in these categories. We support our brands through extensive and cost-effective advertising and promotion, the expenditures for which represented approximately 23% of our total revenues in the first half of fiscal 2009. We sell our products nationally through mass merchandiser, drug and food channels, principally utilizing our own sales force.

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

Developments During Fiscal 2009

Products

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

2.0% Convertible Notes

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

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Stock Repurchase

During the first six months of fiscal 2009, we repurchased 491,392 shares of our common stock under our stock repurchase program for $26.1 million at an average price per share of $53.13.

Results of Operations

The following table sets forth, for the periods indicated, certain items from our unaudited consolidated statements of income expressed as a percentage of total revenues:

	For the Three Months Ended May 31,						For the Six  Months Ended May 31,
	2009			2008			2009			2008
TOTAL REVENUES		100.0	%		100.0	%		100.0	%		100.0	%
COSTS AND EXPENSES:
Cost of sales		30.5			28.0			30.4			28.4
Advertising and promotion		22.1			25.9			23.4			27.3
Selling, general and administrative		11.8			13.0			12.5			12.9
Product recall expenses		—			—			—			2.5
Total costs and expenses		64.4			66.9			66.3			71.1
INCOME FROM OPERATIONS		35.6			33.1			33.7			28.9
OTHER INCOME (EXPENSE):
Interest expense		(4.3	)		(5.6	)		(4.6	)		(5.5	)
Investment and other income, net		0.1			0.1			0.1			0.1
Loss on early extinguishment of debt		—			—			(0.3	)		(0.2	)
Total other income (expense)		(4.2	)		(5.5	)		(4.8	)		(5.6	)
INCOME BEFORE INCOME TAXES		31.4			27.6			28.9			23.3
PROVISION FOR INCOME TAXES		11.5			9.8			10.5			8.3
NET INCOME		19.9	%		17.8	%		18.4	%		15.0	%

Critical Accounting Policies

The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to use estimates.  Several different estimates or methods can be used by management that might yield different results.  The following are the significant estimates used by management in the preparation of the unaudited consolidated financial statements for the three and six months ended May 31, 2009.

Allowance for Doubtful Accounts

As of May 31, 2009, an estimate was made of the collectibility of the outstanding accounts receivable balances.   This estimate requires the utilization of outside credit services, knowledge about the customer and the customer’s industry, new developments in the customer’s industry and operating results of the customer as well as general economic conditions and historical trends.  When all these facts are compiled, a judgment as to the collectibility of the individual account is made.   Many factors can impact this estimate, including those noted in this paragraph.  The adequacy of the estimated allowance may be impacted by the deterioration in the financial condition of a large customer, weakness in the economic environment resulting in a higher level of customer bankruptcy filings or delinquencies and the competitive environment in which the customer operates.  During the second quarter of fiscal 2009, we performed a detailed assessment of the collectibility of trade accounts receivable and did not make any significant adjustments to our estimate of allowance for doubtful accounts.  The balance of allowance for doubtful accounts was $0.5 and $0.4 million at May 31, 2009 and November 30, 2008, respectively.

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

We separate returns into the two categories of seasonal and non-seasonal products.  We use the historical return detail of seasonal and non-seasonal products for at least the most recent three fiscal years on generally all products, which is normalized for any specific occurrence that is not reasonably likely to recur, to determine the amount of product return as a percentage of sales, and estimate an allowance for potential returns based on product sold in the current period.  To consider product sold in current and prior periods, an estimate of inventory held by our retail customers is calculated based on customer inventory detail.  This estimate of inventory held by our customers, along with historical returns as a percentage of sales, is used to determine an estimate of potential product returns.  This estimate of the allowance for seasonal and non-seasonal returns is further analyzed by considering retail customer point of sale data.  We also consider specific events, such as discontinued product or product divestitures, when determining the adequacy of the allowance.  Based on consideration of the sales of Icy Hot Pro Therapy performing below expectations, review of retail point of sales data and an estimate of inventory on hand at customers, an allowance of product returns of Icy Hot Pro Therapy was $0.7 million as of November 30, 2008.  As of May 31, 2009, the allowance remaining for Icy Hot Pro Therapy returns is $0.4 million.

Our estimate of product returns for seasonal and non-seasonal products as of May 31, 2009 was $2.4 million and $1.1 million, respectively, and $1.4 million and $1.3 million, respectively, as of November 30, 2008.  For the six months ended May 31, 2009, we increased our estimate of returns for seasonal products by approximately $1.0 million, which resulted in a decrease to net sales in our consolidated financial statements, and decreased our estimate for non-seasonal returns by approximately $0.2 million, which resulted in an increase to net sales in our consolidated financial statements.  During the six months ended May 31, 2008, we increased our estimate of returns for seasonal products by approximately $1.3 million, which resulted in a decrease to net sales in our consolidated financial statements, and decreased our estimate for non-seasonal returns by approximately $0.2 million, which resulted in an increase to net sales in our consolidated financial statements.  Each percentage point change in the seasonal return rate would impact net sales by approximately $0.2 million.  Each percentage point change in the non-seasonal return rate would impact net sales by approximately $0.6 million.

We routinely enter into agreements with customers to participate in promotional programs.  The cost of these programs is recorded as either advertising and promotion expense or as a reduction of sales as prescribed by Emerging Issues Task Force 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products)” (“EITF 01-9”).  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 liability 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 of issued coupons based on an internal analysis of historical coupon redemption rates and expected future retail sales by considering recent point of sale data.  The estimate for vendor allowances is based on estimated unit sales of a product under a program and amounts committed for such programs in each fiscal year.  Estimated unit sales are determined by considering customer forecasted sales, point of sale data and the nature of the program being offered.  The three most recent years of expected program payments versus actual payments made and current year retail point of sale trends are analyzed to determine future expected payments.  Customer delays in requesting promotional program payments due to their audit of program participation and resulting request for reimbursement is also considered to evaluate the accrual for vendor allowances.  The costs of these programs is often variable based on the number of units actually sold.  As of May 31, 2009, the accrued liability related to coupon redemption and reserve for vendor allowances was $3.0 million and $5.6 million, respectively, and $1.9 million and $6.4 million, respectively as of May 31, 2008.  Each percentage point change in promotional program participation and advertising and promotion expense would impact net sales by approximately $0.1 million and an insignificant amount, respectively.

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Income Taxes

We account for income taxes using the asset and liability approach as prescribed by SFAS 109, FIN 48 and other applicable FSP’s and FASB Interpretations.  This approach requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns.  Using the enacted tax rates in effect for the year in which the differences are expected to reverse, deferred tax assets and liabilities are determined based on the differences between the financial reporting and the tax basis of an asset or liability.  We adopted FIN 48, as amended by FSP FIN 48-1, on December 1, 2007.  FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS 109.  We record income tax expense in our consolidated financial statements based on an estimated annual effective income tax rate.  Our tax rate for the six months ended May 31, 2009 was 36.3%, as compared to 35.6% for the six months ended May 31, 2008.

Accounting for Acquisitions and Intangible Assets

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

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

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

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

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

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

Fair Value Measurements

On December 1, 2007, we adopted SFAS 157, which provides guidance for using fair value to measure assets and liabilities.  SFAS 157 applies both to items recognized and reported at fair value in the financial statements and to items disclosed at fair value in the notes to the financial statements.  SFAS 157 does not change existing accounting rules governing what can or must be recognized and reported at fair value and clarifies that fair value is defined as the price received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date.  Additionally, SFAS 157 does not eliminate practicability exceptions that exist in accounting pronouncements amended by SFAS 157 when measuring fair value.  As a result, we are not required to recognize any new assets or liabilities at fair value.

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

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Stock-Based Compensation

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

Comparison of Three Months Ended May 31, 2009 and 2008

To facilitate discussion of our operating results for the three months ended May 31, 2009 and 2008, we have included the following selected data from our unaudited consolidated statements of income:

					Increase (Decrease)
	2009		2008		Amount			Percentage
	(dollars in thousands)
Domestic net sales	$	116,098	$	108,691	$	7,407			6.8	%
International revenues (including royalties)		5,732		8,025		(2,293	)		(28.6	)
Total revenues		121,830		116,716		5,114			4.4
Cost of sales		37,131		32,641		4,490			13.8
Advertising and promotion expense		26,969		30,247		(3,278	)		(10.8	)
Selling, general and administrative expense		14,330		15,186		(856	)		(5.6	)
Interest expense		5,285		6,565		(1,280	)		(19.5	)
Net  income		24,230		20,732		3,498			16.9

Domestic Net Sales

Domestic net sales for the three months ended May 31, 2009 increased $7.4 million, or 6.8%, to $116.1 million from $108.7 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)
	2009		2008		Amount			Percentage
	(dollars in thousands)
Medicated skin care	$	37,970	$	34,471	$	3,499			10.2	%
Topical pain care		24,314		24,772		(458	)		(1.8	)
Oral care		18,466		15,415		3,051			19.8
Internal OTC		11,686		13,274		(1,588	)		(12.0	)
Medicated dandruff shampoos		9,724		8,707		1,017			11.7
Dietary supplements		5,569		5,133		436			8.5
Other OTC and toiletry products		8,369		6,919		1,450			21.0
Total	$	116,098	$	108,691	$	7,407			6.8

Net sales in the medicated skin care category increased $3.5 million, or 10.2%, in the second quarter of fiscal 2009 compared to the prior year quarter primarily due to the launch of Gold Bond Anti-Itch Lotion, Gold Bond Foot Pain Cream, Gold Bond Ultimate Protecting Lotion, Cortizone-10 Cooling Gel and Cortizone-10 Easy Relief during the first quarter of fiscal 2009 and the continued growth of our existing Gold Bond lotion business.  

Net sales in the topical pain care category decreased $0.5 million, or 1.8%, for the second quarter of fiscal 2009 compared to the prior year quarter, due primarily to lower sales of Aspercreme and certain other smaller brands in the category and reduced SKU count at certain retail customers, partially offset by the second quarter launch of Icy Hot Medicated Roll and first quarter launch of Icy Hot No-Mess Applicator in fiscal 2009.

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Net sales in the oral care category increased $3.1 million, or 19.8%, in the second quarter of fiscal 2009 compared to the prior year quarter due in part to the launch of ACT Total Care in the first quarter of fiscal 2009 and the continued performance of ACT Restoring and ACT Rinse.

Net sales in the internal OTC category decreased $1.6 million, or 12.0%, in the second quarter of fiscal 2009 compared to the prior year quarter due to increased competitive pressure from the private label sector within the category, the lack of a launch of any new products in fiscal 2009 similar to the first quarter of fiscal 2008 launch of Unisom Sleepmelts and decreased distribution at certain retail customers of certain products within this category.

Net sales in the medicated dandruff shampoos category increased $1.0 million, or 11.7%, in the second quarter of fiscal 2009 compared to the prior year quarter primarily resulting from the launch of Selsun Blue Itchy Dry Scalp in the first quarter of fiscal 2009, partially offset by a decline in sales of Selsun Salon products due to distribution changes as a result of the launch of Selsun Blue Itchy Dry Scalp.

Net sales in the dietary supplements category increased $0.4 million, or 8.5%, for the second quarter of fiscal 2009 compared to the prior year quarter, due mainly to sales of Dexatrim Max Complex 7, which was initially launched in the third quarter of fiscal 2008.

Net sales in the other OTC and toiletry products category increased $1.5 million, or 21.0%, in the second quarter of fiscal 2009 compared to the prior year quarter primarily due to the timing of shipments of Bullfrog.

Domestic sales variances were principally the result of changes in unit sales volume with the exception of certain selected products for which we implemented a unit sales price increase effective April 2008 and December 2008 and the increased utilization of promotion programs considered a vendor allowance per the provisions of EITF 01-9, which are accounted for as a reduction of total revenues and not as a component of advertising and promotion expense in the three month period ended May 31, 2009 as compared to the same year ago period.

International Revenues

For the second quarter of fiscal 2009, international revenues decreased $2.3 million, or 28.6%, compared to the prior year quarter, primarily as a result of terminating shipments to certain distributors serving Latin American markets to reduce the potential for diversion of English language packaging back to the United States market, unfavorable exchange rates that decreased revenues by approximately $1.0 million and the unfavorable macro-economic conditions in the markets where our products are sold.  We are seeking new Latin American distributors for the affected markets and are converting the packaging for the major products sold in these markets to local Spanish language.

Cost of Sales

Cost of sales in the second quarter of fiscal 2009 was 30.5% as a percentage of total revenues compared to 28.0% in the prior year quarter and gross margin for the same period of fiscal 2009 was 69.5% compared to 72.0% in the prior year quarter.  The decrease in gross margin was primarily attributable to the increased cost of certain raw material input components and an increased utilization by retailers of programs to reduce product prices to consumers, the costs of which are recorded as a reduction of total revenues rather than advertising and promotion expense.

Advertising and Promotion Expense

Advertising and promotion expenses in the second quarter of fiscal 2009 decreased $3.3 million, or 10.8%, compared to the prior year quarter and were 22.1% of total revenues in the second quarter of fiscal 2009 compared to 25.9% for the prior year quarter.  The decrease in advertising and promotion expense was a result of greater utilization by retailers of programs to reduce product prices to consumers, the costs of which are recorded as a reduction of total revenues rather than advertising and promotion expense, and reduced sampling programs, partially offset by an increase in marketing research expenses.

Selling, General and Administrative Expense

Selling, general and administrative expenses in the second quarter of fiscal 2009 decreased $0.9 million, or 5.6%, compared to the prior year quarter.  Selling, general and administrative expenses were 11.8% and 13.0% of total revenues for the second quarter of fiscal 2009 and 2008, respectively.  The decrease in selling, general and administrative expenses as a percentage of total revenues was attributable to foreign currency exchange gains resulting from intercompany transactions and reduced transportation costs related to outbound product shipments.

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Interest Expense

Interest expense decreased $1.3 million, or 19.5%, in the second quarter of fiscal 2009 compared to the prior year quarter reflecting the repayment of $48.2 million in principal of our Credit Facility since May 31, 2008 and the exchange of 487,123 shares of common stock for $28.7 million of the 2.0% Convertible Notes in December 2008.  Until our indebtedness is reduced substantially, interest expense will continue to represent a significant percentage of our total revenues.

Comparison of Six Months Ended May 31, 2009 and 2008

To facilitate discussion of our operating results for the six months ended May 31, 2009 and 2008, we have included the following selected data from our unaudited consolidated statements of income:

					Increase (Decrease)
	2009		2008		Amount			Percentage
	(dollars in thousands)
Domestic net sales	$	227,006	$	220,006	$	7,000			3.2	%
International revenues (including royalties)		10,916		17,483		(6,567	)		(37.6	)
Total revenues		237,922		237,489		433			0.2
Cost of sales		72,388		67,374		5,014			7.4
Advertising and promotion expense		55,558		64,743		(9,185	)		(14.2	)
Selling, general and administrative expense		29,756		30,652		(896	)		(2.9	)
Product recall expenses		—		6,043		(6,043	)		(100.0	)
Interest expense		10,949		13,117		(2,168	)		(16.5	)
Loss on early extinguishment of debt		696		526		170			32.3
Net income		43,796		35,605		8,191			23.0

Domestic Net Sales

Domestic net sales for the six months ended May 31, 2009 increased $7.0 million, or 3.2%, compared to the same period in fiscal 2008.  A comparison of domestic net sales for the categories of products included in our portfolio of OTC healthcare products is as follows:

					Increase (Decrease)
	2009		2008		Amount			Percentage
	(dollars in thousands)
Medicated skin care	$	79,427	$	72,124	$	7,303			10.1	%
Topical pain care		46,357		50,087		(3,730	)		(7.4	)
Oral Care		36,751		31,187		5,564			17.8
Internal OTC		23,050		24,484		(1,434	)		(5.9	)
Medicated dandruff shampoos		19,087		19,286		(199	)		(1.0	)
Dietary supplements		9,841		10,507		(666	)		(6.3	)
Other OTC and toiletry products		12,493		12,331		162			1.3
Total	$	227,006	$	220,006	$	7,000			3.2

Net sales in the medicated skin care category increased $7.3 million, or 10.1%, for the first six months of fiscal 2009 compared to the same period in fiscal 2008 primarily due to the launch of Gold Bond Anti-Itch Lotion, Gold Bond Foot Pain Cream, Gold Bond Ultimate Protecting Lotion, Cortizone-10 Cooling Gel and Cortizone-10 Easy Relief during the first quarter of fiscal 2009 and the continued growth of our existing Gold Bond lotion business.  

Net sales in the topical pain care category decreased $3.7 million, or 7.4%, for the first six months of fiscal 2009 compared to the same period in fiscal 2008, primarily as a result of the discontinuance of shipments of Icy Hot Heat Therapy following the voluntary recall of the product announced on February 8, 2008 and lower sales of Aspercreme and certain other smaller brands in the category and reduced SKU count at certain retail customers, partially offset by the first quarter launch of Icy Hot No-Mess Applicator and the second quarter launch of Icy Hot Medicated Roll in fiscal 2009.  Excluding sales of Icy Hot Heat Therapy, sales in the category decreased 3.8% compared to the prior year period.

Net sales in the oral care category increased $5.6 million, or 17.8%, for the first six months of fiscal 2009 compared to the same period in fiscal 2008 due in part to the launch of ACT Total Care in the first quarter of fiscal 2009 and the continued performance of ACT Restoring and ACT Rinse.

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Net sales in the internal OTC category decreased $1.4 million, or 5.9%, for the first six months of fiscal 2009 compared to the same period in fiscal 2008 primarily due to increased competitive pressure from the private label sector within the category, the lack of a launch of any new products in fiscal 2009 similar to the first quarter of fiscal 2008 launch of Unisom Sleepmelts and decreased distribution at certain retail customers of certain products within this category.

Net sales in the medicated dandruff shampoos category decreased $0.2 million, or 1.0%, for the first six months of fiscal 2009 compared to the same period in fiscal 2008 primarily resulting from a decline in sales of Selsun Salon products due to distribution changes to accommodate the launch of Selsun Blue Itchy Dry Scalp in the first quarter of fiscal 2009, offset by the initial sell-in of Selsun Blue Itchy Dry Scalp.

Net sales in the dietary supplements category decreased $0.7 million, or 6.3%, for the first six months of fiscal 2009 compared to the same period in fiscal 2008, primarily resulting from the decline in sales of Dexatrim Max2O, partially offset by sales of Dexatrim Max Complex 7, which was initially launched in the third quarter of fiscal 2008.

Net sales in the other OTC and toiletry products category increased $0.2 million, or 1.3%, for the first six months of fiscal 2009 compared to the same period in fiscal 2008.

Domestic sales variances were principally the result of changes in unit sales volume with the exception of certain selected products for which we implemented a unit sales price increase effective April 2008 and December 2008 and the increased utilization of promotion programs considered a vendor allowance per the provisions of EITF 01-9, which are accounted for as a reduction of total revenues and not as a component of advertising and promotion expense in the six month period ended May 31, 2009 as compared to the same year ago period.

International Revenues

For the six months ended May 31, 2009, international revenues decreased $6.6 million, or 37.6%, compared to the same period in fiscal 2008, primarily as a result of terminating shipments to certain distributors serving Latin American markets to reduce the potential for diversion of English language packaging back to the United States market and unfavorable exchange rates that decreased revenues by approximately $1.8 million and the unfavorable macro-economic conditions in the markets where our products are sold.  We are seeking new Latin American distributors for the affected markets and are converting the packaging for the major products sold in these markets to local Spanish language.

Cost of Sales

Cost of sales for the six months ended May 31, 2009 was 30.4% as a percentage of total revenues compared to 28.4% in the prior year period and gross margin for the same period of fiscal 2009 was 69.6% compared to 71.6% in the prior year period. The decrease in gross margin was primarily attributable to the increased cost of certain raw material input components and an increased utilization by retailers of programs to reduce product prices to consumers, the costs of which are recorded as a reduction of total revenues rather than advertising and promotion expense.

Advertising and Promotion Expense

Advertising and promotion expenses for the six months ended May 31, 2009 decreased $9.2 million, or 14.2%, compared to the same period in fiscal 2008 and were 23.4% of total revenues for the six months ended May 31, 2009 as compared to 27.3% for the same period in fiscal 2008. The decrease in advertising and promotion expense was a result of greater utilization by retailers of programs to reduce product prices to consumers, the costs of which are recorded as a reduction of total revenues rather than advertising and promotion expense, and reduced sampling programs, partially offset by an increase in marketing research expenses.

Selling, General and Administrative Expense

Selling, general and administrative expenses for the six months ended May 31, 2009 decreased $0.9 million, or 2.9%, compared to the same period of fiscal 2008 and were 12.5% and 12.9% of total revenues for the six months ended May 31, 2009 and 2008, respectively. The decrease in selling, general and administrative expenses as a percentage of total revenues was attributable to foreign currency exchange gains resulting from intercompany transactions and reduced transportation costs related to outbound product shipments.

Product Recall Expenses

During the first half of fiscal 2008, we incurred $6.0 million of product recall expenses related to the voluntary recall of our Icy Hot Heat Therapy product that was initiated in February 2008.  Based in part on consideration of on-hand inventory and retail point of sales data, the $6.0 million of product recall expenses related to product returns, inventory obsolescence, destruction costs, consumer refunds, legal fees and other estimated expenses.  As of May 31, 2009, we do not expect to record additional expenses related to the recall of Icy Hot Heat Therapy.

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Interest Expense

Interest expense decreased $2.2 million, or 16.5%, for the six months ended May 31, 2009 compared to the same period in fiscal 2008 reflecting the repayment of $48.2 million in principal of our Credit Facility since May 31, 2008 and the exchange of 487,123 shares of our common stock for $28.7 million of the 2.0% Convertible Notes in December 2008.  Until our indebtedness is reduced substantially, interest expense will continue to represent a significant percentage of our total revenues.

Loss on Early Extinguishment of Debt

On December 4, 2008, we issued an aggregate of 487,123 shares of our common stock in exchange for $28.7 million in aggregate principal of our outstanding 2.0% Convertible Notes.  In connection with this transaction, we retired a proportional share of the 2.0% Convertible Notes debt issuance costs and recorded the resulting amount as loss on early extinguishment of debt of $0.7 million in the first quarter of fiscal 2009.

During the first quarter of fiscal 2008, we utilized borrowings under the revolving credit facility portion of our Credit Facility to repay $35.0 million of the term loan under the Credit Facility.  In connection with the term loan repayment, we retired a proportional share of the term loan debt issuance costs and recorded the resulting amount as loss on extinguishment of debt of $0.5 million.

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, working capital, acquisitions, repurchases of our common stock, servicing long-term debt, payment of income taxes and capital expenditures.

Cash of $43.5 million and $31.3 million was provided by operations for the six months ended May 31, 2009 and 2008, respectively.  The increase in cash flows from operations over the prior year period was primarily attributable to higher net income and an increase in accounts payable and accrued liabilities, partially offset by an increase in inventory.

Investing activities used cash of $0.9 million and $3.6 million in the six months ended May 31, 2009 and 2008, respectively.  Cash flow used in investing activities was primarily a result of purchases of manufacturing equipment.

Financing activities used cash of $46.3 million and $31.1 million in the six months ended May 31, 2009 and 2008, respectively.  Cash flow used in financing activities was a result of the repayment of amounts outstanding under the Credit Facility and the repurchase of 491,392 shares of our common stock.

As of May 31, 2009, our total debt was $409.8 million, consisting of the 7.0% Subordinated Notes of $107.5 million, the 2.0% Convertible Notes of $96.3 million, the 1.625% Convertible Notes of $100.0 million and $106.0 million outstanding under the term loan portion of our Credit Facility.  As of May 31, 2009, no amounts were outstanding under the revolving credit facility portion of our Credit Facility and we were in compliance with all applicable financial and restrictive covenants under the Credit Facility.

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

Foreign Operations

Historically, our primary foreign operations have been through our Canadian and United Kingdom (“U.K.”) subsidiaries.  Since November 1, 2004, our European business has been conducted through Chattem Global Consumer Products Limited, a wholly-owned subsidiary located in Limerick, Ireland.   In connection with the acquisition of ACT in Western Europe in May 2007, we established Chattem Greece, a wholly-owned subsidiary located in Alimos Attica, Greece.  In November 2008, we established Chattem Peru SRL (“Chattem Peru”), a wholly-owned subsidiary located in Lima, Peru.  Chattem Peru utilizes third party

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distributors to sell certain of our Selsun Blue products throughout Peru.  The functional currencies of these subsidiaries are Canadian dollars, British pounds, Euros and Peruvian Sol, respectively.  Fluctuations in exchange rates can impact operating results, including total revenues and expenses, when translations of the subsidiary financial statements are made in accordance with SFAS No. 52, “Foreign Currency Translation”.  For the six months ended May 31, 2009 and 2008, these subsidiaries accounted for 5% and 7% of total revenues, respectively, and 2% and 3% of total assets, respectively.  It has not been our practice to hedge our assets and liabilities or our intercompany transactions due to the inherent risks associated with foreign currency hedging transactions and the timing of payments between us and our foreign subsidiaries.  Historically, gains or losses from foreign currency transactions have not had a material impact on our operating results.  Gains of $0.4 million and an insignificant amount, resulting from foreign currency transactions for the six months ended May 31, 2009 and 2008, respectively, are included in selling, general and administrative expenses in the unaudited consolidated statements of income.

Recent Accounting Pronouncements

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

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

In May 2008, the FASB issued FSP Accounting Principles Board (“APB”) Opinion No. 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP 14-1”).  FSP 14-1 specifies that issuers of convertible debt instruments should separately account for the liability and equity components of the instrument in a manner that will reflect the entity’s non-convertible debt borrowing rate on the instrument’s issuance date when interest is recognized in subsequent periods.  Upon adoption of FSP 14-1, the proceeds received from the issuance of the 2.0% Convertible Notes and the 1.625% Convertible Notes (collectively, the “Convertible Notes”) will be allocated between the liability and equity component by determining the fair value of the liability component using our non-convertible debt borrowing rate at the time the Convertible Notes were issued.  The difference between the proceeds of the Convertible Notes and the calculated fair value of the liability component will be recorded as a debt discount with a corresponding increase to common shares in our consolidated balance sheet.  The debt discount will be amortized as additional non-cash interest expense over the remaining life of the Convertible Notes using the effective interest rate method.  Although FSP 14-1 will have no impact on our cash flows, FSP 14-1 will result in additional non-cash interest expense until maturity or early extinguishment of the Convertible Notes.  The provisions of FSP 14-1 are to be applied retrospectively to all periods presented upon adoption and are effective for fiscal years beginning after December 15, 2008, or our fiscal 2010, and interim periods within those fiscal years.  Upon adoption of FSP 14-1, we estimate non-cash interest expense will increase approximately $6.6 million and $7.2 million (or $0.22 and $0.25 per share) for the fiscal years ended November 30, 2009 and 2008, respectively.  The additional non-cash interest expense is expected to increase as the Convertible Notes approach their respective maturity dates and accrete to their face values.

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

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162” (“SFAS 168”).  SFAS 168 eliminates the previous levels of U.S. GAAP. It does not include any guidance or interpretations of GAAP beyond what is already reflected in the FASB literature. It merely takes previously issued FASB standards and other authoritative pronouncements, changes the nomenclature previously used to refer to FASB standards in the past, and includes them in specific topic areas.  SFAS 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009.  We are currently evaluating the impact, if any, of SFAS 168.

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 Forward Looking Statements

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

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

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

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

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

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

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

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

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

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

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

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

• our business is regulated by numerous federal, state and foreign governmental authorities, which subjects us to elevated compliance costs, risks of non-compliance and the potential adverse effect of new or changing regulations;

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

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

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

• we rely on third party manufacturers for a portion of our product portfolio, including products under our Gold Bond, Icy Hot, Selsun, Dexatrim, ACT, Unisom and Cortizone-10 brands;

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

• our business could be adversely affected if we are unable to successfully protect our intellectual property or defend claims of infringement by others;

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

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

• we are subject to the risk of doing business internationally;

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

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

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

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

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

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

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

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

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

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

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

• virtually all of our assets consists of intangibles; and

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

Item 3.  Quantitative and Qualitative Disclosures About Market 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 1.50% or the higher of the federal funds rate plus 0.50% or the prime rate (the “Base Rate”).  The applicable percentages are calculated based on our leverage ratio.  The term loan under our Credit Facility bears interest at either LIBOR plus 1.75% or the Base Rate plus 0.75%.  As of May 31, 2009, we had no borrowings outstanding under the revolving credit facility portion of our Credit Facility and $106.0 million was outstanding under the term loan portion of our Credit Facility.  The variable rate for the term loan portion was LIBOR plus 1.75%, or 2.88%, as of May 31, 2009.  The 7.0% Subordinated Notes, the 1.625% Convertible Notes and the 2.0% Convertible Notes are fixed interest rate obligations.

In November 2006, we entered into an interest rate swap (“swap”) agreement effective January 2007.  The swap has decreasing notional principal amounts beginning October 2007 and a swap rate of 4.98% over the life of the agreement.  As of May 31, 2009, the decrease in fair value of $0.5 million, net of tax, was recorded to other comprehensive income and the swap was deemed to be an effective cash flow hedge.  The swap agreement terminates in January 2010.

The impact on our results of operations of a one-point rate change on the July 1, 2009 outstanding $105.3 million term loan balance of our Credit Facility for the next twelve months would be approximately $0.5 million, net of tax.

We are subject to risk from changes in the foreign exchange rates relating to our Canadian, U.K., Irish, Grecian and Peruvian subsidiaries.  Assets and liabilities of these subsidiaries are translated to U.S. dollars at 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 transactions denominated in foreign currencies, are included in selling, general and administrative expenses in our consolidated statements of income.  The potential loss resulting from a hypothetical 10.0% adverse change in the quoted foreign currency exchange rate amounts to approximately $1.4 million as of May 31, 2009.

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

Item 4.   Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures (as such terms are defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of May 31, 2009 (the “Evaluation Date”).  Based on such evaluation, such officers have concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective in alerting them on a timely basis to material information relating to us (including our consolidated subsidiaries) required to be included in our reports filed or submitted under the Exchange Act.

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PART II.  OTHER INFORMATION

Item 1.    Legal Proceedings

See Note 18 of Notes to Consolidated Financial Statements included in Part 1, Item 1 of this Report.

Item 1A.  Risk Factors

There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended November 30, 2008.

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

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

Period	Total Number of Shares Purchased		Average Price Paid Per Share (1)		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2)		Approximate Dollar Value of Shares that may yet be Purchased under the Plans or  Programs (2)
March 1– March 31		50,500	$	56.10		50,500	$	73,913,336
April 1 – April 30		390,892		52.49		390,892		71,080,472
May 1 – May 31		50,000		55.13		50,000		50,562,818
Total Second Quarter		491,392	$	53.13		491,392	$	47,806,121

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

(2)   On April 30, 2008, our Board of Directors increased the authorization to a total of $100.0 million of our common stock under the terms of our existing stock repurchase program.  There is no expiration date specified for our stock buyback program.

Item 3.   Defaults Upon Senior Securities

None.

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

Our annual meeting of shareholders was held on April 8, 2009 in Chattanooga, Tennessee.  At the meeting, the following items were submitted to a vote of shareholders:

(1)     The following persons were elected as directors to serve for a three-year term:  Robert E. Bosworth (11,515,577 votes for and 6,074,875 votes withheld), Gary D. Chazen (17,336,304 votes for and 254,148 votes withheld), and Joey B. Hogan (15,477,439 votes for and 2,113,013 votes withheld).  Other directors whose terms of office continued after the annual meeting are: Samuel E. Allen, Philip H. Sanford, Ruth W. Brinkley, Zan Guerry and Bill W. Stacy.

(2)	Approval of the Chattem, Inc. 2009 Equity Incentive Plan (11,122,285 votes for; 4,375,685 votes against; and 70,287 abstentions).
(3)	Ratification of Grant Thornton, LLP as our independent registered public accounting firm for fiscal 2009 (17,568,439 votes for; 11,981 votes against; and 13,639 abstentions).

Item 5.   Other Information

None.

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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:     July 10, 2009	/s/ Zan Guerry
	Zan Guerry
	Chairman and Chief Executive Officer

Dated:     July 10, 2009	/s/ Robert B. Long
	Robert B. Long
	Vice President and Chief Financial Officer

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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

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EX-31.1

Exhibit 31.1

CERTIFICATION

I, Zan Guerry, Chairman and Chief Executive Officer, certify that:

1.   I have reviewed this quarterly report on Form 10-Q of Chattem, Inc.;

2.   Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.   Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.   The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting  (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a.   designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b.   designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c.   evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and

d.   disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a.   all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b.   any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:       July 10, 2009 /s/ Zan Guerry Zan Guerry Chairman and Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Robert B. Long, Vice President and Chief Financial Officer, certify that:

1.   I have reviewed this quarterly report on Form 10-Q of Chattem, Inc.;

2.   Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.   Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.   The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting  (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a.   designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b.   designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c.   evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and

d.   disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a.   all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b.   any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:       July 10, 2009 /s/ Robert B. Long Robert B. Long Vice President and Chief Financial Officer

EX-32

Exhibit 32

Certification

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code)

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code), each of the undersigned officers of Chattem, Inc., a Tennessee corporation (the “Company”), does hereby certify, to such officer’s knowledge, that:

The Quarterly Report on Form 10-Q for the quarter ended May 31, 2009 (the “Form 10-Q”) of the Company fully complies with the requirements of Section 13 (a) or 15(d) of the Securities Exchange Act of 1934 and information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated:     July 10, 2009	/s/ Zan Guerry
	Zan Guerry
	Chairman and Chief Executive Officer

Dated:     July 10, 2009	/s/ Robert B. Long
	Robert B. Long
	Vice President and Chief Financial Officer

The foregoing certification is being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code) and is not being filed as part of the Form 10-Q, or as a separate disclosure document.         

A SIGNED ORIGINAL OF THIS WRITTEN STATEMENT REQUIRED BY SECTION 906 HAS BEEN PROVIDED TO CHATTEM, INC. AND WILL BE RETAINED BY CHATTEM, INC. AND FURNISHED TO THE SECURITIES AND EXCHANGE COMMISSION OR ITS STAFF UPON REQUEST.