UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT

PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended August 31, 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 September 30, 2009,19,043,177 shares of the Company’s common stock, without par value, were outstanding.

CHATTEM, INC.

INDEX

	PAGE NO.
PART I.  FINANCIAL INFORMATION
Item 1.  Financial Statements
Consolidated Balance Sheets as of August 31, 2009 and
November 30, 2008	3
Consolidated Statements of Income for the Three and Nine
Months Ended August 31, 2009 and August 31, 2008	5
Consolidated Statements of Cash Flows for the Nine Months
Ended August 31, 2009 and August 31, 2008	6
Notes to Consolidated Financial Statements	7
Item 2.  Management's Discussion and Analysis of Financial Condition
and Results of Operations	28
Item 3.  Quantitative and Qualitative Disclosures About Market Risk	41
Item 4.  Controls and Procedures	41
PART II.  OTHER INFORMATION
Item 1.  Legal Proceedings	42
Item 1A. Risk Factors	42
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds	42
Item 3.  Defaults Upon Senior Securities	42
Item 4.  Submission of Matters to a Vote of Security Holders	42
Item 5.  Other Information	42
Item 6.  Exhibits	43
SIGNATURES	44

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PART 1. FINANCIAL INFORMATION

Item 1. Financial Statements

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands)

ASSETS	AUGUST 31,    2009		NOVEMBER 30,  2008
	(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents	$	59,400	$	32,310
Accounts receivable, less allowances of $11,126 at     August 31, 2009 and $9,718 at November 30, 2008		48,589		49,417
Inventories		42,336		40,933
Deferred income taxes		4,009		3,968
Prepaid expenses and other current assets		7,625		2,451
Total current assets		161,959		129,079
PROPERTY, PLANT AND EQUIPMENT, NET		32,893		32,243
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net		615,956		616,670
Debt issuance costs, net		9,340		12,253
Other		2,609		2,727
Total other noncurrent assets		627,905		631,650
TOTAL ASSETS	$	822,757	$	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	AUGUST 31,  2009			NOVEMBER 30,  2008
	(Unaudited)
CURRENT LIABILITIES:
Current maturities of long-term debt	$	3,000		$	3,000
Accounts payable and other		14,746			18,116
Bank overdraft		—			1,184
Accrued liabilities		23,435			21,293
Total current liabilities		41,181			43,593
LONG-TERM DEBT, less current maturities		396,920			456,500
DEFERRED INCOME TAXES		50,206			35,412
OTHER NONCURRENT LIABILITIES		1,346			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 19,043 at August 31, 2009 and     18,978 at November 30, 2008		36,749			28,926
Retained earnings		298,454			231,230
		335,203			260,156
Cumulative other comprehensive income (loss), net of tax:
Interest rate hedge adjustment		(800	)		(1,787	)
Foreign currency translation adjustment		244			(968	)
Unrealized actuarial gains and losses		(1,543	)		(1,543	)
Total shareholders’ equity		333,104			255,858
TOTAL LIABILITIES AND SHAREHOLDERS’           EQUITY	$	822,757		$	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 AUGUST 31,						FOR THE NINE MONTHS   ENDED AUGUST 31,
	2009			2008			2009			2008
TOTAL REVENUES	$	115,171		$	111,929		$	353,093		$	349,418
COSTS AND EXPENSES:
Cost of sales		34,765			31,753			107,153			99,127
Advertising and promotion		22,866			26,789			78,424			91,532
Selling, general and administrative		15,275			15,024			45,031			45,676
Litigation settlement		—			11,196			—			11,196
Product recall (income) expenses		—			(112	)		—			5,931
Total costs and expenses		72,906			84,650			230,608			253,462
INCOME FROM OPERATIONS		42,265			27,279			122,485			95,956
OTHER INCOME (EXPENSE):
Interest expense		(5,126	)		(6,176	)		(16,075	)		(19,293	)
Investment and other income, net		45			109			223			362
Loss on early extinguishment of debt		(405	)		—			(1,101	)		(526	)
Total other income (expense)		(5,486	)		(6,067	)		(16,953	)		(19,457	)
INCOME BEFORE INCOME TAXES		36,779			21,212			105,532			76,499
PROVISION FOR INCOME TAXES		13,351			7,246			38,308			26,928
NET INCOME	$	23,428		$	13,966		$	67,224		$	49,571
NUMBER OF COMMON SHARES:
Weighted average outstanding-basic		19,026			18,784			19,236			19,002
Weighted average and potential dilutive outstanding		19,161			19,004			19,323			19,385
NET INCOME PER COMMON SHARE:
Basic	$	1.23		$	.74		$	3.49		$	2.61
Diluted	$	1.22		$	.73		$	3.48		$	2.56

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 NINE MONTHS ENDED AUGUST 31,
	2009			2008
OPERATING ACTIVITIES:
Net income	$	67,224		$	49,571
Adjustments to reconcile net income to net cash provided by     operating activities:
Depreciation and amortization		5,671			6,316
Deferred income taxes		12,635			12,404
Tax benefit realized from stock options exercised		(325	)		(2,342	)
Stock-based compensation		5,667			4,281
Loss on early extinguishment of debt		1,101			526
Other, net		(1	)		137
Changes in operating assets and liabilities:
Accounts receivable		828			(7,567	)
Inventories		(1,363	)		2,611
Prepaid expenses and other current assets		(5,174	)		(5,885	)
Accounts payable and accrued liabilities		(2,376	)		17,248
Net cash provided by operating activities		83,887			77,300
INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(3,623	)		(3,567	)
Decrease (increase) in other assets, net		1,986			(1,255	)
Net cash used in investing activities		(1,637	)		(4,822	)
FINANCING ACTIVITIES:
Repayment of long-term debt		(11,380	)		(37,250	)
Proceeds from borrowings under revolving credit facility		1,000			148,000
Repayments of revolving credit facility		(20,500	)		(158,500	)
Change in bank overdraft		(1,184	)		(7,584	)
Repurchase of common shares		(26,107	)		(26,327	)
Proceeds from exercise of stock options		2,587			4,487
Tax benefit realized from stock options exercised		325			2,342
Debt retirement costs		(18	)		—
Net cash used in financing activities		(55,277	)		(74,832	)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		117			(22	)
CASH AND CASH EQUIVALENTS:
Increase (decrease) for the period		27,090			(2,376	)
At beginning of period		32,310			15,407
At end of period	$	59,400		$	13,031
PAYMENTS FOR:
Interest	$	10,743		$	14,129
Taxes	$	23,412		$	10,733

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

3. RECENT ACCOUNTING PRONOUNCEMENTS

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

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 requires enhanced disclosures about an entity’s derivative and hedging activities. SFAS 161 amends and expands the disclosure requirements of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, with the intent to provide users of financial statements adequate information about how derivative and hedging activities affect an entity’s financial position, financial performance and cash flows. SFAS 161 is effective for quarterly interim periods beginning after November 15, 2008 and fiscal years that include those quarterly interim periods. We have included all disclosures as required by SFAS 161, none of which have a material impact on our financial statements.

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

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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 for the fiscal years ended November 30, 2009 and 2008 by approximately $6,600 and $7,200 (or $0.22 and $0.25 per share), respectively.  The additional non-cash interest expense is expected to increase each fiscal year 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 April 2009, the FASB issued FSP No. 107-1 and Accounting Principles Board (“APB”) 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP 107-1”). FSP 107-1, which requires disclosures about the fair value of financial instruments in interim financial statements as well as in annual financial statements, was effective for us for the quarter ended August 31, 2009. The adoption of FSP 107-1 did not have a material impact on our financial statements.

In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”), which provides general standards of accounting for and disclosure of subsequent events. SFAS No. 165 clarifies that management must evaluate, as of each reporting period (i.e. interim and annual), events or transactions that occur after the balance sheet date through the date the financial statements for such reporting period are issued. It also requires management to disclose the date through which subsequent events have been evaluated and whether that is the date on which the financial statements were issued. Statement 165 is effective prospectively for interim or annual financial periods ending after June 15, 2009. The Company adopted SFAS No. 165 in the third quarter of fiscal 2009 (see Note 19).

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, 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 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).

8

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

	Three Months Ended August 31,				Nine Months Ended August 31,
	2009		2008		2009		2008
Income from operations	$	2,124	$	1,701	$	5,667	$	4,281
Provision for income taxes		771		581		2,057		1,507
Net income	$	1,353	$	1,120	$	3,610	$	2,774
Basic net income per share	$	0.07	$	0.06	$	0.19	$	0.15
Diluted net income per share	$	0.07	$	0.06	$	0.19	$	0.14

The stock option compensation expense is 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 $224 and $185 of stock option compensation cost as a component of the carrying cost of inventory on-hand as of August 31, 2009 and 2008, respectively.

There were no options granted during the three months ended August 31, 2009. The weighted average grant-date fair value of stock options granted during the three months ended August 31, 2008 was $25.31, and for the nine months ended August 31, 2009 and 2008 was $20.99 and $27.98, respectively.   The fair value of each stock option grant was estimated on the date of grant using a Flex Lattice Model.  The following assumptions were used to determine the fair value of stock option grants during the nine months ended August 31, 2009 and 2008:

	Nine Months Ended   August 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		0.3	%		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 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 nine months ended August 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	(68	)		38.07
Cancelled	(13	)		61.26
Outstanding at August 31, 2009	1,815		$	51.74	4.2 years	$	21,426
Exercisable at August 31, 2009	875		$	43.94	3.4 years	$	16,393

The total fair value of stock options that vested during the three and nine months ended August 31, 2009 and 2008 was $2,128 and $1,677 and $5,707 and $4,282, respectively.  The total intrinsic value of stock options exercised during the three and nine months ended August 31, 2009 and 2008 was $932 and $1,860 and $1,739 and $6,563, respectively.

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As of August 31, 2009, we had $18,000 of unrecognized compensation cost related to stock options that will be recorded over a weighted average period of 2.7 years.

We are also authorized to grant restricted shares of common stock to employees under our stock incentive plans that have been approved by shareholders.  The restricted shares under these plans meet the definition of “nonvested shares” in SFAS 123R.  The restricted shares generally vest over a four year service period commencing upon the date of grant.  The total fair market value of restricted shares on the date of grant is amortized to expense on a straight line basis over the four-year vesting period.  The amortization expense related to restricted shares during the three and nine months ended August 31, 2009 and 2008 was $0 and $64 and $43 and $221, respectively.  All grants of restricted shares were fully vested effective February 28, 2009.

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

	Number of   Shares		Weighted Average Grant Date Fair  Value
Nonvested at December 1, 2008		1	$	35.37
Granted		–		–
Vested		1		35.37
Forfeited		–		–
Nonvested at August 31, 2009		–		–

5. EARNINGS PER SHARE

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

	For the Three Months     Ended August 31,				For the Nine Months  Ended August 31,
	2009		2008		2009		2008
NET INCOME	$	23,428	$	13,966	$	67,224	$	49,571
NUMBER OF COMMON SHARES:
Weighted average outstanding		19,026		18,784		19,236		19,002
Issued upon assumed exercise of outstanding stock options(1)		–		50		–		70
Issued upon assumed conversion of convertible notes		135		167		87		310
Effect of issuance of restricted common shares		–		3		–		3
Weighted average and potential dilutive outstanding		19,161		19,004		19,323		19,385
NET INCOME PER COMMON   SHARE:
Basic	$	1.23	$	.74	$	3.49	$	2.61
Diluted	$	1.22	$	.73	$	3.48	$	2.56

(1)  Because their effects are anti-dilutive, excludes shares issuable under stock option plans whose grant price was greater than the average market price of common shares outstanding as follows: 1,119 and 756 shares for the three months ended August 31, 2009 and 2008, respectively, and 925 and 562 shares for the nine months ended August 31, 2009 and 2008, respectively.

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6. LONG-TERM DEBT

Long-term debt consisted of the following as of August 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 5.93% and 6.57% as of August 31, 2009 and November 30, 2008, respectively		105,250		107,500
7.0% Senior Subordinated Notes due 2014		98,370		107,500
Total long-term debt				399,920			459,500
Less:  current maturities				(3,000	)		(3,000	)
Total long-term debt, net of current maturities			$	396,920		$	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 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.  Effective September 30, 2009, we entered into an amendment to our Credit Facility, see Note 19.

As of August 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 September 30, 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 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 such repayment, we retired a proportional share of the term loan debt issuance costs and recorded the resulting loss on early extinguishment of debt of $526 in the first quarter of fiscal 2008.

Borrowings under the Credit Facility are secured by substantially all of our assets, except real property, and shares of capital stock of our domestic subsidiaries held by us and by the assets of the guarantors (our domestic subsidiaries).  The Credit Facility contains covenants, representations, warranties and other agreements by us that are customary in credit agreements and security instruments relating to financings of this type.  The significant financial covenants include fixed charge coverage ratio, leverage ratio, senior secured leverage ratio and brand value calculations.  At August 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 our 7.0% Subordinated Notes in the open market at an average premium of 1.6% over the principal amount of the 7.0% Subordinated Notes.  During the third quarter of fiscal 2009, we repurchased $9,130 of our 7.0% Subordinated Notes in open market transactions at an average premium of 0.2% above the face amount of the 7.0% Subordinated Notes.  In connection with the repurchase of the 7.0% Subordinated Notes, we retired a proportional share of the related debt issuance costs.  The premium paid for the 7.0% Subordinated Notes combined with the early extinguishment of the proportional debt issuance costs resulted in a loss on extinguishment of $405.  The outstanding

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balance of the 7.0% Subordinated Notes was reduced to $98,370 as of August 31, 2009.  Subsequent to August 31, 2009, we repurchased additional 7.0% Subordinated Notes, see Note 19.

Interest payments on the 7.0% Subordinated Notes are due semi-annually in arrears 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 September 30, 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 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 was recorded as additional interest expense in the accompanying consolidated statement of income.  As of August 31, 2009, we had $75,500 of LIBOR based borrowings hedged under the provisions of the swap.  During the nine months ended August 31, 2009, the decrease in fair value of the swap of $987, net of tax, was recorded to cumulative other comprehensive income.  The fair value of the swap of $1,743 is included in accrued liabilities.  As of August 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 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 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 with respect to which the Counterparty has been timely notified of such conversion.

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.

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

In December 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 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 with respect to which the Counterparty has been timely notified of such conversion.

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 have not been accounted for as separate derivatives. 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 transactions. Integration of the note hedge with the 2.0% Convertible Notes and the 1.625% Convertible Notes, respectively, creates an in-substance original issue debt discount for income tax reporting purposes and therefore, the cost of the note hedge transactions will be accounted for as interest expense over the term of the 2.0% Convertible Notes and the 1.625% Convertible Notes, respectively, for income tax reporting purposes. The income tax benefit related to each respective convertible note issuance was recognized as a deferred tax asset.

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

2009	$	750
2010		3,000
2011		3,000
2012		3,000
2013		191,800
Thereafter		198,370
	$	399,920

7. FAIR VALUE MEASUREMENTS

We currently measure and record in the accompanying consolidated financial statements an interest rate swap at fair value.  SFAS 157 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 within the hierarchy an asset or liability falls requires significant judgment.  We evaluate our hierarchy disclosures each quarter.

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

	Fair Value Measurements as of   August 31, 2009
	Level 1		Level 2		Level 3		Total
Liabilities
Interest rate swap (1)	$	–	$	1,743	$	–	$	1,743

(1)   The total fair value of the interest rate swap is classified as a current liability as of August 31, 2009 and matures on January 15, 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 August 31, 2009, no assets or liabilities are measured at fair value on a nonrecurring basis.

At August 31, 2009 and November 30, 2008, the carrying value of the 7.0% Subordinated Notes and the term loan portion of our Credit Facility approximated fair value based on market prices and market volume for same or similar issues.  At August 31, 2009 and November 30, 2008, the fair value of the 2.0% Convertible Notes was determined to be $100,096 and $153,965, respectively, based upon consideration of our closing stock price of $61.24 and $72.57, respectively, and determination of conversion value as defined in the indenture under which the 2.0% Convertible Notes were issued.  At August 31, 2009 and November 30, 2008, the fair value of the 1.625% Convertible Notes was determined to be $83,664 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

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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 $3,535 and $3,823 were included in selling, general and administrative expenses for the three months ended August 31, 2009 and 2008, respectively, and $10,953 and $11,806 for the nine months ended August 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 August 31, 2009 and November 30, 2008, respectively.  The gross carrying amount of intangible assets subject to amortization at August 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 August 31, 2009 and November 30, 2008 was $4,401 and $3,687, respectively.  Amortization of our intangible assets subject to amortization under the provisions of SFAS 142 for the three months ended August 31, 2009 and 2008 was $231 and $228, respectively, and for the nine months ended August 31, 2009 and 2008 was $714 and $661, respectively.

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

2009	$	231
2010		925
2011		925
2012		208
2013		75
Thereafter		263
	$	2,627

11. INVENTORIES

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

	2009		2008
Raw materials and work in process	$	18,640	$	16,753
Finished goods		23,696		24,180
Total inventories	$	42,336	$	40,933

12. ACCRUED LIABILITIES

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

	2009		2008
Interest	$	4,874	$	3,216
Salaries, wages and commissions		3,813		5,333
Product advertising and promotion		2,934		2,611
Litigation settlement and legal fees		1,069		799
Income taxes payable		8,293		4,636
Interest rate swap		1,743		2,602
Other		709		2,096
Total accrued liabilities	$	23,435	$	21,293

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13. COMPREHENSIVE INCOME

Comprehensive income consisted of the following components for the three and nine months ended August 31, 2009 and 2008, respectively:

	For the Three Months Ended August 31,					For the Nine Months Ended August 31,
	2009		2008			2009		2008
Net income	$	23,428	$	13,966		$	67,224	$	49,571
Other – interest rate hedge adjustment, net of tax of $312, $145, $607 and $(38),respectively		508		235			987		23
Other – foreign currency translation adjustment		71		(651	)		1,212		(491	)
Total	$	24,007	$	13,550		$	69,423	$	49,103

14. STOCK REPURCHASE

During the three months ended August 31, 2009, we did not repurchase any of our common stock.  In the nine months ended August 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 nine months ended August 31, 2008, we repurchased 231 and 418 shares of our common stock for $13,773 and $26,327 at an average price per share of $59.65 and $62.94, respectively.  The repurchased shares were retired and returned to unissued.  Effective September 30, 2009 our Board of Directors increased the authorization to repurchase our common stock to a total of $100,000, see Note 19.

15. RETIREMENT PLANS AND POSTRETIREMENT HEALTH CARE BENEFITS

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 August 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 nine months ended August 31, 2009 and 2008 included the following components:

	For the Three Months Ended August 31,						For the Nine Months Ended August 31,
	2009			2008			2009			2008
Interest cost	$	146		$	152		$	437		$	457
Amortization of loss		46			–			139			–
Expected return on plan assets		(170	)		(234	)		(510	)		(703	)
Net periodic pension cost (benefit)	$	22		$	(82	)	$	66		$	(246	)

No employer contributions were made for the nine months ended August 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 fourth by the IRS.  We make matching contributions of 25% on the first 6% of contributed compensation.  The cost of the matching contribution totaled $78 and $75 for the three months ended August 31, 2009 and 2008, respectively, and $238 and $225 for the nine months ended August 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 $228 and $218 for the three months ended August 31, 2009 and 2008, respectively, and $703 and $675 for the nine months ended August 31, 2009

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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 nine months ended August 31, 2009 and 2008 included the following components:

	For the Three Months Ended August 31,					For the Nine Months Ended August 31,
	2009		2008			2009		2008
Service cost	$	2	$	5		$	5	$	16
Interest cost		14		14			42		42
Recognized net actuarial gain		–		(24	)		–		(72	)
Net periodic postretirement health cost (benefit)	$	16	$	(5	)	$	47	$	(14	)

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 estimated tax rate for the nine months ended August 31, 2009 and 2008 was 36.3% and 35.2%, respectively. The unrecognized tax benefit increased to $8,892 as of August 31, 2009. This increase consists primarily of the deduction of certain elements of compensation in our 2008 federal and state tax returns.

17. PRODUCT SEGMENT INFORMATION

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

	For the Three Months Ended August 31,				For the Nine Months Ended August 31,
	2009		2008		2009		2008
Medicated skin care	$	38,429	$	35,806	$	117,856	$	107,931
Topical pain care		26,023		24,192		72,380		74,279
Oral care		17,089		15,859		53,839		47,045
Internal OTC		11,307		12,149		34,357		36,633
Medicated dandruff shampoos		7,216		7,654		26,304		26,940
Dietary supplements		5,141		4,939		14,982		15,446
Other OTC and toiletry products		3,391		4,364		15,884		16,695
Total domestic net sales		108,596		104,963		335,602		324,969
International revenues		6,575		6,966		17,491		24,449
Total revenues	$	115,171	$	111,929	$	353,093	$	349,418

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18. COMMITMENTS AND CONTINGENCIES

GENERAL LITIGATION

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

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

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

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

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

We were 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

18

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 September 30, 2009, there were approximately 150 consumers with pending claims against us and five 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.  We responded to the motion on August 30, 2009 and LecTec filed a reply on September 30, 2009.  The motion is now before the court and we expect a ruling by the end of the year. The trial date is currently scheduled for January 4, 2011.  We are vigorously defending this lawsuit.

On July 31, 2009, Colgate-Palmolive Company filed a complaint in the U.S. District Court for the Southern District of New York alleging that our Act Total Care product infringes Colgate-Palmolive’s Total trademark.  The complaint seeks injunctive relief and damages.  We filed an answer on September 24, 2009 that denies all material allegations made in the complaint.  The case is not yet set for trial.

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

We maintain insurance coverage for product liability claims relating to our products under claims-made policies which are subject to annual renewal.  For the current annual policy period beginning September 1, 2009, we maintain product liability insurance coverage in the amount of $10,000 through our captive insurance subsidiary, of which approximately $2,107 has been funded as of September 30, 2009.  We also have $50,000 of excess coverage through our captive insurance subsidiary which is reinsured on a 50% quota share basis by a third party insurance carrier.

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

19

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.

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

20

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. SUBSEQUENT EVENTS

On September 8, 2009, we repurchased $6,975 of our 7.0% Subordinated Notes in open market transactions at a premium of 1.5% above the face amount of the 7.0% Subordinated Notes.  In connection with the repurchase of the 7.0% Subordinated Notes, we retired a proportional share of the related debt issuance costs.  The premium paid for the 7.0% Subordinated Notes combined with the early extinguishment of the proportional debt issuance costs resulted in a loss on extinguishment of debt of $411 that will be recorded in our fourth quarter of fiscal 2009.

Effective September 30, 2009, we entered into an amendment to our Credit Facility that, among other things, extends the maturity date of the revolving credit facility portion of our Credit Facility to January 2013, increases the applicable interest rates in the revolving credit facility portion of our Credit Facility and increases our flexibility to repurchase shares of our common stock and our 7.0% Subordinated Notes.  Borrowings under the revolving credit facility portion of our Credit Facility bears interest at LIBOR plus applicable percentages of 2.25% to 2.75% or the highest of the federal funds rate plus 0.50%, the prime rate, or the Eurodollar base rate plus 1.00% (the “Base Rate”), plus applicable percentages of 1.25% to 1.75%.  Borrowings under the term loan portion of our Credit Facility bear interest at either LIBOR plus 1.75% or the Base Rate plus 0.75%.

Effective September 30, 2009, in connection with the amendment to our Credit Facility, 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.  As of September 30, 2009, the current amount available under the authorization from the Board of Directors was $100,000.

We performed an evaluation of subsequent events through October 6, 2009.

20. CONSOLIDATING FINANCIAL STATEMENTS

The consolidating financial statements, for the dates or periods indicated, of Chattem, Inc.  (“Chattem”), Signal Investment & Management Co. (“Signal”), SunDex, LLC (“SunDex”) and Chattem (Canada) Holdings, Inc. (“Canada”), the guarantors of the long-term debt of Chattem, and the non-guarantor direct and indirect wholly-owned subsidiaries of Chattem are presented below.  Signal is 89% owned by Chattem and 11% owned by Canada.  SunDex and Canada are wholly-owned subsidiaries of Chattem.  The guarantees of Signal, SunDex and Canada are full and unconditional and joint and several.  The guarantees of Signal, SunDex and Canada as of August 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 August 31, 2009 is $203,620.

21

Note 20

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING BALANCE SHEETS

AUGUST 31, 2009

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	47,751		$	501		$	11,148		$	—		$	59,400
Accounts receivable, less allowances of $11,126		42,857			18,045			5,732			(18,045	)		48,589
Interest receivable		107			718			(90	)		(735	)		—
Inventories		36,883			1,506			3,947			—			42,336
Deferred income taxes		3,969			—			40			—			4,009
Prepaid expenses and other current assets		7,522			—			103			—			7,625
Total current assets		139,089			20,770			20,880			(18,780	)		161,959
PROPERTY, PLANT AND EQUIPMENT, NET		31,492			775			626			—			32,893
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net		2,628			674,057			1,561			(62,290	)		615,956
Debt issuance costs, net		9,340			—			—			—			9,340
Investment in subsidiaries		608,230			64,682			97,690			(770,602	)		—
Note receivable		—			34,694			—			(34,694	)		—
Other		2,609			—			—			—			2,609
Total other noncurrent assets		622,807			773,433			99,251			(867,586	)		627,905
TOTAL ASSETS	$	793,388		$	794,978		$	120,757		$	(886,366	)	$	822,757
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt	$	3,000		$	—		$	—		$	—		$	3,000
Accounts payable and other		13,359			—			1,387			—			14,746
Accrued liabilities		38,336			251			3,630			(18,782	)		23,435
Total current liabilities		54,695			251			5,017			(18,782	)		41,181
LONG-TERM DEBT, less current maturities		412,323			(17,203	)		36,494			(34,694	)		396,920
DEFERRED INCOME TAXES		(21,119	)		72,567			(1,242	)		—			50,206
OTHER NONCURRENT LIABILITIES		1,346			—			—			—			1,346
INTERCOMPANY ACCOUNTS		13,046			(20,528	)		7,482			—			—
SHAREHOLDERS’ EQUITY:
Preferred shares, without par value, authorized 1,000, none issued		—			—			—			—			—
Common shares, without par value, authorized 100,000, issued and outstanding 19,043		36,749			—			—			—			36,749
Shares of subsidiaries		—			641,659			78,999			(720,658	)		—
Dividends		—			(31,197	)		—			31,197			—
Retained earnings		298,454			147,735			(5,013	)		(142,722	)		298,454
		335,203			758,197			73,986			(832,183	)		335,203
Cumulative other comprehensive income (loss) net of tax
Interest rate hedge adjustment		(800	)		—			—			—			(800	)
Foreign currency translation adjustment		237			1,694			(980	)		(707	)		244
Unrealized actuarial gains and losses		(1,543	)		—			—			—			(1,543	)
Total shareholders’ equity		333,097			759,891			73,006			(832,890	)		333,104
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	793,388		$	794,978		$	120,757		$	(886,366	)	$	822,757

22

Note 20

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
Cumulative 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

23

Note 20

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF INCOME

FOR THE NINE MONTHS ENDED AUGUST 31, 2009

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED
TOTAL REVENUES	$	325,295		$	70,647		$	15,297		$	(58,146	)	$	353,093
COSTS AND EXPENSES:
Cost of sales		98,174			3,956			7,579			(2,556	)		107,153
Advertising and promotion		71,746			3,203			3,475			—			78,424
Selling, general and administrative		42,800			929			1,302			—			45,031
Product recall expenses		(509	)		—			509			—			—
Equity in subsidiary income		(37,381	)		—			—			37,381			—
Total costs and expenses		174,830			8,088			12,865			34,825			230,608
INCOME (LOSS) FROM OPERATIONS		150,465			62,559			2,432			(92,971	)		122,485
OTHER INCOME (EXPENSE):
Interest expense		(16,109	)		—			(2,028	)		2,062			(16,075	)
Investment and other income, net		173			2,063			2,006			(4,019	)		223
Loss on early extinguishment of debt		(1,101	)		—			—			—			(1,101	)
Royalties		(53,197	)		(2,384	)		(9	)		55,590			—
Corporate allocations		1,583			(1,431	)		(152	)		—			—
Intercompany R&D expense		2,727			(2,727	)		—			—			—
Total other income (expense)		(65,924	)		(4,479	)		(183	)		53,633			(16,953	)
INCOME (LOSS) BEFORE INCOME TAXES		84,541			58,080			2,249			(39,338	)		105,532
PROVISION FOR INCOME TAXES		17,317			20,145			846			—			38,308
NET INCOME (LOSS)	$	67,224		$	37,935		$	1,403		$	(39,338	)	$	67,224

24

Note 20

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF INCOME

FOR THE NINE MONTHS ENDED AUGUST 31, 2008

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED
TOTAL REVENUES	$	317,818		$	68,598		$	18,342		$	(55,340	)	$	349,418
COSTS AND EXPENSES:
Cost of sales		89,316			3,745			8,369			(2,303	)		99,127
Advertising and promotion		82,308			4,560			4,664			—			91,532
Selling, general and administrative		43,392			430			1,854			—			45,676
Litigation settlement		491			—			10,705			—			11,196
Product recall expenses		5,129			—			802			—			5,931
Equity in subsidiary income		(30,498	)		—			—			30,498			—
Total costs and expenses		190,138			8,735			26,394			28,195			253,462
INCOME (LOSS) FROM OPERATIONS		127,680			59,863			(8,052	)		(83,535	)		95,956
OTHER INCOME (EXPENSE):
Interest expense		(19,279	)		—			(1,927	)		1,913			(19,293	)
Investment and other income, net		87			1,922			2,141			(3,788	)		362
Loss on early extinguishment of debt		(526	)		—			—			—			(526	)
Royalties		(50,592	)		(2,444	)		—			53,036			—
Corporate allocations		1,543			(1,423	)		(120	)		—			—
Total other income (expense)		(68,767	)		(1,945	)		94			51,161			(19,457	)
INCOME (LOSS) BEFORE INCOME TAXES		58,913			57,918			(7,958	)		(32,374	)		76,499
PROVISION FOR INCOME TAXES		9,342			20,388			(2,802	)		—			26,928
NET INCOME (LOSS)	$	49,571		$	37,530		$	(5,156	)	$	(32,374	)	$	49,571

25

Note 20

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED AUGUST 31, 2009

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED
OPERATING ACTIVITIES:
Net income (loss)	$	67,224		$	37,935		$	1,403		$	(39,338	)	$	67,224
Adjustments to reconcile net income (loss) to net cash provided by (used in)operating activities:
Depreciation and amortization		5,559			—			112			—			5,671
Deferred income taxes		838			11,800			(3	)		—			12,635
Tax benefit realized from stock options exercised		(325	)		—			—			—			(325	)
Stock-based compensation		5,667			—			—			—			5,667
Loss on early extinguishment of debt		1,101			—			—			—			1,101
Other, net		116			—			(117	)		—			(1	)
Equity in subsidiary income		(39,338	)		—			—			39,338			—
Changes in operating assets and liabilities:
Accounts receivable		1,318			(1,819	)		(490	)		1,819			828
Interest receivable		1			(77	)		(1	)		77			—
Inventories		(1,049	)		305			(619	)		—			(1,363	)
Prepaid expenses and other current assets		(3,498	)		—			229			(1,905	)		(5,174	)
Accounts payable and accrued liabilities		(509	)		(448	)		(1,428	)		9			(2,376	)
Net cash provided by (used in) operating activities		37,105			47,696			(914	)		—			83,887
INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(3,645	)		—			22			—			(3,623	)
Decrease in other assets, net		843			—			1,143			—			1,986
Net cash (used in) provided by investing activities		(2,802	)		—			1,165			—			(1,637	)
FINANCING ACTIVITIES:
Repayment of long-term debt		(11,380	)		—			—			—			(11,380	)
Proceeds from borrowings under revolving credit facility		1,000			—			—			—			1,000
Repayments of revolving credit facility		(20,500	)		—			—			—			(20,500	)
Change in bank overdraft		(1,184	)		—			—			—			(1,184	)
Repurchase of common shares		(26,107	)		—			—			—			(26,107	)
Proceeds from exercise of stock options		2,587			—			—			—			2,587
Tax benefit realized from stock options exercised		325			—			—			—			325
Debt retirement costs		(18	)		—			—			—			(18	)
Intercompany debt proceeds (payments)		16,003			(16,003	)		—			—			—
Changes in intercompany accounts		1,427			(1,565	)		138			—			—
Dividends paid		29,240			(31,197	)		1,957			—			—
Net cash (used in) provided by financing activities		(8,607	)		(48,765	)		2,095			—			(55,277	)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		—			—			117			—			117
CASH AND CASH  EQUIVALENTS:
Increase (decrease) for the period		25,696			(1,069	)		2,463			—			27,090
At beginning of period		22,055			1,570			8,685			—			32,310
At end of period	$	47,751		$	501		$	11,148		$	—		$	59,400

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Note 20

CHATTEM, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED AUGUST 31, 2008

(Unaudited and in thousands)

	CHATTEM			GUARANTOR SUBSIDIARY COMPANIES			NON-GUARANTOR SUBSIDIARY COMPANIES			ELIMINATIONS			CONSOLIDATED
OPERATING ACTIVITIES:
Net income (loss)	$	49,571		$	37,530		$	(5,156	)	$	(32,374	)	$	49,571
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		6,208			—			108			—			6,316
Deferred income taxes		603			11,801			—			—			12,404
Tax benefit realized from stock options exercised		(2,342	)		—			—			—			(2,342	)
Stock-based compensation		4,281			—			—			—			4,281
Loss on early extinguishment of debt		526			—			—			—			526
Other, net		115			—			22			—			137
Equity in subsidiary income		(32,374	)		—			—			32,374			—
Changes in operating assets and liabilities:
Accounts receivable		(5,444	)		(442	)		(2,123	)		442			(7,567	)
Interest receivable		—			(15	)		—			15			—
Inventories		1,009			1,378			224			—			2,611
Prepaid expenses and other current assets		(5,843	)		—			108			(150	)		(5,885	)
Accounts payable and accrued liabilities		5,497			101			11,957			(307	)		17,248
Net cash provided by operating activities		21,807			50,353			5,140			—			77,300
INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(3,326	)		—			(241	)		—			(3,567	)
Decrease (increase) in other assets, net		(1,333	)		—			78			—			(1,255	)
Net cash used in investing activities		(4,659	)		—			(163	)		—			(4,822	)
FINANCING ACTIVITIES:
Repayment of long-term debt		(37,250	)		—			—			—			(37,250	)
Proceeds from borrowings under revolving credit facility		148,000			—			—			—			148,000
Repayments of revolving credit facility		(158,500	)		—			—			—			(158,500	)
Change in bank overdraft		(7,584	)		—			—			—			(7,584	)
Repurchase of common shares		(26,327	)		—			—			—			(26,327	)
Proceeds from exercise of stock options		4,487			—			—			—			4,487
Tax benefit realized from stock options exercised		2,342			—			—			—			2,342
Changes in intercompany accounts		2,977			1,903			(4,880	)		—			—
Dividends paid		50,623			(52,498	)		1,875			—			—
Net cash used in financing activities		(21,232	)		(50,595	)		(3,005	)		—			(74,832	)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		—			—			(22	)		—			(22	)
CASH AND CASH EQUIVALENTS:
(Decrease) increase for the period		(4,084	)		(242	)		1,950			—			(2,376	)
At beginning of period		4,685			590			10,132			—			15,407
At end of period	$	601		$	348		$	12,082		$	—		$	13,031

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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 22% of our total revenues for the nine months ended August 31, 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 nine months 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, Gold Bond Ultimate Concentrated Therapy, Cortizone-10 Cooling Gel, Cortizone-10 Easy Relief Applicator, Icy Hot No-Mess Applicator, Icy Hot Medicated Roll, Capzasin Quick Relief, Selsun Blue Itchy Dry Scalp and Dexatrim Max Slim Packs.

2.0% Convertible Notes

In December 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 nine 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.  Effective September 30, 2009, our board of directors increased the authorization back to a total of $100.0 million of our common stock under the terms of our existing stock repurchase program.

7.0% Senior Subordinated Notes Repurchase

During the third quarter of fiscal 2009, we repurchased $9.1 million of our 7.0% Senior Subordinated Notes (“7.0% Subordinated Notes) in open market transactions at an average premium of 0.2% above the face amount of the 7.0% Subordinated Notes.  In connection with the repurchase of the $9.1 million of 7.0% Subordinated Notes, we retired a proportional share of the related debt issuance costs.  The premium paid for the $9.1 million of 7.0% Subordinated Notes combined with the early extinguishment of the proportional debt issuance costs resulted in a loss on extinguishment of debt of $0.4 million in our third quarter of fiscal 2009.

Subsequent to August 31, we repurchased an additional $7.0 million of our 7.0% Subordinated Notes in open market transactions at a premium of 1.5% above the face amount of the 7.0% Subordinated Notes.  In connection with the repurchase of $7.0 million of the 7.0% Subordinated Notes, we retired a proportional share of the related debt issuance costs.  The premium paid for the $7.0 million of 7.0% Subordinated Notes combined with the early extinguishment of the proportional debt issuance costs resulted in a loss on extinguishment of debt of $0.4 million that will be recorded in our fourth quarter of fiscal 2009.

Credit Facility Amendment

Effective September 30, 2009, we entered into an amendment to our Credit Facility that, among other things, extends the maturity date of the revolving credit facility portion of our Credit Facility to January 2013, increases the applicable interest rates on the revolving credit facility portion of our Credit Facility and increases our flexibility to repurchase shares of our common stock and our 7.0% Subordinated Notes.

Manufacturing Expansion

During the third quarter of fiscal 2009, we began construction on a new manufacturing facility in Chattanooga, Tennessee that is expected to be completed during the fourth quarter of fiscal 2010.  The purpose of the facility is to allow for the internal manufacturing of ACT and other brands.

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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 August 31,						For the Nine Months Ended August 31,
	2009			2008			2009			2008
TOTAL REVENUES		100.0	%		100.0	%		100.0	%		100.0	%
COSTS AND EXPENSES:
Cost of sales		30.2			28.4			30.3			28.4
Advertising and promotion		19.8			23.9			22.2			26.2
Selling, general and administrative		13.3			13.4			12.8			13.0
Litigation settlement		–			10.0			–			3.2
Product recall (income) expenses		–			(0.1	)		–			1.7
Total costs and expenses		63.3			75.6			65.3			72.5
INCOME FROM OPERATIONS		36.7			24.4			34.7			27.5
OTHER INCOME (EXPENSE):
Interest expense		(4.4	)		(5.5	)		(4.6	)		(5.5	)
Investment and other income, net		–			0.1			0.1			0.1
Loss on early extinguishment of debt		(0.4	)		–			(0.3	)		(0.2	)
Total other income (expense)		(4.8	)		(5.4	)		(4.8	)		(5.6	)
INCOME BEFORE INCOME TAXES		31.9			19.0			29.9			21.9
PROVISION FOR INCOME TAXES		11.6			6.5			10.9			7.7
NET INCOME		20.3	%		12.5	%		19.0	%		14.2	%

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 nine months ended August 31, 2009.

Allowance for Doubtful Accounts

As of August 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 third quarter of fiscal 2009, we performed a detailed assessment of the collectibility of trade accounts receivable and did not make any significant adjustments to our estimate of allowance for doubtful accounts.  The balance of allowance for doubtful accounts was $0.5 million and $0.4 million at August 31, 2009 and November 30, 2008, respectively.

Revenue Recognition

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

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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 or evidence of its destruction.

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.

Our estimate of product returns for seasonal and non-seasonal products as of August 31, 2009 was $2.8 million and $1.0 million, respectively, and $1.4 million and $1.3 million, respectively, as of November 30, 2008.  For the nine months ended August 31, 2009, we increased our estimate of returns for seasonal products by approximately $1.4 million, which resulted in a decrease to net sales in our consolidated financial statements, and decreased our estimate for non-seasonal returns by approximately $0.3 million, which resulted in an increase to net sales in our consolidated financial statements.  During the nine months ended August 31, 2008, we increased our estimate of returns for seasonal products by approximately $1.9 million,  which resulted in a decrease to net sales in our consolidated financial statements, and decreased our estimate of returns for non-seasonal products by approximately $0.3 million, which resulted in an increase to net sales in our consolidated financial statements.  Each percentage point change in the seasonal and non-seasonal return rate would impact net sales by approximately $0.2 million and $0.6 million, respectively, for the nine months ended August 31, 2009.

We routinely enter into agreements with customers to participate in promotional programs.  The costs of these programs are 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 accrual for outstanding coupons by utilizing a third-party clearinghouse to track coupons issued, coupon value, distribution and expiration dates, quantity distributed and estimated redemption rates that are provided by us.  We estimate the redemption rates of issued coupons based on internal analysis of historical coupon redemption rates and expected future retail sales by considering recent point of sale data.  The estimate for vendor allowances is based on estimated unit sales of a product under a program and amounts committed for such programs in each fiscal year.  Estimated unit sales are determined by considering customer forecasted sales, point of sale data and the nature of the program being offered.  The three most recent years of expected program payments versus actual payments made and current year retail point of sale trends are analyzed to determine future expected payments.  Customer delays in requesting promotional program payments due to their audit of program participation and resulting request for reimbursement is also considered to evaluate the accrual for vendor allowances.  The costs of these programs are often variable based on the number of units actually sold.  As of August 31, 2009, the accrued liability related to coupon redemption and reserve for vendor allowances was $2.0 million and $5.6 million, respectively, and $1.8 million and $5.1 million, respectively, as of August 31, 2008.  Each percentage point change in promotional program participation and advertising and promotion expense would impact net sales by $0.2 million and an insignificant amount, respectively, for the nine months ended August 31, 2009.

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

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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 estimated tax rate for the nine months ended August 31, 2009 and 2008 was 36.3% and 35.2%, respectively.

Accounting for Acquisitions and Intangible Assets

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

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

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

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

Our intangible assets consist of exclusive brand licenses, trademarks and other intellectual property, customer relationships and non-compete agreements.  We have determined that our trademarks have indefinite useful lives, as cash flows from the use of the trademarks are expected to be generated indefinitely. The useful lives of our intangible assets are reviewed as circumstances dictate 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 in the quarter ended November 30, 2008.  No impairment or adjustment to the carrying value of our indefinite-lived intangible assets was required as a result of this testing.

Fair Value Measurements

On December 1, 2007, we adopted SFAS 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.

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

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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 August 31, 2009 and 2008

To facilitate discussion of our operating results for the three months ended August 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	$	108,596	$	104,963	$	3,633			3.5	%
International revenues (including royalties)		6,575		6,966		(391	)		(5.6	)
Total revenues		115,171		111,929		3,242			2.9
Cost of sales		34,765		31,753		3,012			9.5
Advertising and promotion expense		22,866		26,789		(3,923	)		(14.6	)
Selling, general and administrative expense		15,275		15,024		251			1.7
Litigation settlement		–		11,196		(11,196	)		(100.0	)
Product recall income		–		112		(112	)		(100.0	)
Interest expense		5,126		6,176		(1,050	)		(17.0	)
Loss on early extinguishment of debt		405		–		405			100.0
Net  income		23,428		13,966		9,462			67.8

Domestic Net Sales

Domestic net sales for the three months ended August 31, 2009 increased $3.6 million, or 3.5%, to $108.6 million from $105.0 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	$	38,429	$	35,806	$	2,623			7.3	%
Topical pain care		26,023		24,192		1,831			7.6
Oral care		17,089		15,859		1,230			7.8
Internal OTC		11,307		12,149		(842	)		(6.9	)
Medicated dandruff shampoos		7,216		7,654		(438	)		(5.7	)
Dietary supplements		5,141		4,939		202			4.1
Other OTC and toiletry products		3,391		4,364		(973	)		(22.3	)
Total	$	108,596	$	104,963	$	3,633			3.5

Net sales in the medicated skin care category increased $2.6 million, or 7.3%, in the third quarter of fiscal 2009 compared to the prior year quarter, primarily as a result of the launch of Gold Bond Ultimate Concentrated Therapy in the third quarter of fiscal 2009,  the launches 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 partially offset by a decrease in our Gold Bond powder business.

Net sales in the topical pain care category increased $1.8 million, or 7.6%, in the third quarter of fiscal 2009 compared to the prior year quarter, primarily as a result of the second quarter launch of Icy Hot Medicated Roll and first quarter launch of Icy Hot No-Mess Applicator in fiscal 2009. The increase was partially offset by lower sales of Aspercreme and certain other smaller brands in the category, reduced product count at certain retail customers and the reduction of our estimate of Icy Hot Pro Therapy returns in the third quarter of fiscal 2008.

Net sales in the oral care category increased $1.2 million, or 7.8%, in the third quarter of fiscal 2009 compared to the prior year quarter as a result of 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 $0.8 million, or 6.9%, in the third quarter of fiscal 2009 compared to the prior year quarter due to increased competitive pressure from private label brands within the category and decreased distribution at certain retail customers of certain of our products within this category.

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Net sales in the medicated dandruff shampoos category decreased $0.4 million, or 5.7%, in the third quarter of fiscal 2009 compared to the prior year quarter, primarily resulting from a decline in sales of Selsun Salon products due to distribution changes in connection with the launch and initial sell-in of Selsun Blue Itchy Dry Scalp in the first quarter of fiscal 2009.

Net sales in the dietary supplements category increased $0.2 million, or 4.1%, in the third quarter of fiscal 2009 compared to the prior year quarter, primarily as a result of the growth of Dexatrim Max Complex 7, partially offset by a decline in sales of Garlique.

Net sales in the other OTC and toiletry products category decreased $1.0 million, or 22.3%, in the third quarter of fiscal 2009 compared to the prior year quarter, primarily as a result of the timing of shipments of Bullfrog.

Domestic sales variances were principally the result of changes in unit sales volume with the exception of certain selected products for which we implemented a unit sales price increase in December 2008 and the $1.8 million increase in 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 August 31, 2009 as compared to the same year ago period.

International Revenues

For the third quarter of fiscal 2009, international revenues decreased $0.4 million, or 5.6%, compared to the prior year quarter, primarily as a result of unfavorable exchange rates that decreased revenues by approximately $0.6 million and the unfavorable macro-economic conditions in the markets where our products are sold, partially offset by successful product launches in the Canadian market.

Cost of Sales

Cost of sales in the third quarter of fiscal 2009 was 30.2% as a percentage of total revenues compared to 28.4% in the prior year quarter and gross margin for the same period of fiscal 2009 was 69.8% compared to 71.6% 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 of promotional programs by retailers 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 third quarter of fiscal 2009 decreased $3.9 million, or 14.6%, compared to the prior year quarter and were 19.8% of total revenues in the third quarter of fiscal 2009 compared to 23.9% for the prior year quarter.  The decrease in advertising and promotion expense was a result of greater utilization of promotional programs by retailers 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 product sampling programs, partially offset by an increase in marketing research expenses.

Selling, General and Administrative Expense

Selling, general and administrative expenses in the third quarter of fiscal 2009 increased $0.3 million, or 1.7%, compared to the prior year quarter.  Selling, general and administrative expenses were 13.3% and 13.4% of total revenues for the third quarter of fiscal 2009 and 2008, respectively.  The decrease in selling, general and administrative expenses as a percentage of total revenues was attributable to reduced transportation costs related to outbound product shipments.

Litigation Settlement

During the third quarter of fiscal 2008, we reached a settlement on all 26 known claims alleging pulmonary arterial hypertension as a result of the ingestion of Dexatrim products in 1998 through 2003.  Included as litigation settlement in the consolidated statements of income is the settlement of the 26 claims totaling $13.3 million and $0.5 million of legal expenses, which was partially offset by $2.6 million funded with proceeds of the Dexatrim litigation settlement trust.  There was no corresponding charge in the third quarter of fiscal 2009.

Product Recall Income

Product recall income in the third quarter of fiscal 2008 represented a $0.6 million adjustment to reduce the estimated charges that were initially recorded related to the voluntary recall of Icy Hot Heat Therapy initiated in February 2008, offset by legal fees and settlement payments of approximately $0.5 million incurred during the quarter.  There was no corresponding charge in the third quarter of fiscal 2009.

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Interest Expense

Interest expense decreased $1.1 million, or 17.0%, in the third quarter of fiscal 2009 compared to the prior year quarter reflecting the repayment of $22.5 million in principal outstanding under our Credit Facility since August 31, 2008, the exchange of 487,123 shares of our common stock for $28.7 million of the 2.0% Convertible Notes in December 2008 and the repurchase of $9.1 million of our 7.0% Subordinated Notes in the third quarter of fiscal 2009.  Until our indebtedness is reduced substantially, interest expense will continue to represent a significant percentage of our total revenues.

Loss on Early Extinguishment of Debt

During the third quarter of fiscal 2009, we repurchased $9.1 million of our 7.0% Subordinated Notes in open market transactions at an average premium of 0.2% above the face amount of the 7.0% Subordinated Notes.  In connection with the repurchase of the 7.0% Subordinated Notes, we retired a proportional share of the related debt issuance costs.  The premium paid for the $9.1 million of 7.0% Subordinated Notes combined with the early extinguishment of the proportional debt issuance costs resulted in a net loss on extinguishment of debt of $0.4 million.  There was no corresponding charge in the third quarter of fiscal 2008.

Comparison of Nine Months Ended August 31, 2009 and 2008

To facilitate discussion of our operating results for the nine months ended August 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	$	335,602	$	324,969	$	10,633			3.3	%
International revenues (including royalties)		17,491		24,449		(6,958	)		(28.5	)
Total revenues		353,093		349,418		3,675			1.1
Cost of sales		107,153		99,127		8,026			8.1
Advertising and promotion expense		78,424		91,532		(13,108	)		(14.3	)
Selling, general and administrative expense		45,031		45,676		(645	)		(1.4	)
Litigation settlement		–		11,196		(11,196	)		(100.0	)
Product recall expenses		–		5,931		(5,931	)		(100.0	)
Interest expense		16,075		19,293		(3,218	)		(16.7	)
Loss on early extinguishment of debt		1,101		526		575			109.3
Net income		67,224		49,571		17,653			35.6

Domestic Net Sales

Domestic net sales for the nine months ended August 31, 2009 increased $10.6 million, or 3.3%, as compared to the corresponding period of 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	$	117,856	$	107,931	$	9,925			9.2	%
Topical pain care		72,380		74,279		(1,899	)		(2.6	)
Oral care		53,839		47,045		6,794			14.4
Internal OTC		34,357		36,633		(2,276	)		(6.2	)
Medicated dandruff shampoos		26,304		26,940		(636	)		(2.4	)
Dietary supplements		14,982		15,446		(464	)		(3.0	)
Other OTC and toiletry products		15,884		16,695		(811	)		(4.9	)
Total	$	335,602	$	324,969	$	10,633			3.3

Net sales in the medicated skin care category increased $9.9 million, or 9.2%, for the first nine months of fiscal 2009 compared to the same period in fiscal 2008, primarily as a result of the launch of Gold Bond Ultimate Concentrated Therapy in the third quarter to fiscal 2009, the launches of Gold Bond Anti-Itch Lotion, Gold Bond Foot Pain Cream, Gold Bond Ultimate

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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 partially offset by a decrease in our Gold Bond powder business.  

Net sales in the topical pain care category decreased $1.9 million, or 2.6%, for the first nine 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, lower sales of Aspercreme and certain other smaller brands in the category, reduced product count at certain retail customers and the reduction of our estimate of Icy Hot Pro Therapy returns in the third quarter of fiscal 2008. The decrease was 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 were generally unchanged compared to the prior year period.

Net sales in the oral care category increased $6.8 million, or 14.4%, for the first nine months of fiscal 2009 compared to the same period in fiscal 2008 as a result of 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 $2.3 million, or 6.2%, for the first nine months of fiscal 2009 compared to the same period in fiscal 2008 primarily as a result of increased competitive pressure from private label brands within the category, the lack of new products in fiscal 2009 similar to the first quarter launch of Unisom Sleepmelts in fiscal 2008 and decreased distribution at certain retail customers of certain products within this category.

Net sales in the medicated dandruff shampoos category decreased $0.6 million, or 2.4%, for the first nine months of fiscal 2009 compared to the same period in fiscal 2008 primarily resulting from a decline in sales of Selsun Salon products as a result of 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 $0.5 million, or 3.0%, for the first nine months of fiscal 2009 compared to the same period in fiscal 2008, primarily as a result of a decline in sales of Garlique and Sunsource, 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 decreased $0.8 million, or 4.9%, for the first nine months of fiscal 2009 compared to the same period in fiscal 2008, primarily due to reduced sales of certain smaller brands in the category.

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 $8.5 million increase in 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 nine month period ended August 31, 2009 as compared to the same year ago period.

International Revenues

For the nine months ended August 31, 2009, international revenues decreased $7.0 million, or 28.5%, 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, unfavorable exchange rates that decreased revenues by approximately $2.3 million and the unfavorable macro-economic conditions in the markets where our products are sold.  We are in the process of identifying new distributors for the affected markets and are also converting the packaging for the major products sold in these markets to local Spanish language.

Cost of Sales

Cost of sales for the nine months ended August 31, 2009 was 30.3% 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 69.7% 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 of promotional programs by retailers 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 nine months ended August 31, 2009 decreased $13.1 million, or 14.3%, compared to the same period in fiscal 2008 and were 22.2% of total revenues for the nine months ended August 31, 2009 as compared to 26.2% for the same period in fiscal 2008. The decrease in advertising and promotion expense was a result of greater utilization of promotional programs by retailers to reduce product prices to consumers, the costs of which are recorded as

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a reduction of total revenues rather than advertising and promotion expense, and reduced product sampling programs, partially offset by an increase in marketing research expenses.

Selling, General and Administrative Expense

Selling, general and administrative expenses for the nine months ended August 31, 2009 decreased $0.6 million, or 1.4%, compared to the same period of fiscal 2008 and were 12.8% and 13.0% of total revenues for the nine months ended August 31, 2009 and 2008, respectively. The decrease in selling, general and administrative expenses as a percentage of total revenues was attributable to favorable foreign currency translation adjustments resulting from intercompany transactions and reduced transportation costs related to outbound product shipments.

Litigation Settlement

During the third quarter of fiscal 2008, we reached a settlement on all 26 known claims alleging pulmonary arterial hypertension as a result of the ingestion of Dexatrim products in 1998 through 2003.  Included as litigation settlement in the consolidated statements of income is the settlement of the 26 claims totaling $13.3 million and $0.5 million of legal expenses, which was partially offset by $2.6 million funded with proceeds from the Dexatrim litigation settlement trust.  There was no corresponding charge in fiscal 2009.

Product Recall Expenses

The $5.9 million of product recall expenses in the first nine months of fiscal 2008 relates to the voluntary recall of our Icy Hot Heat Therapy product initiated in February 2008.  The product recall expenses include product returns, inventory obsolescence, destruction costs, consumer refunds, legal fees, settlement payments and other estimated expenses.  The estimate was made by management based on consideration of on-hand inventory and retail point of sales data at the time of the initial recall and was adjusted during the third quarter of fiscal 2008.  There was no corresponding charge in fiscal 2009.

Interest Expense

Interest expense decreased $3.2 million, or 16.7%, for the nine months ended August 31, 2009 compared to the same period for fiscal 2008 reflecting the repayment of $22.5 million in principal outstanding under our Credit Facility since August 31, 2008, the exchange of 487,123 shares of our common stock for $28.7 million of the 2.0% Convertible Notes in December 2008 and the repurchase of $9.1 million of our 7.0% Subordinated Notes in the third quarter of fiscal 2009.  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 third quarter of fiscal 2009, we repurchased $9.1 million of our 7.0% Subordinated Notes in open market transactions at an average premium of 0.2% above the face amount of the 7.0% Subordinated Notes.  In connection with the repurchase of the 7.0% Subordinated Notes, we retired a proportional share of the related debt issuance costs.  The premium paid for the $9.1 million of 7.0% Subordinated Notes combined with the early extinguishment of the proportional debt issuance costs resulted in a net loss on extinguishment of debt of $0.4 million recorded in the third 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 $83.9 million and $77.3 million was provided by operating activities for the nine months ended August 31, 2009 and 2008, respectively.  The increase in cash flows from operating activities over the prior year period was primarily attributable to

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increased net income, offset by changes in our working capital balances as compared to the similar working capital balances as of November 30, 2008.

Investing activities used cash of $1.6 million and $4.8 million in the nine months ended August 31, 2009 and 2008, respectively.  Cash flow used in investing activities primarily resulted from the purchase of manufacturing equipment and the initial expenditures necessary for the construction of a new manufacturing facility being constructed in Chattanooga, Tennessee.

Financing activities used cash of $55.3 million and $74.8 million in the nine months ended August 31, 2009 and 2008, respectively.  Cash flow used in financing activities in fiscal 2009 was used to repay $21.8 million outstanding under the Credit Facility, repurchase $9.1 million of our 7.0% Subordinated Notes and the repurchase of 491,392 shares of our common stock.  Cash flow used in financing activities in fiscal 2008 was used to repay $47.8 million of principal outstanding under the Credit Facility and the repurchase of 418,281 shares of our common stock.

As of August 31, 2009, our total debt was $399.9 million, consisting of $98.4 million of the 7.0% Subordinated Notes, $96.3 million of the 2.0% Convertible Notes, $100.0 million of the 1.625% Convertible Notes and $105.3 million outstanding under the term loan portion of our Credit Facility.  As of August 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.  As of September 30, 2009, we had no borrowings outstanding under the revolving credit facility portion of our Credit Facility and our borrowing capacity was $100.0 million.

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

Foreign Operations

Historically, our primary foreign operations have been through our Canadian and United Kingdom (“U.K.”) subsidiaries.  Our European business is conducted through Chattem Global Consumer Products Limited, a wholly-owned subsidiary located in Limerick, Ireland.   In connection with the acquisition of ACT in Western Europe in May 2007, we established Chattem Greece, a wholly-owned subsidiary located in Alimos Attica, Greece.  In November 2008, we established Chattem Peru SRL (“Chattem Peru”), a wholly-owned subsidiary located in Lima, Peru.  Chattem Peru utilizes third party distributors to sell certain of our Selsun Blue products throughout Peru.  The functional currencies of these subsidiaries are Canadian dollars, British pounds, Euros and Peruvian Sol, respectively.  Fluctuations in exchange rates can impact operating results, including total revenues and expenses, when translations of the subsidiary financial statements are made in accordance with SFAS No. 52, “Foreign Currency Translation”.  For the nine months ended August 31, 2009 and 2008, these subsidiaries accounted for 5% and 7% of total revenues, respectively, and 2% and 2% of total assets, respectively.  It has not been our practice to hedge our assets and liabilities or our intercompany transactions due to the inherent risks associated with foreign currency hedging transactions and the timing of payments between us and our foreign subsidiaries.  Historically, gains or losses from foreign currency transactions have not had a material impact on our operating results.  A gain of $0.5 million and loss of $0.3 million resulting from foreign currency transactions for the nine months ended August 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 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 March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 requires enhanced disclosures about an entity’s derivative and hedging activities. SFAS 161 amends and expands the disclosure requirements of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, with the intent to provide users of financial statements adequate information about how derivative and hedging activities affect an entity’s financial position, financial performance and cash flows. SFAS 161 is effective

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for quarterly interim periods beginning after November 15, 2008 and fiscal years that include those quarterly interim periods. We have included all disclosures as required by SFAS 161, none of which have a material impact on our financial statements.

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 for the fiscal years ended November 30, 2009 and 2008 by approximately $6,600 and $7,200 (or $0.22 and $0.25 per share), respectively.  The additional non-cash interest expense is expected to increase each fiscal year 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 April 2009, the FASB issued FSP No. 107-1 and Accounting Principles Board (“APB”) 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP 107-1”). FSP 107-1, which requires disclosures about the fair value of financial instruments in interim financial statements as well as in annual financial statements, was effective for us for the quarter ended August 31, 2009. The adoption of FSP 107-1 did not have a material impact on our financial statements.

In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”), which provides general standards of accounting for and disclosure of subsequent events. SFAS No. 165 clarifies that management must evaluate, as of each reporting period (i.e. interim and annual), events or transactions that occur after the balance sheet date through the date the financial statements for such reporting periods are issued. It also requires management to disclose the date through which subsequent events have been evaluated and whether that is the date on which the financial statements were issued. Statement 165 is effective prospectively for interim or annual financial periods ending after June 15, 2009. The Company adopted SFAS No. 165 in the third quarter of fiscal 2009.

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, 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;

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

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

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• 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 consist 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.  Effective September 30, 2009, borrowings under the revolving credit facility portion of our Credit Facility bear interest at LIBOR plus applicable percentages of 2.25% to 2.75% or the highest of the federal funds rate plus 0.50%, the prime rate, or the Eurodollar base rate plus 1.00% (the “Base Rate”), plus applicable percentages of 1.25% to 1.75%.  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 September 30, 2009, we had no borrowings outstanding under the revolving credit facility portion of our Credit Facility and $104.5 million was outstanding under the term loan portion of our Credit Facility, of which $76.3 million was bearing interest at LIBOR plus 1.75% and $28.2 million was bearing interest at the Base Rate plus 0.75%.  The weighted average variable rate for the term loan was 2.72%.  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 August 31, 2009, the decrease in fair value for the nine months ended August 31, 2009 of $1.0 million, net of tax, was recorded to cumulative other comprehensive income and the swap was deemed to be an effective cash flow hedge as of August 31, 2009 and expires on January 15, 2010.

The impact on our results of operations of a one-point rate change on the September 30, 2009 outstanding $104.5 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 quarter-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 $1.5 million as of August 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 August 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.

There was no change in internal control over financial reporting during the quarter ended August 31, 2009 that has affected our internal control over financial reporting.

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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 fiscal year ended November 30, 2008.

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

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

Period	Total Number of Shares Purchased		Average Price Paid Per Share (1)		Total Number of Shares Purchased as Part of Publicly Announced Plans or  Programs (2)		Approximate Dollar Value that may yet be Purchased under the Plans or  Programs (2)
June 1– June 30		–	$	–		–	$	47,806,121
July 1 – July 31		–		–		–		47,806,121
August 1 – August 31		–		–		–		47,806,121
Total Third Quarter		–	$	–		–	$	47,806,121

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

(2)   On September 30, 2009, 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

None.

Item 5. Other Information

Effective September 30, 2009, we entered into a seventh amendment (the “Seventh Amendment”) to our amended Credit Facility, with Signal, SunDex and Canada, as guarantors, the Lenders (as defined in the amended Credit Facility) party thereto, and Bank of America, N.A., as agent for the Lenders. Under the terms of the Seventh Amendment, the maturity date of the revolving credit facility portion of the amended Credit Facility has been extended to January 2, 2013, which is also the maturity date of the term loan portion of the amended Credit Facility. In addition, the Seventh Amendment, among other things, (i) increases the applicable interest rates for borrowings under the revolving credit facility portion of the amended Credit Facility (which will bear interest at (x) LIBOR plus applicable percentages of 2.25% to 2.75% or (y) the highest of the federal funds rate plus 0.50%, the prime rate, or the Eurodollar base rate plus 1.00% (the “Base Rate”) plus applicable percentages of 1.25% to 1.75%) and the fees payable by us (which will range from 0.375% to 0.500%) with respect to unused revolving loan commitments, and (ii) modifies certain covenants which increases our flexibility to repurchase shares of our common stock and our 7.0% Subordinated Notes.

After giving effect to the Seventh Amendment, the amended Credit Facility continues to provide for up to $100,000,000 of revolving loan borrowing capacity, with the ability to increase such capacity by up to $50,000,000, and a term loan, of which $105,250,000 was outstanding as of August 31, 2009. Borrowings under the term loan portion of the amended Credit Facility bear interest at either LIBOR plus 1.75% or the Base Rate plus 0.75%. Except as set forth in the Seventh Amendment, the covenants and events of default contained in the amended Credit Facility, which are customary in credit agreements and security instruments relating to financings of this type, remain unchanged as a result of our entry into the Seventh Amendment.

The foregoing summary description of the Seventh Amendment is qualified in its entirety by reference to the full text of the Seventh Amendment, which is attached hereto as Exhibit 10.1 and incorporated by reference herein.

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Item 6. Exhibits

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

Exhibit Number	Description
10.1	Seventh Amendment to Credit Agreement, dated as of September 30, 2009, among Chattem, Inc., its domestic subsidiaries, identified lenders and Bank of America, N.A., as agent
31.1	Certification required by Rule 13a-14(a) under the Securities Exchange Act of 1934
31.2	Certification required by Rule 13a-14(a) under the Securities Exchange Act of 1934
32	Certification required by Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350

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CHATTEM, INC.

SIGNATURES

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

	CHATTEM, INC.
	(Registrant)
Dated: October 6, 2009	By:	/s/ Zan Guerry
		Zan Guerry
		Chairman and Chief Executive Officer

Dated: October 6, 2009	By:	/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
10.1	Seventh Amendment to Credit Agreement, dated as of September 30, 2009, among Chattem, Inc., its domestic subsidiaries, identified lenders and Bank of America, N.A., as agent
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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