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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549




FORM 10-Q




QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934



FOR THE QUARTERLY PERIOD ENDED FEBRUARY 28, 2003
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








REGISTRANT 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, AND HAS BEEN
SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS.

THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN RULE 12b-2 OF THE EXCHANGE
ACT).

AS OF APRIL 11, 2003 19,112,345 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 February 28, 2003 and
November 30, 2002 .................................................. 3

Consolidated Statements of Income for the Three
Months Ended February 28, 2003 and 2002............................. 5

Consolidated Statements of Cash Flows for the Three Months Ended
February 28, 2003 and 2002.......................................... 6

Notes to Consolidated Financial Statements ........................... 7

Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ............................................ 22

Item 3. Quantitative and Qualitative Disclosures About Market Risks.... 29

Item 4. Controls and Procedures........................................ 30

PART II. OTHER INFORMATION

Item 1. Legal Proceedings............................................... 31

Item 6. Exhibits and Reports on Form 8-K .............................. 31

SIGNATURES ............................................................... 32













2


PART 1. FINANCIAL INFORMATION
-----------------------------

ITEM 1. FINANCIAL STATEMENTS
- ----------------------------

CHATTEM, INC. AND SUBSIDIARIES
------------------------------

CONSOLIDATED BALANCE SHEETS
---------------------------
(In thousands)


FEBRUARY 28, NOVEMBER 30,
ASSETS 2003 2002
- ------ -------- --------
(Unaudited)

CURRENT ASSETS:
Cash and cash equivalents ..................................... $ 20,726 $ 15,924
Accounts receivable, less allowance for doubtful accounts
of $1,089 at February 28, 2003 and $962 at
November 30, 2002 ............................................ 32,443 25,673
Refundable and deferred income taxes .......................... 10,831 9,837
Inventories ................................................... 19,885 18,769
Prepaid expenses and other current assets ..................... 1,931 2,184
-------- --------
Total current assets ........................................ 85,816 72,387
-------- --------

PROPERTY, PLANT AND EQUIPMENT, NET .............................. 27,339 26,658
-------- --------

OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net ... 245,702 245,787
Debt issuance costs, net ...................................... 6,753 7,126
Other ......................................................... 2,912 3,605
-------- --------
Total other noncurrent assets ............................... 255,367 256,518
-------- --------

TOTAL ASSETS .............................................. $368,522 $355,563
======== ========






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



3


CHATTEM, INC. AND SUBSIDIARIES
------------------------------

CONSOLIDATED BALANCE SHEETS
---------------------------
(In thousands)



FEBRUARY 28, NOVEMBER 30,
LIABILITIES AND SHAREHOLDERS' EQUITY 2003 2002
- ------------------------------------ --------- ---------
(Unaudited)

CURRENT LIABILITIES:
Current maturities of long-term debt ..................... $ 7,750 $ 7,250
Accounts payable ......................................... 10,493 12,209
Payable to bank .......................................... 1,984 452
Accrued liabilities ...................................... 30,342 21,104
--------- ---------
Total current liabilities .............................. 50,569 41,015
--------- ---------

LONG-TERM DEBT, less current maturities ..................... 215,200 217,458
--------- ---------

DEFERRED INCOME TAXES ....................................... 22,540 20,744
--------- ---------

OTHER NONCURRENT LIABILITIES ................................ 1,622 1,602
--------- ---------

COMMITMENTS AND CONTINGENCIES (Note 10)


SHAREHOLDERS' EQUITY:
Preferred shares, without par value, authorized 1,000,
none issued ............................................. -- --
Common shares, without par value, authorized 50,000,
issued 19,108 at February 28, 2003 and 19,177 at
November 30, 2002 ....................................... 78,074 79,313
Retained earnings (deficit) .............................. 3,492 (1,097)
--------- ---------
81,566 78,216
Unamortized value of restricted common shares issued ...... (1,580) (1,713)
Cumulative other comprehensive income:
Foreign currency translation adjustment ................. (1,395) (1,759)
--------- ---------
Total shareholders' equity ............................. 78,591 74,744
--------- ---------

TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY ............................................ $ 368,522 $ 355,563
========= =========





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









4



CHATTEM, INC. AND SUBSIDIARIES
------------------------------

CONSOLIDATED STATEMENTS OF INCOME
---------------------------------
(Unaudited and in thousands, except per share amounts)



FOR THE THREE MONTHS ENDED
FEBRUARY 28,
-------------------------
2003 2002
-------- --------

REVENUES:
Net sales .............................................. $ 58,125 $ 48,414
Royalties .............................................. 300 --
-------- --------
Total revenues ....................................... $ 58,425 $ 48,414
-------- --------

COSTS AND EXPENSES:
Cost of sales .......................................... 17,691 14,461
Advertising and promotion .............................. 18,405 15,874
Selling, general and administrative .................... 9,814 9,537
-------- --------
Total costs and expenses ............................. 45,910 39,872
-------- --------

INCOME FROM OPERATIONS ................................... 12,515 8,542
-------- --------

OTHER INCOME (EXPENSE):
Interest expense ....................................... (5,147) (4,841)
Investment and other income, net ....................... 34 106
-------- --------
Total other income (expense) ......................... (5,113) (4,735)
-------- --------

INCOME BEFORE INCOME TAXES
AND CHANGE IN ACCOUNTING PRINCIPLE ..................... 7,402 3,807

PROVISION FOR INCOME TAXES ............................... 2,813 1,435
-------- --------

INCOME BEFORE CHANGE IN ACCOUNTING PRINCIPLE ............. 4,589 2,372

CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE, NET OF INCOME TAX
BENEFIT (Note 2) ....................................... -- (8,877)
-------- --------

NET INCOME (LOSS) ........................................ $ 4,589 $ (6,505)
======== ========

NUMBER OF COMMON SHARES:
Weighted average outstanding - basic ................... 19,165 17,928
======== ========
Weighted average and potential dilutive outstanding .... 19,949 18,637
======== ========

NET INCOME (LOSS) PER COMMON SHARE:
Basic:
Income before change in accounting principle .......... $ .24 $ .13
Change in accounting principle ........................ -- (.49)
-------- --------
Total basic ......................................... $ .24 $ (.36)
======== ========
Diluted:
Income before change in accounting principle .......... $ .23 $ .13
Change in accounting principle ........................ -- (.48)
-------- --------
Total diluted ....................................... $ .23 $ (.35)
======== ========



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

5



CHATTEM, INC. AND SUBSIDIARIES
------------------------------

CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
(Unaudited and in thousands)


FOR THE THREE MONTHS ENDED
FEBRUARY 28,
-------------------------
2003 2002
-------- --------

OPERATING ACTIVITIES:
Net income (loss) ................................................ $ 4,589 $ (6,505)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization ................................ 1,499 1,263
Deferred income tax provision ................................ 952 1,024
Cumulative effect of change in accounting principle, net ..... -- 8,877
Stock option charge .......................................... -- 131
Other, net ................................................... (129) 143
Changes in operating assets and liabilities:
Accounts receivable ........................................ (6,770) (7,254)
Refundable income taxes .................................... -- 1,031
Inventories ................................................ (1,116) (1,260)
Prepaid expenses and other current assets .................. 253 287
Accounts payable and accrued liabilities ................... 7,522 6,299
-------- --------
Net cash provided by operating activities ............... 6,800 4,036
-------- --------

INVESTING ACTIVITIES:
Purchases of property, plant and equipment ....................... (1,464) (510)
Decrease in other assets, net .................................... 955 392
-------- --------
Net cash used in investing activities ................... (509) (118)
-------- --------

FINANCING ACTIVITIES:
Repayment of long-term debt ...................................... (1,750) --
Proceeds from exercise of stock options .......................... 160 115
Repurchase of common shares ...................................... (1,579) (630)
Change in payable to bank ........................................ 1,532 1,865
-------- --------
Net cash provided by (used in) financing activities ...... (1,637) 1,350
-------- --------

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND
CASH EQUIVALENTS ................................................. 148 (107)
-------- --------

CASH AND CASH EQUIVALENTS:
Increase for the period .......................................... 4,802 5,161
At beginning of period ........................................... 15,924 35,445
-------- --------
At end of period ................................................. $ 20,726 $ 40,606
======== ========

PAYMENTS FOR:
Interest ......................................................... $ 383 $ 39
Taxes ............................................................ $ 6 $ 81


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







6


CHATTEM, INC. AND SUBSIDIARIES
------------------------------

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
(UNAUDITED)

All monetary amounts are expressed in thousands of dollars unless contrarily
evident. Unless otherwise indicated the number of shares of our common stock and
related per share computations included in these financial statements and notes
thereto have been adjusted to reflect the two-for-one split of our common stock
on November 29, 2002.

1. The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and the instructions to Form 10-Q and Rule
10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. These consolidated financial
statements should be read in conjunction with the audited consolidated
financial statements and related notes thereto included in our Annual
Report on Form 10-K for the year ended November 30, 2002. 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. In June 2001 the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill
and Other Intangible Assets" ("SFAS 142"). The provisions of SFAS 142,
which were adopted by us on December 1, 2001, require us to discontinue
the amortization of the cost of intangible assets with indefinite lives
and to perform certain fair value based tests of the carrying value of
indefinite lived intangible assets. Accordingly, we discontinued the
amortization of the cost of these intangible assets. Also in connection
with the adoption of SFAS 142, we obtained independent appraisals to
determine the fair values of these intangible assets at December 1, 2001
and compared their fair values with their carrying values to determine the
write-down of $8,877, net of income tax benefit of $5,440, or $.48 per
diluted share. The write-down was primarily related to our SUNSOURCE
product line which has experienced a decline in sales volume since its
initial purchase in 1997 and to a lesser degree our DEXATRIM product line,
which discontinued the marketing of one of its products in November 2000.
This adjustment is shown as a cumulative effect of change in accounting
principle in the consolidated statement of income for the three months
ended February 28, 2002. After reviewing all pertinent information
relating to the revaluation of these intangible assets and performing the
annual impairment test as prescribed by SFAS 142, we determined that a
revaluation thereof was not required at this time.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 62, Amendment of FASB Statement No. 13, and
Technical Corrections" ("SFAS 145"). SFAS 145, which was adopted by us
effective December 1, 2002, will require us to classify gains and losses
on extinguishments of debt as income or loss from continuing operations
rather than as extraordinary items as previously required under FASB
Statement No. 4. We will also be required to reclassify any gain or loss
on extinguishment of debt previously classified as an extraordinary item
in prior periods presented. Our results of operations, financial position
and cash flows, therefore, will not be affected.

On December 31, 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure" ("SFAS 148"). SFAS
148, which was adopted by us on December 1, 2002, amends SFAS 123,
"Accounting for Stock-Based Compensation" and Accounting Principles Board
Opinion No. 28, "Interim Financial Reporting", to require disclosure in
the summary of significant accounting policies of the effects of an
entity's accounting policy with respect to stock-based employee
compensation on reported net income and earnings per share in annual and
interim financial statements. The adoption of this pronouncement did not
have an impact on our results of operations, financial position or cash
flows.

3. We incur significant expenditures on television, radio and print
advertising to support our nationally branded over-the-counter ("OTC")
health care products. Customers purchase products from us with the
understanding that the brands will be supported by our extensive media
advertising. This advertising supports the retailers'

7


sales effort and maintains the important brand franchise with the
consuming public. Accordingly, we consider our advertising program to be
clearly implicit in our sales arrangements with our customers. Therefore,
we believe it is appropriate to allocate a percentage of the necessary
supporting advertising expenses to each dollar of sales by charging a
percentage of sales on an interim basis based upon anticipated annual
sales and advertising expenditures (in accordance with Accounting
Principles Board Opinion No. 28) and adjusting that accrual to the actual
expenses incurred at the end of the year.

4. Shipping and handling costs of $1,458 and $1,517 are included in selling
expenses for the three months ended February 28, 2003 and 2002,
respectively.

5. Inventories consisted of the following at February 28, 2003 and November
30, 2002:

2003 2002
---------- ----------
Raw materials and work in process $ 10,277 $ 9,104
Finished goods ............................ 11,335 11,392
Excess of current cost over LIFO
values .................................. (1,727) (1,727)
---------- ----------
Total inventories ..................... $ 19,885 $ 18,769
========== ==========

6. Accrued liabilities consisted of the following at February 28, 2003 and
November 30, 2002:

2003 2002
---------- ----------
Interest................................... $ 7,759 $ 3,366
Salaries, wages and commissions............ 1,266 3,739
Product advertising and promotion.......... 13,771 7,524
Product acquisitions and divestitures...... 737 737
Taxes...................................... 3,512 1,993
Consulting fees............................ 745 747
Legal fees................................. 139 789
Insurance.................................. 1,310 934
Other ..................................... 1,103 1,275
---------- ----------
Total accrued liabilities ............. $ 30,342 $ 21,104
========== ==========

7. Comprehensive income (loss) consisted of the following components for the
three months ended February 28, 2003 and 2002, respectively:

2003 2002
---------- ----------
Net income (loss).......................... $ 4,589 $ (6,505)
Other - foreign currency
translation adjustment................... 364 (194)
---------- ----------
Total comprehensive income (loss) $ 4,953 $ (6,699)
========== ==========

8. In fiscal 1999 and 2000 our board of directors authorized repurchases of
our common stock not to exceed $20,000. Under these authorizations
1,142,200 shares, before the two-for-one split of our common stock on
November 29, 2002, had been reaquired through November 30, 2002 at a cost
of $15,225. In January 2003, our board of directors increased to $10,000
the total authorization to repurchase our common stock under the buyback
program. In the first quarter of 2003, we repurchased 103,000 shares of
our common stock for $1,579. All repurchased shares were retired and
returned to unisssued. At February 28, 2003,

8


$8,421 of our current authorization was available for future repurchases.
We, however, are limited in our ability to repurchase shares due to
restrictions under the terms of the indenture with respect to which our
8.875% Notes were issued and under the terms of our current credit
facility.

9. On January 22, 2002, Kmart Corporation ("Kmart"), a customer of ours
representing approximately 5% of fiscal 2001 consolidated revenues, filed
a petition under Chapter 11 of the United States Bankruptcy Code. This
bankruptcy filing did not impact our results of operations and financial
position for fiscal 2001. At the time of the filing Kmart owed us
approximately $1,200. In the first quarter of fiscal 2002 we established
an allowance for doubtful accounts of $1,000 to cover our estimated bad
debt related to Kmart. In the second quarter of fiscal 2002 we sold our
receivable from Kmart to a financial institution for $367. We continue to
sell to Kmart Corporation at decreased volume levels and as of February
28, 2003 our receivables from Kmart were approximately $755.

10. We were named as a defendant in a lawsuit brought by the Center for
Environment Health ("CEH") contending that we violated the California Safe
Drinking Water and Toxic Enforcement Act of 1998 (Proposition 65) by
selling to California consumers, without a warning, topical skin care
products containing zinc oxide which in turn contains lead. The lawsuit
contended that the purported failure to comply with Proposition 65
requirements also constituted a violation of the California Business &
Professions Code. Violations of either Proposition 65 or the California
Business and Professions Code render a defendant liable for civil
penalties of up to $2.5 per day per violation.

We were also named as a defendant in a lawsuit filed on December 29, 1999,
JOHNSON et al. v. BRISTOL-MYERS SQUIBB CO., et al. This was a putative
class action brought by two named plaintiffs on behalf of the general
public in California, against the same entities that are defendants in the
CEH lawsuit. As with the CEH lawsuit, the Johnson lawsuit alleged that we
violated Proposition 65 by selling to California consumers without a
warning topical skin care products containing zinc oxide which in turn
contains lead. The lawsuit did not assert claims directly under
Proposition 65, but asserted that the alleged failure to comply with
Proposition 65 gave rise to claims under California's Business and
Professions Code and the California Civil Code. The lawsuit sought
injunctive and equitable relief, restitution, the disgorgement of
allegedly wrongfully obtained revenues and damages.

The plaintiffs in the two separate actions filed a consolidated amended
complaint that included a claim based upon the allegation that zinc oxide
allegedly also contains cadmium. During the third quarter of fiscal 2002 a
settlement was finalized among the parties for these two cases pending
final court approval. Final court approval of the settlement is expected
during our second quarter of fiscal 2003. In the settlement, we paid an
amount that was within the expected range that had been previously accrued
by us. The settlement amount was not material to our results of
operations.

As of April 10, 2003, we have been named as a defendant in approximately
318 lawsuits involving claims by approximately 1,473 plaintiffs 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. Most of the lawsuits
seek an unspecified amount of compensatory and exemplary damages or
punitive damages. The lawsuits that are federal cases have now been
transferred to the United States District Court for the Western District
of Washington (In re Phenylpropanolamine (PPA) Products Liability
Litigation, MDL No. 1407). The remaining cases are state court cases which
have been filed in a number of different states.

We anticipate that additional lawsuits will be filed with similar or other
allegations related to our DEXATRIM products containing PPA. None of these
lawsuits has, to date, been resolved by settlement or judicial ruling. The
earliest scheduled trial date of any of these cases is May 19, 2003. It is
anticipated that certain state court cases will be set for trial during
the course of the year and that significant evidentiary and other hearings
will be held during the course of the year in the federal cases.

Approximately half of the existing suits represent cases involving alleged
injuries by products manufactured and sold prior to our acquisition of
DEXATRIM in December 1998. We are being defended and are indemnified from
liability by The DELACO Company, Inc. ("DELACO"), successor to Thompson

9


Medical Company, Inc. which owned DEXATRIM prior to December 1998. We
understand that DELACO maintains product liability insurance coverage for
products manufactured and sold prior to December 1998 with annual limits
of coverage and has an excess liability policy, but otherwise has only
nominal assets. Accordingly, it is unlikely that DELACO will be able to
indemnify us beyond its insurance coverage. In addition, there can be no
assurance that the insurance maintained by DELACO will be sufficient to
cover claims related to products manufactured or sold prior to our
acquisition of DEXATRIM. Our product liability insurance, as described
more fully below, would not apply to claims arising from products
manufactured and sold prior to our acquisition of DEXATRIM.

Of the existing lawsuits, about two-thirds of the cases make non-specific
factual allegations against a broad group of PPA manufacturers. There are
approximately 20 identified cases which we currently believe contain
allegations that the plaintiff suffered a hemorrhagic stroke within three
days of ingesting DEXATRIM products containing PPA that were sold after
our acquisition of DEXATRIM in December 1998. As additional lawsuits are
filed and discovery in the existing lawsuits continues, we expect to know
more about the characteristics of the cases, which will result in a
fluctuation in the number of cases ascribed to the categories listed
above.

In addition, we have also been named as a defendant in a lawsuit alleging
that the plaintiff was injured as a result of the ingestion of DEXATRIM
containing ephedrine. Our available insurance for the defense of this
lawsuit, as described below, is $35,000. We discontinued the manufacturing
and shipment of DEXATRIM containing ephedrine on September 20, 2002.

We are aggressively defending these lawsuits. It is too early in the
litigation to evaluate fully the risks that these lawsuits pose, or
express a range of likely outcomes. It is also too early to estimate the
number of lawsuits related to DEXATRIM with PPA or DEXATRIM with ephedrine
that will be filed or whether our available insurance will be sufficient
to cover these claims. If these lawsuits result in liabilities greater
than our insurance coverage, we may not have sufficient resources to
satisfy these obligations.

We currently maintain product liability insurance, principally through
third party insurers, that provides coverage for product liability claims,
including those asserted in the lawsuits currently pending and anticipated
to be filed against us relating to the existence of PPA in DEXATRIM. We
have $102,000 of product liability insurance coverage for injuries related
to DEXATRIM containing PPA occurring after our acquisition of DEXATRIM in
December 1998 and prior to May 31, 2001, if the claims are made before May
31, 2004. Injuries occurring before December 1998 or after May 31, 2001,
or claims made after May 31, 2004, would not be covered by these insurance
policies. We currently have one claim in which there are multiple PPA
manufacturers as defendants that relates to injuries occurring after May
31, 2001. We believe we have meritorious defenses to this claim. Our
insurance policies are subject to certain other limitations that are
generally customary for policies of this type.

We maintain a significantly lower level of insurance coverage for all
other potential claims relating to our products, including DEXATRIM
products containing ephedrine. Our product liability insurance coverage
for all of our other products, including DEXATRIM products containing
ephedrine, consists of $2,000 of coverage through a third party insurer,
$8,000 of self-insured coverage through our captive insurance subsidiary,
of which approximately $1,500 is currently funded, and $25,000 of excess
coverage through a third party insurer.

We have also been named as a defendant in a lawsuit brought in the State
of California by Citizens for Responsible Business, Inc. under the
California Business and Professional Code. The lawsuit charges that our
alleged failure to comply with newly-added provisions of the Federal Food,
Drug, and Cosmetic Act with respect to the labeling of products purported
to contain "ginseng," constitutes a violation of the Code. Numerous other
retail and manufacturing companies were also named as defendants in the
suit. This lawsuit was settled in March 2003 with payment of the
settlement amount to be made by May 1, 2003. The settlement amount is not
material to our results of operations. Under the terms of the settlement,
the plaintiffs will provide a general release to us and all of our
suppliers, distributors and retailers with respect to all of our products,
while we are prohibited from shipping after July 1, 2003 products
containing "Siberian Ginseng" that do not comply with the new labeling
requirements.

10


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

In 1994, the Nonprescription Drug Manufacturers Association (now the
Consumer Healthcare Products Association) ("CHPA") initiated a large-scale
study in conjunction with the Yale University School of Medicine to
investigate a possible association, if any, of stroke in women aged 18 to
49 using PPA which, until November 2000, was the active ingredient in
certain of the DEXATRIM products (the "Yale Study"). PPA was also used in
numerous other OTC medications, which were also part of the Yale Study. In
May 2000, the results of the Yale Study were filed with the Food and Drug
Administration ("FDA"). The investigators concluded that the results of
the Yale Study suggest that PPA increases the risks of hemorrhagic stroke.
The FDA indicated at that time that no immediate action was required and
scheduled a FDA advisory panel to meet in October 2000 to discuss the
results of the study.

On October 19, 2000, a Nonprescription Drugs Advisory Committee ("NDAC"),
commissioned by the FDA to review the safety of PPA, determined that there
is an association between PPA and hemorrhagic stroke and recommended that
PPA not be considered generally recognized as safe for OTC use as a nasal
decongestant or for weight control. In response to a request from the FDA
to cease voluntarily marketing DEXATRIM with PPA, we announced on November
7, 2000 our decision to cease immediately shipping DEXATRIM with PPA and
to accept product returns from any retailers who decide to discontinue
marketing DEXATRIM with PPA.

The FDA, the Drug Enforcement Administration and a number of state and
local governments have enacted or proposed restrictions or prohibitions on
the sale of products that contain ephedrine. Ephedrine can refer to the
herbal substance derived from the plant ephedra or the plant heart leaf,
which, until September 2002, was used in the manufacturing of some forms
of DEXATRIM Natural and DEXATRIM Results, or synthetic ephedrine, a FDA
regulated ingredient used in some OTC drug products, which has not been
used in our products. These restrictions include the prohibition of OTC
sales, required warnings or labeling statements, record keeping and
reporting requirements, the prohibition of sales to minors, per
transaction limits on the quantity of product that may be purchased and
limitations on advertising and promotion. The enactment of further
restrictions or prohibitions on sales, the perceived safety concerns
related to ephedrine and the possibility of further regulatory action
could result in an increase in the number of ephedrine related lawsuits
filed, including ones in which we are named as a defendant. In late 2000,
the FDA requested the National Institutes of Health to commission a review
of the safety and efficacy of ephedrine in herbal products used to control
weight. In response to this request, a report issued on February 28, 2003
by the RAND-based Southern California Evidence-Based Practice Center for
the U.S. Department of Health and Human Services Agency for Healthcare
Research and Quality (the "RAND Report") concluded that ephedrine,
ephedrine plus caffeine and ephedra-containing dietary supplements with or
without herbs containing caffeine all promote modest amounts of weight
loss over the short term and use of ephedra or ephedrine plus caffeine is
associated with an increased risk of gastrointestinal, psychiatric and
autonomic symptoms. The adverse event reports contained a smaller number
of more serious adverse events. Given the small number of such events, the
RAND Report concluded that further study would be necessary to determine
whether consumption of ephedra or ephedrine may be causally related to
these serious adverse events. In September 2001, the Public Citizen Health
Research Group petitioned the FDA to ban the production and sale of
dietary supplements containing ephedrine alkaloids. To date, the
Department of Health and Human Services, which oversees the FDA, and the
FDA have not reached a final decision on the petition.

We have developed alternative formulations for DEXATRIM Natural and
DEXATRIM Results to exclude ephedrine and discontinued the manufacturing
and shipment of DEXATRIM products containing ephedrine in September 2002.
Our DEXATRIM products containing ephedrine may continue to be sold in the
trade until our customers' existing supply of inventory is exhausted or
until the products are returned to us. Negative

11


publicity relating to the possible harmful effects of ephedrine and the
possibility of further regulatory action to restrict or prohibit the sale
of products containing ephedrine could result in a return of products from
retailers or our decision to accept product returns of DEXATRIM with
ephedrine, for which we have provided a $750 allowance in the first
quarter of fiscal 2003.

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, seeking 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 thus should be included in the FDA's
yet-to-be finalized monograph for external analgesics. We have met with
the FDA and submitted a proposed protocol study to evaluate the efficacy
of 10% trolamine salicylate as an active ingredient in OTC external
analgesic drug products. Based on comments received from the FDA at the
meeting, we may revise and resubmit the protocol. After we receive final
comments from the FDA, we expect that it will take one or two years to
produce the clinical data for FDA review. The FDA could finalize the OTC
external analgesic monograph before the protocol and clinical data results
are finalized, which would place 10% trolamine salicylate in non-monograph
status, thus requiring the submission of a new drug application to market
and sell OTC products with 10% trolamine salicylate. This submission would
likely require us to provide clinical data, which would be expensive. We
are working to develop alternate formulations for SPORTSCREME and
ASPERCREME in the event that the FDA does not consider the available
clinical data to conclusively demonstrate the efficacy of trolamine
salicylate when the OTC external analgesic monograph is finalized. If 10%
trolamine salicylate is not included in the final monograph, we would
likely be required to discontinue these products as currently formulated
and remove them from the market after expiration of an anticipated grace
period. If this occurred, we believe we could still market these products
as homeopathic products, and could also reformulate them using ingredients
approved in the FDA monograph.

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.
Selenium sulfide, an ingredient in SELSUN BLUE, is on the state's list as
a carcinogen. Although we are not aware of any action that has been
brought with respect to selenium sulfide under Proposition 65, it is
possible that such a claim could be brought, in which case we would be
required to demonstrate that exposure to selenium sulfide in SELSUN BLUE,
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 the product
to acceptable levels of selenium sulfide.

11. Certain prior year amounts have been reclassified to conform to the
current period's presentation.

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

13. On March 28, 2002, we completed the acquisition of SELSUN BLUE, a line of
medicated dandruff shampoos, from Abbott Laboratories for $75,000, plus
inventories of $1,380 and assumed liabilities of $1,178. This acquisition
includes worldwide rights (except India) to manufacture, sell and market
SELSUN BLUE plus related intellectual property and certain manufacturing
equipment. Abbott Laboratories will continue to manufacture the product
for us until June 2003 domestically, or such earlier date as we move
production to our Chattanooga, Tennessee facilities, and until March 2004
internationally, or such earlier date as we enter into our own agreements
with contract manufacturers. Most of our SELSUN BLUE domestic product
lines are presently being manufactured at our Chattanooga facilities. We
generally pay Abbott a fee of 10% over standard manufacturing costs until
we assume manufacturing or enter into third party agreements. We also rely
on Abbott to market, sell and distribute SELSUN BLUE products in most
foreign countries until we satisfy various foreign regulatory
requirements, new distributors are in place and any applicable marketing
permits are transferred. During the marketing transition period, Abbott
will initially pay us a royalty equal to 28% of international sales of
SELSUN BLUE in these countries with the royalty

12


reduced to 14% of international sales in certain countries if foreign
regulatory requirements are satisfied prior to our assumption of sales and
marketing responsibility in such countries. Abbott will pay all costs and
expenses related to the manufacture, marketing and sales of SELSUN BLUE in
these countries. As we assume responsibility for the sales and marketing
effort in a country, the royalty arrangement with respect to such country
will terminate and we will record these international sales directly, as
well as the costs and expenses associated with these sales.

The following table summarizes our estimate of how the results for SELSUN
BLUE international for the three months ended February 28, 2003 would have
been presented had the transition period been finalized on the date of
acquisition:

SELECTED SELSUN BLUE INTERNATIONAL DATA (Unaudited)

For the Three Months Ended
February 28, 2003
-----------------

NET SALES................................... $ 3,110
-----------

COSTS AND EXPENSES:
Cost of sales............................. 1,205
Advertising and promotion................. 460
Selling, general and administrative....... 1,145
-----------
Total costs and expenses................ 2,810
-----------

INCOME FROM OPERATIONS...................... $ 300
===========

The following unaudited consolidated pro forma information assumes the
acquisition of SELSUN BLUE had occurred at the beginning of the period
presented:

PRO FORMA CONSOLIDATED RESULTS OF OPERATIONS (Unaudited)

For the Three Months
Ended February 28, 2002
-----------------------

Total revenue............................... $ 59,145
Income before change in accounting
principle................................. 2,913
Net loss.................................... (5,964)
Earnings per share - basic:
Income before change in accounting
principle................................. 0.16
Net loss.................................. (0.33)
Earnings per share - diluted:
Income before change in accounting
principle................................. 0.16
Net loss.................................. (0.32)

14. Also on March 28, 2002, we obtained a $60,000 senior secured credit
facility from a syndicate of commercial banks led by Bank of America,
N.A., as agent (the "Credit Facility"). The Credit Facility includes a
$15,000 revolving credit facility and a $45,000 term loan. The Credit
Facility together with our

13


available cash was used to finance the acquisition of SELSUN BLUE and was
used to provide working capital for general corporate purposes. The
$45,000 term loan and any outstanding loans under the revolving credit
facility mature on March 28, 2007. The Credit Facility is secured by the
stock of our domestic subsidiaries and all of our present and future
assets, excluding real property. 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. At February 28, 2003, we owed $18,250 under this credit
facility.

15. Our 1993 Non-Statutory Stock Option Plan provides for issuance of up to
700,000 shares of common stock to key employees. In addition, our 1994
Non-Statutory Stock Option Plan and the 1994 Non-Statutory Stock Option
Plan for Non-Employee Directors provide for the issuance of up to 700,000
and 160,000 shares, respectively, of common stock. Our 1998 Non-Statutory
Stock Option Plan provides for issuance of up to 1,400,000 shares of
common stock to key employees, while the 1999 Non-Statutory Stock Option
Plan for Non-Employee Directors allows issuance of up to 200,000 shares of
common stock. The 2000 Non-Statutory Stock Option Plan provides for the
issuance of up to 1,500,000 shares of common stock. The 2003 Stock
Incentive Plan, which was adopted by our board of directors on January 21,
2003 and is pending approval from our shareholders at the April 16, 2003
annual shareholders' meeting, provides for the issuance of up to 1,500,000
shares of common stock. Options vest ratably over four years and are
exercisable for a period of up to ten years from the date of grant.

For SFAS No. 123 purposes, as amended by SFAS 148, the fair value of each
option grant has been estimated as of the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions for grants in 2003 and 2002: expected dividend yield of 0%,
expected volatility of 64% and 65%, risk-free interest rates of 3.95% and
5.34% and expected lives of six years. (See "Recent Accounting
Pronouncements" for a description of the provisions of SFAS 148.)

Had compensation expense for stock option grants been determined based on
the fair value at the grant dates consistent with the method prescribed by
SFAS No. 123, our net income (loss) and net income (loss) per share would
have been adjusted to the pro forma amounts for the three months ended
February 28, 2003 and 2002 as indicated below:

2003 2002
-------- --------
Net income (loss):
As reported.............................. $ 4,589 $ (6,505)
Compensation cost........................ 168 395
-------- --------
Pro forma................................ $ 4,421 $ (6,900)
======== ========
Net income (loss) per share, basic:
As reported.............................. $ .24 $ (.36)
Pro forma................................ $ .23 $ (.38)

Net income (loss) per share, diluted:
As reported.............................. $ .23 $ (.35)
Pro forma................................ $ .22 $ (.37)

16. The condensed consolidating financial statements, for the dates or periods
indicated, of Chattem, Inc. ("Chattem"), Signal Investment & Management
Co. ("Signal") and SunDex, LLC ("SunDex"), the guarantors of the long-term
debt of Chattem, and the non-guarantor wholly-owned subsidiaries of
Chattem are presented below. Signal and SunDex are wholly-owned
subsidiaries of Chattem; the guarantee of Signal and SunDex is full and
unconditional and joint and several. The guarantee of Signal and Sundex as
of February 28, 2003 arose in conjunction with Chattem's issuance of the
8.875% Senior Subordinated Notes on March 24, 1998 (the "8.875% Notes")
and the $60,000 senior secured credit facility (the "Credit Facility")
obtained by Chattem on March 28, 2002. The guarantees' terms match the
terms of the 8.875%

14


Notes and the Credit Facility. The maximum amount of future payments the
guarantors would be required to make under the guarantee as of February
28, 2003 is $222,950.



























15

Note 16
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING BALANCE SHEETS
----------------------------
FEBRUARY 28, 2003
-----------------
(Unaudited and in thousands)


NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL SUNDEX COMPANIES DR. (CR.) CONSOLIDATED
------- ------ ------ --------- ---------- ------------

ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents ...................... $ 15,562 $ 430 $ 5 $ 4,729 $ -- $ 20,726
Accounts receivable, less allowance for doubtful
accounts of $1,089 ........................... 28,063 -- -- 4,380 -- 32,443
Refundable and deferred income taxes ........... 10,784 -- -- 47 -- 10,831
Inventories .................................... 13,602 -- 3,009 3,274 -- 19,885
Prepaid expenses and other current assets ...... 1,820 -- -- 111 -- 1,931
--------- --------- --------- --------- --------- ---------
Total current assets ......................... 69,831 430 3,014 12,541 -- 85,816
--------- --------- --------- --------- --------- ---------

PROPERTY, PLANT AND EQUIPMENT, NET ............... 26,236 -- 775 328 -- 27,339
--------- --------- --------- --------- --------- ---------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product
rights, net .................................. 1,312 182,100 62,290 -- -- 245,702
Debt issuance costs, net ....................... 6,753 -- -- -- -- 6,753
Investment in subsidiaries ..................... 70,714 -- -- -- (70,714) --
Other .......................................... 2,899 -- -- 13 -- 2,912
--------- --------- --------- --------- --------- ---------
Total other noncurrent assets ................ 81,678 182,100 62,290 13 (70,714) 255,367
--------- --------- --------- --------- --------- ---------

TOTAL ASSETS ............................... $ 177,745 $ 182,530 $ 66,079 $ 12,882 $ (70,714) $ 368,522
========= ========= ========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Current maturities of long-term debt ........... $ 7,750 $ -- $ -- $ -- $ -- $ 7,750
Accounts payable ............................... 9,362 -- -- 1,131 -- 10,493
Payable to bank ................................ 1,984 -- -- -- -- 1,984
Accrued liabilities ............................ 29,715 -- -- 627 -- 30,342
--------- --------- --------- --------- --------- ---------
Total current liabilities .................... 48,811 -- -- 1,758 -- 50,569
--------- --------- --------- --------- --------- ---------

LONG-TERM DEBT, less current maturities .......... 215,200 -- -- -- -- 215,200
--------- --------- --------- --------- --------- ---------

DEFERRED INCOME TAXES ............................ (1,069) 23,609 -- -- -- 22,540
--------- --------- --------- --------- --------- ---------

OTHER NONCURRENT LIABILITIES ..................... 1,622 -- -- -- -- 1,622
--------- --------- --------- --------- --------- ---------

INTERCOMPANY ACCOUNTS ............................ (166,244) 167,145 (3,286) 2,385 -- --
--------- --------- --------- --------- --------- ---------

SHAREHOLDERS' EQUITY:
Preferred shares, without par value, authorized
1,000, none issued ........................... -- -- -- -- -- --
Common shares, without par value, authorized
50,000, issued 19,108 ........................ 78,074 2 63,065 7,647 70,714 78,074
Retained earnings (deficit) .................... 3,403 (8,226) 6,300 2,015 -- 3,492
--------- --------- --------- --------- --------- ---------
Total ........................................ 81,477 (8,224) 69,365 9,662 70,714 81,566
Unamortized value of restricted common shares
issued ....................................... (1,580) -- -- -- -- (1,580)
Cumulative other comprehensive income:
Foreign currency translation adjustment ....... (472) -- -- (923) -- (1,395)
--------- --------- --------- --------- --------- ---------
Total shareholders' equity (deficit) ......... 79,425 (8,224) 69,365 8,739 70,714 78,591
--------- --------- --------- --------- --------- ---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY ..................... $ 177,745 $ 182,530 $ 66,079 $ 12,882 $ 70,714 $ 368,522
========= ========= ========= ========= ========= =========


16


Note 16
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING BALANCE SHEETS
----------------------------
NOVEMBER 30, 2002
-----------------
(In thousands)

NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL SUNDEX COMPANIES DR. (CR.) CONSOLIDATED
------- ------ ------ --------- ---------- ------------

ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents ...................... $ 11,505 $ 1,133 $ 5 $ 3,281 $ -- $ 15,924
Accounts receivable, less allowance for doubtful
accounts of $962 ............................. 21,585 -- -- 4,088 -- 25,673
Refundable and deferred income taxes ........... 9,791 -- -- 46 -- 9,837
Inventories .................................... 12,734 -- 3,139 2,896 -- 18,769
Prepaid expenses and other current assets ...... 2,064 -- -- 120 -- 2,184
--------- --------- --------- --------- --------- ---------
Total current assets ......................... 57,679 1,133 3,144 10,431 -- 72,387
--------- --------- --------- --------- --------- ---------

PROPERTY, PLANT AND EQUIPMENT, NET ............... 25,567 -- 775 316 -- 26,658
--------- --------- --------- --------- --------- ---------
OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product
rights, net .................................. 1,397 182,100 62,290 -- -- 245,787
Debt issuance costs, net ....................... 7,126 -- -- -- -- 7,126
Investment in subsidiaries ..................... 70,714 -- -- -- (70,714) --
Other .......................................... 3,590 -- -- 15 -- 3,605
--------- --------- --------- --------- --------- ---------
Total other noncurrent assets ................ 82,827 182,100 62,290 15 (70,714) 256,518
--------- --------- --------- --------- --------- ---------

TOTAL ASSETS ............................... $ 166,073 $ 183,233 $ 66,209 $ 10,762 $ (70,714) $ 355,563
========= ========= ========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Current maturities of long-term debt ........... $ 7,250 $ -- $ -- $ -- $ -- $ 7,250
Accounts payable ............................... 10,957 -- -- 1,252 -- 12,209
Payable to bank ................................ 452 -- -- -- -- 452
Accrued liabilities ............................ 20,015 -- -- 1,089 -- 21,104
--------- --------- --------- --------- --------- ---------
Total current liabilities .................... 38,674 -- -- 2,341 -- 41,015
--------- --------- --------- --------- --------- ---------

LONG-TERM DEBT, less current maturities .......... 217,458 -- -- -- -- 217,458
--------- --------- --------- --------- --------- ---------

DEFERRED INCOME TAXES ............................ (1,065) 21,809 -- -- -- 20,744
--------- --------- --------- --------- --------- ---------

OTHER NONCURRENT LIABILITIES ..................... 1,602 -- -- -- -- 1,602
--------- --------- --------- --------- --------- ---------

INTERCOMPANY ACCOUNTS ............................ (169,271) 170,530 (1,803) 544 -- --
--------- --------- --------- --------- --------- ---------

SHAREHOLDERS' EQUITY:
Preferred shares, without par value, authorized
1,000, none issued ........................... -- -- -- -- --
Common shares, without par value, authorized
50,000, issued 19,177 ........................ 79,313 2 63,065 7,647 70,714 79,313
Retained earnings (deficit) .................... 1,563 (9,108) 4,947 1,501 -- (1,097)
--------- --------- --------- --------- --------- ---------
Total ........................................ 80,876 (9,106) 68,012 9,148 70,714 78,216
Unamortized value of restricted common shares
issued ....................................... (1,713) -- -- -- -- (1,713)
Cumulative other comprehensive income:
Foreign currency translation adjustment ....... (488) -- -- (1,271) -- (1,759)
--------- --------- --------- --------- --------- ---------
Total shareholders' equity (deficit) ......... 78,675 (9,106) 68,012 7,877 70,714 74,744
--------- --------- --------- --------- --------- ---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY .................... $ 166,073 $ 183,233 $ 66,209 $ 10,762 $ 70,714 $ 355,563
========= ========= ========= ========= ========= =========


17


Note 16
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING STATEMENTS OF INCOME
----------------------------------
FOR THE THREE MONTHS FEBRUARY 28, 2003
--------------------------------------
(Unaudited and in thousands)

NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL SUNDEX COMPANIES DR. (CR.) CONSOLIDATED
------- ------ ------ --------- ---------- ------------

TOTAL REVENUES ...................... $ 44,235 $ -- $ 9,573 $ 4,617 $ -- $ 58,425
--------- --------- --------- --------- --------- ---------
COSTS AND EXPENSES:
Cost of sales ..................... 13,050 -- 2,701 1,940 -- 17,691
Advertising and promotion ......... 13,773 -- 3,247 1,385 -- 18,405
Selling, general and administrative 9,227 2 56 529 -- 9,814
--------- --------- --------- --------- --------- ---------
Total costs and expenses ........ 36,050 2 6,004 3,854 -- 45,910
--------- --------- --------- --------- --------- ---------

INCOME (LOSS) FROM OPERATIONS ....... 8,185 (2) 3,569 763 -- 12,515
--------- --------- --------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense .................. (5,147) -- -- -- -- (5,147)
Investment and other income, net .. 25 1 -- 8 -- 34
Royalties ......................... (2,262) 2,852 (500) (90) -- --
Corporate allocations ............. 915 -- (887) (28) -- --
--------- --------- --------- --------- --------- ---------
Total other income (expense) ... (6,469) 2,853 (1,387) (110) -- (5,113)
--------- --------- --------- --------- --------- ---------

INCOME BEFORE INCOME TAXES .......... 1,716 2,851 2,182 653 -- 7,402

PROVISION FOR INCOME TAXES .......... 876 969 829 139 -- 2,813
--------- --------- --------- --------- --------- ---------

NET INCOME .......................... $ 840 $ 1,882 $ 1,353 $ 514 $ -- $ 4,589
========= ========= ========= ========= ========= =========


18


Note 16
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING STATEMENTS OF INCOME
----------------------------------
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2002
--------------------------------------------
(Unaudited and in thousands)

NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL COMPANIES DR. (CR.) CONSOLIDATED
------- ------ --------- --------- ------------

NET SALES .......................................... $ 45,758 $ -- $ 2,656 $ -- $ 48,414
--------- --------- --------- --------- ---------
COSTS AND EXPENSES:
Cost of sales .................................... 13,350 -- 1,111 -- 14,461
Advertising and promotion ........................ 15,108 -- 766 -- 15,874
Selling, general and administrative .............. 8,989 -- 548 -- 9,537
--------- --------- --------- --------- ---------
Total costs and expenses ....................... 37,447 -- 2,425 -- 39,872
--------- --------- --------- --------- ---------

INCOME FROM OPERATIONS ............................. 8,311 -- 231 -- 8,542
--------- --------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense ................................. (4,841) -- -- -- (4,841)
Investment and other income, net ................. 47 54 5 -- 106
Royalties ........................................ (2,343) 2,396 (53) -- --
Corporate allocations ............................ 22 -- (22) -- --
--------- --------- --------- --------- ---------
Total other income (expense) .................. (7,115) 2,450 (70) -- (4,735)
--------- --------- --------- --------- ---------

INCOME BEFORE INCOME TAXES AND
CHANGE IN ACCOUNTING PRINCIPLE ................... 1,196 2,450 161 -- 3,807

PROVISION FOR INCOME TAXES ......................... 466 833 136 -- 1,435
--------- --------- --------- --------- ---------

INCOME BEFORE CHANGE IN
ACCOUNTING PRINCIPLE ............................. 730 1,617 25 -- 2,372

CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE, NET OF
INCOME TAX BENEFIT ............................... -- (8,877) -- -- (8,877)
--------- --------- --------- --------- ---------

NET INCOME (LOSS) .................................. $ 730 $ (7,260) $ 25 $ -- $ (6,505)
========= ========= ========= ========= =========


19


Note 16
CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONSOLIDATING STATEMENTS OF CASH FLOWS
--------------------------------------
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2003
--------------------------------------------
(Unaudited and in thousands)

NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL SUNDEX COMPANIES DR. (CR.) CONSOLIDATED
------- ------ ------ --------- --------- ------------

OPERATING ACTIVITIES:
Net income .................................... $ 840 $ 1,882 $ 1,353 $ 514 $ -- $ 4,589
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization ............... 1,465 -- -- 34 -- 1,499
Deferred income tax provision ............... 2,832 (1,880) -- -- -- 952
Provision for income taxes .................. (1,798) 969 829 -- -- --
Other, net .................................. (134) -- -- 5 -- (129)
Changes in operating assets and liabilities: --
Accounts receivable ....................... (6,665) -- -- (105) -- (6,770)
Inventories ............................... (1,016) -- 130 (230) -- (1,116)
Prepaid expenses and other current assets . 239 -- -- 14 -- 253
Accounts payable and accrued liabilities .. 8,319 -- -- (797) -- 7,522
--------- --------- --------- --------- --------- ---------
Net cash provided by (used in) operating
activities ............................ 4,082 971 2,312 (565) -- 6,800
--------- --------- --------- --------- --------- ---------
INVESTING ACTIVITIES: ........................... --
Purchases of property, plant and equipment .... (1,429) -- -- (35) -- (1,464)
Change in other assets, net ................... 951 -- -- 4 -- 955
--------- --------- --------- --------- --------- ---------
Net cash used in investing activities ... (478) -- -- (31) -- (509)
--------- --------- --------- --------- --------- ---------
FINANCING ACTIVITIES:
Repayment of long-term debt ................... (1,750) -- -- -- -- (1,750)
Proceeds from exercise of stock options ....... 160 -- -- -- -- 160
Repurchase of common shares ................... (1,579) -- -- -- -- (1,579)
Change in payable to bank ..................... 1,532 -- -- -- -- 1,532
Changes in intercompany accounts .............. 1,085 (674) (2,312) 1,901 --
Dividends paid ................................ 1,000 (1,000) -- -- -- --
--------- --------- --------- --------- --------- ---------
Net cash provided by (used in) financing
activities ........................... 448 (1,674) (2,312) 1,901 -- (1,637)
--------- --------- --------- --------- --------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON
CASH AND CASH EQUIVALENTS ..................... 5 -- -- 143 -- 148
--------- --------- --------- --------- --------- ---------
CASH AND CASH EQUIVALENTS: ...................... --
Increase (decrease) for the period ............ 4,057 (703) -- 1,448 -- 4,802
At beginning of period ........................ 11,505 1,133 5 3,281 -- 15,924
--------- --------- --------- --------- --------- ---------
At end of period .............................. $ 15,562 $ 430 $ 5 $ 4,729 $ -- $ 20,726
========= ========= ========= ========= ========= =========


20


Note 16
CHATTEM, INC. AND SUBSIDIARIES
------------------------------

CONSOLIDATING STATEMENTS OF CASH FLOWS
--------------------------------------

FOR THE THREE MONTHS ENDED FEBRUARY 28, 2002
--------------------------------------------
(Unaudited and in thousands)

NON-GUARANTOR
SUBSIDIARY ELIMINATIONS
CHATTEM SIGNAL COMPANIES DR. (CR.) CONSOLIDATED
------- ------ --------- --------- ------------

OPERATING ACTIVITIES:
Net income (loss) ................................ $ 730 $ (7,260) $ 25 $ -- $ (6,505)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization .................. 1,233 -- 30 -- 1,263
Deferred income tax provision .................. 191 833 -- -- 1,024
Cumulative effect of change in accounting
principle, net ............................... -- 8,877 -- -- 8,877
Stock option charge ............................ 131 -- -- -- 131
Other, net ..................................... 143 -- -- -- 143
Changes in operating assets and liabilities:
Accounts receivable .......................... (7,907) -- 653 -- (7,254)
Refundable income taxes ...................... 1,031 -- -- -- 1,031
Inventories .................................. (1,192) -- (68) -- (1,260)
Prepaid expenses and other current assets .... 271 -- 16 -- 287
Accounts payable and accrued liabilities ..... 6,956 -- (657) -- 6,299
--------- --------- --------- --------- ---------
Net cash provided by (used in) operating
activities ............................... 1,587 2,450 (1) -- 4,036
--------- --------- --------- --------- ---------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment ....... (504) -- (6) -- (510)
Decrease in other assets, net .................... 392 -- -- -- 392
--------- --------- --------- --------- ---------
Net cash used in investing activities ...... (112) -- (6) -- (118)
--------- --------- --------- --------- ---------
FINANCING ACTIVITIES:
Proceeds from exercise of stock options .......... 115 -- -- -- 115
Repurchase of common shares ...................... (630) -- -- -- (630)
Change in payable to bank ........................ 1,865 -- -- -- 1,865
Changes in intercompany accounts ................. 1,496 (1,414) (82) -- --
Dividends paid ................................... 1,000 (1,000) -- -- --
--------- --------- --------- --------- ---------
Net cash provided by (used in) financing
activities .............................. 3,846 (2,414) (82) -- 1,350
--------- --------- --------- --------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON
CASH AND CASH EQUIVALENTS ........................ -- -- (107) -- (107)
--------- --------- --------- --------- ---------
CASH AND CASH EQUIVALENTS:
Increase (decrease) for the period ............... 5,321 36 (196) -- 5,161
At beginning of period ........................... 20,648 10,003 4,794 -- 35,445
--------- --------- --------- --------- ---------
At end of period ................................. $ 25,969 $ 10,039 $ 4,598 $ -- $ 40,606
========= ========= ========= ========= =========


21


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 2002 Annual Report on Form
10-K filed with the Securities and Exchange Commission. All of the applicable
amounts herein for the three months ended February 28, 2003 and 2002,
respectively, reflect the two-for-one split of our common stock on November 29,
2002. All monetary amounts are expressed in thousands of dollars unless
contrarily evident. 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 Securities and Exchange Commission.

GENERAL
- -------

We are a leading marketer and manufacturer of a broad portfolio of branded
over-the-counter ("OTC") healthcare products, toiletries and dietary
supplements, including such categories as topical analgesics, skin care
products, appetite suppressants and medicated dandruff shampoos. Our portfolio
of products includes well-recognized brands, such as:

o ICY HOT, ASPERCREME and FLEXALL topical analgesics;

o GOLD BOND medicated skin care powder, cream, lotion, first aid,
swab and spray products;

o PHISODERM medicated acne treatment products and skin cleansers;

o DEXATRIM appetite suppressants; and

o SELSUN BLUE medicated dandruff shampoos.

Our products target niche markets that are often outside the core product areas
of large companies where we believe we can achieve and sustain significant
market penetration through strong advertising and promotion support. Many of our
products are among the U.S. market leaders in their respective categories. For
example, our portfolio of topical analgesic brands and our GOLD BOND medicated
body powders have the leading U.S. market share in these categories. We sell our
products nationally through mass merchandiser, drug and food channels,
principally utilizing our own sales force.

We have grown by actively acquiring new brands and expanding our existing
brands. Our strategy to achieve future growth is to acquire new brands, generate
profitable internal growth and expand our international business.

On March 28, 2002, we acquired SELSUN BLUE from Abbott Laboratories for $75,000
plus inventories of $1,380 and assumed liabilities of $1,178. We financed the
acquisition with a $45,000 term loan under our senior credit facility and
$31,380 of cash. We acquired worldwide rights (except in India) to manufacture,
sell and market SELSUN BLUE plus related intellectual property and certain
manufacturing equipment.

Abbott Laboratories, or manufacturers under contract to Abbott Laboratories, are
required to manufacture the product for us domestically until June 2003, or such
earlier date as we move production to our Chattanooga, Tennessee facilities, and
internationally until March 2004, or such earlier date as we enter into our own
agreements with contract manufacturers. Most of our domestic SELSUN BLUE product
lines are presently being manufactured at our Chattanooga facilities. We
generally pay Abbott Laboratories ten percent over standard manufacturing costs.
Abbott Laboratories is also marketing, selling and distributing SELSUN BLUE
products for us in certain foreign countries until we satisfy various foreign
regulatory requirements, new distributors are in place and any applicable
marketing permits are transferred. During the transition period, Abbott
Laboratories initially pays us a royalty equal to 28% of international sales of
SELSUN BLUE in these countries with the royalty reduced to 14% of international
sales in certain countries if foreign regulatory requirements are satisfied
prior to our assumption of sales and marketing responsibility in such countries.
Abbott Laboratories pays all costs and expenses related to the manufacture,
marketing and sales of SELSUN BLUE in these countries. As we assume
responsibility for the sales and marketing effort in a country, the royalty
arrangement with respect to such country terminates and we record these
international sales

22


directly, as well as the costs and expenses associated with these sales. We have
completed the transition for certain key markets and expect to complete the
transition for all other relevant foreign countries by March 2004.

In fiscal 2002, our international revenues were $21,042, or 9.4% of total
revenues. In 2001, SELSUN BLUE was sold in approximately 90 countries, with
aggregate international sales of $20,100, or approximately 50% of its total net
sales. We are focusing our efforts on expanding SELSUN BLUE'S international
presence in the existing key markets, as well as new markets such as China and
Japan. As we initially focus on the existing key markets, we are discontinuing
the sale of SELSUN BLUE in certain smaller markets and will thus experience a
short term decrease in international sales of SELSUN BLUE. We also intend to
leverage SELSUN BLUE'S international marketing and distribution network to
launch other brands in countries where they are not currently being sold.

In connection with our acquisition of SELSUN BLUE on March 28, 2002, we obtained
a $60,000 senior secured credit facility from a syndicate of commercial banks
led by Bank of America, N.A., as agent. The senior credit facility includes a
$15,000 revolving credit facility and a $45,000 term loan. The senior credit
facility together with our available cash was used to finance the acquisition of
SELSUN BLUE. As of February 28, 2003, we owed $18,250 under this credit
facility.

Given the perceived safety concerns and the regulatory uncertainties relating to
ephedrine, we have developed alternative formulations for DEXATRIM Natural and
DEXATRIM Results to exclude ephedrine and on September 20, 2002 we discontinued
the manufacturing and shipment of DEXATRIM Natural and DEXATRIM Results
containing ephedrine. Our DEXATRIM products containing ephedrine may continue to
be sold in the trade until our customers' existing supply of inventory is
exhausted or until the products are returned to us. Negative publicity relating
to the possible harmful effects of ephedrine and the possibility of further
regulatory action to restrict or prohibit the sale of products containing
ephedrine could result in a return of products from retailers or our decision to
accept product returns of DEXATRIM with ephedrine, for which we have provided a
$750 allowance in the first quarter of fiscal 2003.

In March 2003, we acquired the FISODERM, FISOHEX and FISOAC product line in
Brazil and nearly all of the worldwide trademarks for PHISODERM, PHISOHEX and
other related trademarks from GlaxoSmithKline for an immaterial amount. This
purchase excludes trademarks in Taiwan, Australia, Papua/New Guinea and New
Zealand. In 2002, sales of the Brazilian product line were less than $200. These
acquisitions, together with the PHISODERM trademark rights previously acquired
in 1994 for the United States, Canada and Puerto Rico, provide us with worldwide
capability to expand our PHISODERM business.

During the three months ended February 28, 2003, we repurchased, and returned to
unissued, 103,000 shares of our common stock for $1,579 in accordance with our
previously announced stock buyback program. In January 2003 our board of
directors increased the total authorization to repurchase stock under our stock
buyback program to $10,000. The remaining availability under the board
authorization is $8,421.

EBITDA, earnings before interest, taxes, depreciation and amortization, is a key
standard used by us to measure operating performance but may not be comparable
to a similarly titled measure reported by other companies. EBITDA is used to
supplement operating income as an indicator of operating performance and not as
an alternative to measures defined and required by generally accepted accounting
principles. For the first quarter of fiscal 2003, income from operations
increased $3,973, or 46.5%, to $12,515 from $8,542 in the 2002 period. EBITDA
for the three months ended February 28, 2003 was $13,649 as compared to $9,537
for the same period of 2002, a $4,112 increase. The income from operations
margin (income from operations/total revenues) and the EBITDA margin
(EBITDA/total revenues) increased from 17.6% and 19.7% of total revenues,
respectively, in the 2002 period to 21.4% and 23.4%, respectively, in the 2003
period. A reconciliation of EBITDA to income from operations is presented in the
following table:

For the Three Months Ended
February 28,
------------
2003 2002
---------- ----------

Income from operations................. $ 12,515 $ 8,542
Depreciation and amortization.......... 1,499 1,263
Less: Amortization of interest......... (365) (268)
---------- ----------
EBITDA................................. $ 13,649 $ 9,537
========== ==========

23


We will continue to seek sales increases through a combination of acquisitions
and internal growth while seeking to maintain high operating income levels. As
previously high-growth brands mature, sales increases will become even more
dependent on acquisitions and development of successful line extensions. During
the first quarter of fiscal 2003, we introduced GOLD BOND Antifungal Foot Swabs,
GOLD BOND First Aid Quick Spray and GOLD BOND First Aid Wipes. Line extensions,
product introductions and acquisitions require a significant amount of
introductory advertising and promotional support. For a period of time, these
products do not generate a commensurate amount of sales and/or earnings. As a
result, we may experience a short-term impact on our profitability due to
acquisitions and line extensions.

RESULTS OF OPERATIONS
- ---------------------

The following table sets forth, for income before change in accounting principle
and for the periods indicated, certain items from our consolidated statements of
income expressed as a percentage of total revenues:

FOR THE THREE MONTHS ENDED
FEBRUARY 28,
------------
2003 2002
---------- ----------

TOTAL REVENUES................................... 100.0% 100.0%
------ ------
COSTS AND EXPENSES:
Cost of sales ................................. 30.3 29.9
Advertising and promotion ..................... 31.5 32.8
Selling, general and administrative ........... 16.8 19.7
------ ------
Total costs and expenses .................... 78.6 82.4
------ ------

INCOME FROM OPERATIONS........................... 21.4 17.6
------ ------
OTHER INCOME (EXPENSE):
Interest expense .............................. (8.8) (10.0)
Investment and other income, net .............. .1 .2
------ ------
Total other income (expense) ................ (8.7) (9.8)
------ ------

INCOME BEFORE INCOME TAXES ...................... 12.7 7.9

PROVISION FOR INCOME TAXES ...................... 4.8 3.0
------ ------

INCOME BEFORE CHANGE IN ACCOUNTING PRINCIPLE..... 7.9% 4.9%
====== ======

CRITICAL ACCOUNTING POLICIES
- ----------------------------

The selection and application of accounting principles and methods impact our
financial results. Our most critical accounting policies are described below.

Impairment Testing of Intangible Assets
---------------------------------------

In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") 142, "Goodwill and Other Intangible
Assets" ("SFAS 142"). The provisions of SFAS 142, which were adopted by us on
December 1, 2001, require us to discontinue the amortization of the cost of
intangible assets with indefinite lives and to perform certain fair value based
tests of the carrying value of indefinite lived intangible assets. SFAS 142
requires this testing to be performed at least annually. These impairment tests
are impacted by judgments as to future cash flows and brand performance. See
Note 2 of Notes to Consolidated Financial Statements for a further discussion of
SFAS 142.

Product Return Allowances
-------------------------

Revenue is recognized when our products are shipped to our customers. It is our
policy across all classes of customers that all sales are final. As is common in
the consumer products industry, customers occasionally return

24


products for a variety of reasons. Examples include product damaged in transit,
discontinuance of a particular size or form of product and shipping errors. We
record an estimate of products to be returned by customers as an allowance
against sales. We generally base this allowance on our historical returns
experience and sales volume. Significant judgment is required when estimating
the reserves for product returns.

CRITICAL ACCOUNTING ESTIMATES
- -----------------------------

The preparation of financial statements in accordance with accounting principles
generally accepted in the United States requires management to use estimates.
Several different estimates or methods can be used by management that might
yield different results. The following are the significant estimates used by
management in the preparation of the February 28, 2003 financial statements:

Allowance For Doubtful Accounts
-------------------------------

As of February 28, 2003, 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. When all these facts are
compiled a judgement as to the collectibility of the individual account is made.
As noted above, many factors can impact this estimate. At present, general
economic conditions as well as the on-going war with Iraq, among other factors,
may have an impact on our customers' financial condition which might in turn
require us to make changes in future estimates.

Product Return Allowances
-------------------------

Product return allowances are estimated based on historical trends as well as
any currently known unusual conditions such as a customer discontinuing a
particular product or less than expected retail sales of a particular product.
An unexpected or sudden change in the retail sales of a particular product could
result in an increase in future product return allowances.

Promotional Accrual
-------------------

We routinely enter into agreements with our customers to participate in
promotional programs. These programs generally take the form of coupons,
temporary price reductions, scan downs and participations in advertising
vehicles produced by the customer. The ultimate cost of these programs is often
variable based on the number of units actually sold. Estimated unit sales of a
product under a promotion program are used to estimate the total cost of the
program. Actual results can differ from the original estimate. We also consider
customer delays in requesting promotional program payments when evaluating the
required accrual. Many customers audit programs significantly after the date of
performance to determine the actual amount due and make a claim for
reimbursement at that time. As a result, changes in the unit sales trends under
promotional programs as well as the timing of payments could result in a change
in the accrual amount.

For a summary of our significant accounting policies, see Note 2 of Notes to
Consolidated Financial Statements included in our Annual Report on Form 10-K for
the year ended November 30, 2002.

COMPARISON OF THREE MONTHS ENDED FEBRUARY 28, 2003 AND 2002
- -----------------------------------------------------------

Our total revenues for the three months ended February 28, 2003, comprised of
net sales and royalties from the international sales of SELSUN BLUE, increased
$10,011, or 20.7%, to $58,425 from $48,414 for the same period last year.
Domestic sales increased $7,299, or 16.1%, to $52,680 from $45,381 for last
year's comparable period. International revenues including the royalties
described above, increased $2,712, or 89.4%, from $3,033 in the fiscal 2002
period to $5,745 in the current period.

For domestic consumer products in the 2003 period, sales increases were
recognized for our SELSUN BLUE (acquired in March 2002), GOLD BOND, PHISODERM
and GARLIQUE products. SELSUN Blue achieved a 38% domestic net sales increase in
the first quarter of fiscal 2003 as compared to the same period of fiscal 2002
when the brand was owned by Abbott Laboratories. Net sales of the GOLD BOND
product line increased 11% in

25


the current fiscal quarter over the same period last year, led by GOLD BOND
Medicated Lotion and the introduction of GOLD BOND Antifungal Foot Swabs, GOLD
BOND First Aid Quick Spray and GOLD BOND First Aid Wipes. PHISODERM net sales
increased 13% over the corresponding year-ago period largely as a result of the
introduction in fiscal 2002 of PHISODERM Clear Confidence Acne Body Wash,
PHISODERM Clear Confidence Acne Facial Masque and PHISODERM Clear Confidence
Acne Clear Swab. GARLIQUE net sales rose 30% in the year-to-year comparison as a
result of a strong marketing program. Sales declines were recorded for our
topical analgesic portfolio (ICY HOT, FLEXALL, ASPERCREME, SPORTSCREME and
ARTHRITIS HOT), DEXATRIM and our menstrual brands. The topical analgesics were
impacted by comparison to the prior year period when substantial growth of the
ICY HOT brand was experienced, led by the ICY HOT Patch. DEXATRIM was hurt by
uncertainty in the diet pill category, and the launch of DEXATRIM Results in the
comparable period last year. PAMPRIN and PREMSYN PMS continued to suffer sales
declines along with the entire menstrual category.

For international operations, the Canadian business produced a 53.9% sales
increase, largely as a result of the acquisition of SELSUN BLUE in March 2002
and the continuing growth of GOLD BOND Medicated Lotion and PHISODERM sales in
that country. The U.K. operations showed a 93.7% sales increase, primarily due
to our acquisition of SELSUN BLUE and sales of our OTC drug brands in Eastern
Europe and elsewhere. Other international sales increased 119.6%, almost
entirely as a result of the acquisition of SELSUN BLUE in the second quarter of
fiscal 2002.

For both the domestic and international operations, sales variances were
principally the result of change in the volume of unit sales of the particular
brand.

Cost of sales as a percentage of total revenues was 30.3% for the first quarter
of fiscal 2003 as compared to 29.9% for the same period in fiscal 2002. The
increase reflects an inventory obsolescence charge of $750 in the first quarter
of fiscal 2003 related to DEXATRIM with ephedrine which we ceased manufacturing
and shipping in September 2002. This charge represented the anticipated cost of
disposing of DEXATRIM product containing ephedrine which we expect will be
returned from retailers.

Advertising and promotion expenses increased $2,531, or 15.9%, to $18,405 in the
current period as compared to $15,874 in the same period last year, and were
31.5% of total revenues for the three months ended February 28, 2003 compared to
32.8% for the comparable period of fiscal 2002. Increases in advertising and
promotion expenditures in the current period were recorded for SELSUN BLUE, the
recently introduced GOLD BOND products, PHISODERM, and NEW PHASE and GARLIQUE of
the SUNSOURCE product line. Decreases of advertising and promotion expenditures
were recognized for most of the topical analgesic brands, DEXATRIM, MUDD, the
other GOLD BOND products and the other SUNSOURCE products.

Selling, general and administrative expenses increased $277, or 2.9%, to $9,814
in the first quarter of fiscal 2003 as compared to $9,537 in the same quarter of
fiscal 2002 and were 16.8% and 19.7% of total revenues, respectively. The
increase in selling, general and administrative expenses was largely represented
by increases in selling expenses as a result of increased sales and increases in
administrative costs. The decrease in the percentage of these expenditures to
total revenues for the current period favorably reflects total revenues
increasing at a higher rate than these expenses.

Interest expense increased $306, or 6.3%, to $5,147 for the three months ended
February 28, 2003 as compared to $4,841 in the same period last year. The
increase was largely the result of the remaining balance under the $45,000
credit facility borrowed to partially fund the acquisition of the SELSUN BLUE
product line in March 2002. Until our indebtedness is reduced substantially,
interest expense will continue to represent a significant percentage of our
total revenues.

Investment and other income decreased $72, or 67.9%, to $34 in the current
period as compared to $106 in the same period of fiscal 2002. This decrease was
primarily due to a decline in interest income as a result of our use of $31,380
cash and cash equivalents to partially finance our acquisition of the SELSUN
BLUE product line in March 2002 as well as lower interest rates on short-term
investments.

26


Income before change in accounting principle increased $2,217, or 93.5%, to
$4,589 for the first quarter of fiscal 2003 as compared to $2,372 in same
quarter of fiscal 2002. This increase primarily resulted from increased revenues
and lower costs and expenses as a percentage of revenues.

In the first quarter of fiscal 2002, we adopted the provisions of SFAS No. 142,
"Goodwill and other Intangible Assets", which requires us to perform annually
certain fair value based tests of the carrying value of our indefinite lived
intangible assets. We obtained independent appraisals to determine the fair
value of these assets as of December 1, 2001, and recorded a write-down of
$8,877, net of income tax benefit of $5,440, as a cumulative effect of change in
accounting principle. The write-down was primarily related to our SUNSOURCE
product line which has experienced a decline in sales volume since its initial
purchase in 1997 and to a lesser degree our DEXATRIM product line which
discontinued the marketing of one of its products in November 2000.

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

Cash of $6,800 and $4,036 was provided by operations for the three months ended
February 28, 2003 and 2002, respectively. The increase in cash flows from
operations over the prior year period was primarily the result of increases in
net income from operations and accounts payable and accrued liabilities.

Investing activities used cash of $509 and $118 in the three months ended
February 28, 2003 and 2002, respectively. The increase in usage of cash in the
current quarter as compared to the same quarter of the prior year was primarily
due to an increase in purchases of property, plant and equipment, offset in part
by a decrease in other non-current assets.

Financing activities used cash of $1,637 in the first quarter of fiscal 2003 but
provided cash of $1,350 in the same period of the prior year. The increase in
usage of cash in the current period as compared to the same period last year was
largely the result of payments of long-term debt and increased repurchases of
our common stock.

The following table presents working capital data at February 28, 2003 and
November 30, 2002 or for the respective twelve months then ended:


Item 2003 2002
---- --------- ---------

Working capital (current assets less current liabilities) ........ $ 35,247 $ 31,372
Current ratio (current assets divided by current liabilities) .... 1.70 1.76
Quick ratio (cash and cash equivalents and accounts
receivable divided by current liabilities) ..................... 1.05 1.01
Average accounts receivable turnover ............................. 7.61 9.49
Average inventory turnover ....................................... 3.73 3.80
Working capital as a percentage of total assets .................. 9.56% 8.82%


The change in the current and quick ratios at February 28, 2003 as compared to
November 30, 2002 was primarily the result of increases in accrued liabilities
and payable to bank, partially offset by increases in cash and cash equivalents
and accounts receivable.

Total long-term debt outstanding was $215,200 at February 28, 2003 compared to
$217,458 at November 30, 2002.

Days sales outstanding in accounts receivable were 50.0 at February 28, 2003 as
compared to 52.3 at February 28, 2002. Our domestic days sales outstanding were
47.9 and 50.8 at February 28, 2003 and 2002, respectively.

27


As of April 10, 2003 we have been named as a defendant in approximately 318
lawsuits involving claims by approximately 1,473 plaintiffs alleging that the
plaintiffs were injured as a result of ingestion of products containing
phenylpropanolamine ("PPA"), which until November 2000 was the active ingredient
in certain of our DEXATRIM products. See Note 10 of Notes to Consolidated
Financial Statements for a discussion of these lawsuits.

As of February 28, 2003, the remaining amount authorized by our board of
directors under our stock buyback program was $8,421; however, we are limited in
our ability to repurchase shares due to restrictions under the terms of the
indenture with respect to which our senior subordinated notes were issued and
under the terms of our current credit facility. Also, on December 21, 1998, we
filed a shelf registration statement with the Securities and Exchange Commission
for $250,000 of debt and equity securities of which $75,000 was utilized in the
sale of the 8.875% notes in May 1999.

We believe that cash provided by operating activities, our cash and cash
equivalents balance and funds available under the revolver of our senior 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 that we make in the
future will require us to obtain additional financing.

FOREIGN OPERATIONS
- ------------------

Historically, our primary foreign operations have been conducted through our
Canadian and United Kingdom subsidiaries. The currencies of these subsidiaries
are Canadian dollars and British pounds, respectively. Fluctuations in exchange
rates can impact operating results, including total revenues and expenses, when
translations of the subsidiary financial statements are made in accordance with
SFAS No. 52, "Foreign Currency Translation." For the three months ended February
28, 2003 and 2002, these subsidiaries accounted for 8% and 5% of total revenues,
respectively, and 3% of total asset for both periods, respectively. It has not
been our practice to hedge our assets and liabilities in Canada and the United
Kingdom or our intercompany transactions due to the inherent risks associated
with foreign currency hedging transactions and the timing of payments between us
and our two foreign subsidiaries. Following our acquisition of SELSUN BLUE,
which is sold in approximately 90 foreign countries, and had $20,100 of
international sales in 2001, our international business operations has expanded
significantly, which will increase our exposure to fluctuations in foreign
exchange rates. During the first quarter of fiscal 2003, a large portion of
these foreign sales was reflected as royalties, which have been paid to us in
U.S. dollars. Historically, gains or losses from foreign currency transactions
have not had a material impact on our operating results. Gains (losses) of $122
and ($24) for the three months ended February 28, 2003 and 2002, respectively,
resulted from foreign currency transactions.

RECENT ACCOUNTING PRONOUNCEMENTS
- --------------------------------

In June 2001 the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"). The provisions of SFAS 142, which were adopted
by us on December 1, 2001, require us to discontinue the amortization of the
cost of intangible assets with indefinite lives and to perform certain fair
value based tests of the carrying value of indefinite lived intangible assets.
Accordingly, we discontinued the amortization of the cost of these intangible
assets. Also in connection with the adoption of SFAS 142, we obtained
independent appraisals to determine the fair values of these intangible assets
at December 1, 2001 and compared their fair values with their carrying values to
determine the write-down of $8,877, net of income tax benefit of $5,440, or $.48
per diluted share. The write-down was primarily related to our SUNSOURCE product
line which has experienced a decline in sales volume since its initial purchase
in 1997 and to a lesser degree our DEXATRIM product line, which discontinued the
marketing of one of its products in November 2000. This adjustment is shown as a
cumulative effect of change in accounting principle in the consolidated
statement of income for the three months ended February 28, 2002. After
reviewing all pertinent information relating to the revaluation of these
intangible assets and performing the annual impairment test as prescribed by
SFAS 142, we determined that a revaluation thereof was not required at this
time.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 62, Amendment of FASB Statement No. 13, and Technical Corrections"
("SFAS 145"). SFAS 145, which was adopted by us effective December 1, 2002, will
require us to classify gains and losses on extinguishments of debt as income or
loss from continuing operations rather than as extraordinary items as previously
required under FASB Statement No. 4. We will also be required to reclassify any
gain or loss on extinguishment of debt previously classified as an extraordinary
item in prior periods presented. Our results of operations, financial position
and cash flows, therefore, will not be affected.

On December 31, 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" ("SFAS 148"). SFAS 148, which was
adopted by us on December 1, 2002, amends SFAS 123, "Accounting for Stock-Based
Compensation" and Accounting Principles Board Opinion No. 28, "Interim Financial
Reporting", to require disclosure in the summary of significant accounting
policies of the effects of an entity's accounting policy with respect to
stock-based employee compensation on reported net income and earnings per share
in annual and interim financial statements. The adoption of this pronouncement
did not have an impact on our results of operations, financial position or cash
flows.

28


FORWARD LOOKING STATEMENTS
- --------------------------

We may from time to time make written and oral forward-looking statements.
Written forward-looking statements may appear in documents filed with the
Securities and Exchange Commission, in press releases and in reports to
shareholders. 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. The forward-looking statements are based on
management's current beliefs and assumptions about expectations, estimates,
strategies and projections for us. 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. The risks, uncertainties
and assumptions of the forward-looking statements include, but are not limited
to existing and possible additional future product liability claims relating to
the prior existence of PPA in DEXATRIM; the possible effect of the negative
public perception resulting from product liability claims on sales of DEXATRIM
products without PPA; the lack of availability, limits of coverage and expense
related to product liability insurance; the reduction of available insurance
coverage as proceeds are used to fund any product liability settlements or
awards; the possibility of other product liability claims including claims
relating to the existence of ephedrine in DEXATRIM products; our ability to fund
liabilities from product liability claims greater than our insurance coverage or
outside the scope of our insurance coverage; the impact of brand acquisitions
and divestitures; extraordinary gains or losses resulting from financings or
debt repayments; product demand and market acceptance risks; product development
risks, such as delays or difficulties in developing, producing and marketing new
products or line extensions; the impact of competitive products, pricing and
advertising; our ability to integrate SELSUN BLUE into our own operations; our
ability to sell and market SELSUN BLUE internationally where we have only
limited experience and infrastructure; constraints resulting from our financial
condition, including the degree to which we are leveraged, debt service
requirements and restrictions under indentures and loan agreements; government
regulations; risks of loss of material customers; public perception regarding
our products; dependence on third party manufacturers; environmental matters;
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 risks 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 risks currently consists of our 8.875% Senior
Notes and our senior credit facility. The aggregate balance outstanding under
the 8.875% Senior Notes as of February 28, 2003 was $204,700. Should interest
rates increase or decrease, the estimated fair value of these notes would
decrease or increase, respectively. Loans under our senior credit facility bear
interest at a rate equal to the higher of LIBOR or the federal funds rate plus
..05% plus percentages ranging from .75% to 1.5% depending on our leverage. As of
February 28, 2003, the variable rate on the term loan under our senior credit
facility was 3.9 %. The balance outstanding under our term loan was $18,250 as
of February 28, 2003. The impact on our results of operations of a one-point
rate change on the outstanding balance of our term loan as of the end of the
first quarter of fiscal 2003 would be approximately $28 net of tax. As of
February 28, 2003, no revolving credit loans or letters of credit were
outstanding under our senior credit facility.

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.

29


ITEM 4. CONTROLS AND PROCEDURES
- -------------------------------

(a) Evaluation of Disclosure Controls and Procedures. Our Chief
Executive Officer and Chief Financial Officer have evaluated the effectiveness
of our disclosure controls and procedures (as such terms are defined in Rules
13(a)-14(c) and 15(d)-14(c) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act") (as of the date within 90 days prior to the filing
date of this Form 10-Q (the "Evaluation Date")). Based on such evaluation, such
officers have concluded that, as of the Evaluation Date, our disclosure controls
and procedures are effective in alerting them on a timely basis to material
information relating to us (including our consolidated subsidiaries) required to
be included in our periodic filings under the Exchange Act.

(b) Changes in Internal Controls. Since the Evaluation Date, there have
not been any significant changes in our internal controls or in other factors
that could significantly affect such controls.




































30


PART II. OTHER INFORMATION
--------------------------

ITEM 1. LEGAL PROCEEDINGS
- --------------------------

See Note 10 of Notes to Consolidated Financial Statements (unaudited)
included in Part I, Item 1 of this Form 10-Q.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------

(a) Exhibits:

Statement regarding computation of per share earnings, filed herewith.
(Exhibit 11).

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
(Exhibit 99)

(b) No reports on Form 8-K report were filed with the Securities and
Exchange Commission during the three months ended February 28, 2003.





































31


CHATTEM, INC.
-------------
SIGNATURES
----------


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





CHATTEM, INC.
(Registrant)


Dated: April 14, 2003 \s\ A. Alexander Taylor II
------------------ --------------------------
A. Alexander Taylor II
President and Director
(Chief Operating Officer)



Dated: April 14, 2003 \s\ Richard D. Moss
------------------ ----------------------------
Richard D. Moss
Vice President and Chief Financial Officer
(Principal Financial Officer)





















32


CERTIFICATIONS

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

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

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

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

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

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

b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and

c. presented in this quarterly report our conclusion about the
effectiveness of this disclosure controls and procedures based on our
evaluation as of the Evaluation Date;


5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):

a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.


Date: April 14, 2003
------------------ /s/ Zan Guerry
-----------------------------------
Zan Guerry, Chairman and
Chief Executive Officer

33


CERTIFICATIONS

I, Richard D. Moss, Vice President and Chief Financial Officer, certify that:

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

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

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

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

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

b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and

c. presented in this quarterly report our conclusion about the
effectiveness of this disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):

a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.


Date: April 14, 2003
------------------ /s/ Richard D. Moss
-----------------------------------
Richard D. Moss, Vice President and
Chief Financial Officer

34




CHATTEM, INC. AND SUBSIDIARIES
------------------------------
EXHIBIT INDEX
-------------




Exhibit Number Description of Exhibit
- -------------- ----------------------


11 Statement regarding computation of per share earnings.


99 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.





..




















35