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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 29, 2004
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 1, 2004, 19,522,598 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

Condensed Consolidated Balance Sheets as of February 29, 2004 and
November 30, 2003 3

Condensed Consolidated Statements of Operations for the Three
Months Ended February 29, 2004 and February 28, 2003 5

Condensed Consolidated Statements of Cash Flows for the Three Months
Ended February 29, 2004 and February 28, 2003 6

Notes to Condensed Consolidated Financial Statements 7

Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 25

Item 3. Quantitative and Qualitative Disclosures About Market Risks 35

Item 4. Controls and Procedures 36



PART II. OTHER INFORMATION

Item 1. Legal Proceedings 37

Item 2. Changes in Securities and Use of Proceeds 37

Item 3. Defaults Upon Senior Securities 37

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

Item 5. Other Information 37

Item 6. Exhibits and Reports on Form 8-K 37



SIGNATURES 38




2


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


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

CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
-------------------------------------
(In thousands)


FEBRUARY 29, NOVEMBER 30,
ASSETS 2004 2003
- ------ ------------ ------------
(Unaudited)

CURRENT ASSETS:

Cash and cash equivalents $ 29,283 $ 26,931
Restricted cash (Note 3) 32,227 --
Accounts receivable, less allowances of $3,765 at
February 29, 2004 and $3,594 at November 30, 2003 34,586 25,478
Inventories 17,568 17,559
Refundable income taxes 8,183 4,431
Deferred income taxes 2,551 3,441
Prepaid expenses and other current assets 1,284 3,376
------------ ------------
Total current assets 125,682 81,216
------------ ------------

PROPERTY, PLANT AND EQUIPMENT, NET 28,389 28,722
------------ ------------

OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product rights, net 245,787 245,847
Debt issuance costs, net 6,432 5,504
Other 2,751 2,096
------------ ------------
Total other noncurrent assets 254,970 253,447
------------ ------------

TOTAL ASSETS $ 409,041 $ 363,385
============ ============



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










3


CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
-------------------------------------
(In thousands)


FEBRUARY 29, NOVEMBER 30,
LIABILITIES AND SHAREHOLDERS' EQUITY 2004 2003
- ------------------------------------ ------------ ------------
(Unaudited)

CURRENT LIABILITIES:
Current maturities of long-term debt $ -- $ 7,750
Called debt (Notes 3 and 13) 30,028 --
Accounts payable and other 11,746 10,924
Accrued liabilities 15,056 15,979
------------ ------------
Total current liabilities 56,830 34,653
------------ ------------

LONG-TERM DEBT, less current maturities and called debt 225,000 204,676
------------ ------------

DEFERRED INCOME TAXES 27,888 26,796
------------ ------------

OTHER NONCURRENT LIABILITIES 1,710 1,689
------------ ------------

COMMITMENTS AND CONTINGENCIES (Note 19)

SHAREHOLDERS' EQUITY:
Preferred shares, without par value, authorized 1,000,
none issued -- --
Common shares, without par value, authorized 50,000,
issued 19,458 at February 29, 2004 and 19,161 at
November 30, 2003 81,474 77,815
Retained earnings 21,562 22,274
------------ ------------
103,036 100,089
Unamortized value of restricted common shares issued (3,233) (2,058)
Cumulative other comprehensive income:
Foreign currency translation adjustment (550) (820)
Minimum pension liability adjustment, net of income taxes (1,640) (1,640)
------------ ------------
Total shareholders' equity 97,613 95,571
------------ ------------

TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $ 409,041 $ 363,385
============ ============




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







4


CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
-----------------------------------------------
(Unaudited and in thousands, except per share amounts)


FOR THE THREE MONTHS ENDED
---------------------------------
FEBRUARY 29, FEBRUARY 28,
2004 2003
------------ ------------

REVENUES:
Net sales $ 60,927 $ 58,125
Royalties 310 300
------------ ------------
Total revenues 61,237 58,425
------------ ------------

COSTS AND EXPENSES:
Cost of sales 16,952 17,691
Advertising and promotion 18,532 18,405
Selling, general and administrative 10,829 9,814
------------ ------------
Total costs and expenses 46,313 45,910
------------ ------------

INCOME FROM OPERATIONS 14,924 12,515
------------ ------------

OTHER INCOME (EXPENSE):
Interest expense (4,755) (5,147)
Investment and other income, net 45 34
Loss on early extinguishment of debt (11,309) --
------------ ------------
Total other income (expense) (16,019) (5,113)
------------ ------------

(LOSS) INCOME BEFORE INCOME TAXES (1,095) 7,402

(BENEFIT FROM) PROVISION FOR INCOME TAXES (383) 2,813
------------ ------------

NET (LOSS) INCOME $ (712) $ 4,589
============ ============

NUMBER OF COMMON SHARES:
Weighted average outstanding - basic 19,099 19,165
============ ============
Weighted average and potential dilutive outstanding 19,881 19,949
============ ============

NET (LOSS) INCOME PER COMMON SHARE:
Basic $ (.04) $ .24
============ ============
Diluted $ (.04) $ .23
============ ============

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







5


CHATTEM, INC. AND SUBSIDIARIES
------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------------------------------------------
(Unaudited and in thousands, except per share amount)


FOR THE THREE MONTHS ENDED
---------------------------------
FEBRUARY 29, FEBRUARY 28,
2004 2003
------------ ------------

OPERATING ACTIVITIES:
Net (loss) income $ (712) $ 4,589
Adjustments to reconcile net (loss) income to net cash provided by
operating activities:
Depreciation and amortization 1,537 1,499
Deferred income taxes 1,982 952
Tax benefit realized from stock option plans 1,083 143
Loss on early extinguishment of debt 11,309 --
Other, net -- (129)
Changes in operating assets and liabilities:
Accounts receivable (9,108) (6,770)
Inventories (9) (1,116)
Refundable income taxes (3,752) (1,134)
Prepaid expenses and other current assets 2,092 253
Accounts payable and accrued liabilities (101) 10,045
------------ ------------
Net cash provided by operating activities 4,321 8,332
------------ ------------

INVESTING ACTIVITIES:
Purchases of property, plant and equipment (491) (1,464)
Purchases of patents, trademarks and other product rights (17) --
(Increase) decrease in other assets, net (490) 955
------------ ------------
Net cash used in investing activities (998) (509)
------------ ------------

FINANCING ACTIVITIES:
Repayment of long-term debt (182,280) (1,750)
Proceeds from long-term debt 200,000 --
Proceeds from borrowings under revolving credit facility 25,000 --
Proceeds from exercise of stock options 1,453 160
Repurchase of common shares (319) (1,579)
Increase in debt issuance costs (5,678) --
Retirement of debt issuance costs (6,946) --
Restricted cash (32,227) --
------------ ------------
Net cash used in financing activities (997) (3,169)
------------ ------------

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
26 148
------------ ------------

CASH AND CASH EQUIVALENTS:
Increase for the period 2,352 4,802
At beginning of period 26,931 15,924
------------ ------------
At end of period $ 29,283 $ 20,726
============ ============

SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Issuance of 70 shares of restricted common stock at a value of $19.98
per share $ 1,399 $ --

PAYMENTS FOR:
Interest $ 6,378 $ 383
Taxes $ 108 $ 6

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



6



CHATTEM, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

All monetary and share amounts are expressed in thousands.

1. BASIS OF PRESENTATION
---------------------

The accompanying unaudited condensed 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 condensed 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, 2003. The
accompanying unaudited condensed consolidated financial statements, in the
opinion of management, include all adjustments necessary for a fair
presentation. All such adjustments are of a normal recurring nature.

2. CASH AND CASH EQUIVALENTS
-------------------------

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

3. RESTRICTED CASH
---------------

On February 10, 2004, we commenced a cash tender offer and consent
solicitation for the $204,538 outstanding principal amount of our 8.875%
Subordinated Notes (defined in Note 13). The consent solicitation expired
on February 24, 2004, and a total of approximately $174,530, or
approximately 85.3% of the 8.875% Subordinated Notes, were tendered and
accepted for payment on February 26, 2004. The remaining principal
outstanding, call premium, accrued interest and interest to call date
amounting to $32,227 was placed in escrow with the trustee of the indenture
to fund the purchase of additional 8.875% Subordinated Notes tendered prior
to March 9, 2004, the expiration date of the tender offer, and the
redemption of the remaining 8.875% Subordinated Notes that were not
tendered in such offer in accordance with their terms on April 1, 2004 at a
redemption price of 102.9583% of their aggregate principal amount (See Note
13). As of February 29, 2004, restricted cash is comprised of the
following:

Called principal $ 30,008
Accrued interest 1,072
Call premium 888
Interest to call date 259
------------
Total restricted cash $ 32,227
============

4. RECLASSIFICATIONS
-----------------

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

5. RECENT ACCOUNTING PRONOUNCEMENTS
--------------------------------

In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting
for Asset Retirement Obligations" ("SFAS 143"). We adopted SFAS 143 on
December 1, 2002. SFAS 143 establishes accounting standards for the
recognition and measurement of an asset retirement obligation and its
associated asset retirement cost. It also provides accounting guidance for
legal obligations associated with the retirement of tangible long-lived
assets. The adoption of SFAS 143 did not have an impact on our financial
position, results of operations or cash flows.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections" ("SFAS 145"). We adopted SFAS 145 on December 1,
2002. SFAS 145 requires 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 SFAS No. 4, "Reporting
Gains and Losses from Extinguishment of

7


Debt". We are also required to reclassify any gain or loss on
extinguishment of debt previously classified as an extraordinary item in
prior periods presented. SFAS 145 also provides accounting standards for
certain lease modifications that have economic effects similar to
sale-leaseback transactions and various other technical corrections. The
adoption of SFAS 145 did not have an impact on our financial position,
results of operations or cash flows, except for the loss on early
extinguishment of debt of $11,309 in the first quarter of fiscal 2004,
which was classified in the condensed consolidated financial statements in
accordance with the provisions of SFAS 145.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). We adopted SFAS
146 on January 1, 2003. SFAS 146 supercedes Emerging Issues Task Force
("EITF") Issue No. 94-3. SFAS 146 requires that the liability for a cost
associated with an exit or disposal activity be recognized when the
liability is incurred, not at the date of an entity's commitment to an exit
or disposal plan. SFAS 146 is to be applied prospectively to exit or
disposal activities initiated after December 31, 2002. The adoption of SFAS
146 did not have an impact on our financial position, results of operations
or cash flows.

In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 supercedes
Interpretation No. 34, "Disclosure of Indirect Guarantees of Indebtedness
of Others," and provides guidance on the recognition and disclosures to be
made by a guarantor in its interim and annual financial statements about
its obligations under certain guarantees. The initial recognition and
measurement provisions of FIN 45 are effective for guarantees issued or
modified after December 31, 2002 and are to be applied prospectively. The
disclosure requirements are effective for financial statements for interim
or annual periods ending after December 15, 2002. We had no instruments or
guarantees that required additional or enhanced disclosure under FIN 45 at
February 29, 2004, except as disclosed in Note 20, and no guarantees issued
or modified after December 31, 2002 that required recognition and
measurement in accordance with the provisions of FIN 45. The adoption of
FIN 45 did not have an impact on our financial position, results of
operations or cash flows.

In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure" ("SFAS 148"). SFAS 148
amends SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123")
to provide alternative methods of transition for a voluntary change to the
fair-value-based method of accounting for stock-based employee
compensation. SFAS 148 also amends Accounting Principles Board Opinion No.
28, "Interim Financial Reporting" ("APB 28"), 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 transition guidance and annual disclosure provisions of
SFAS 148 are effective for fiscal years ending December 31, 2002. We
implemented the interim disclosure provision in our first quarter of fiscal
2003. The adoption of SFAS 148 did not have an impact on our financial
position, results of operations or cash flows.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities" ("FIN 46"). FIN 46 requires a company to
consolidate a variable interest entity ("VIE"), as defined, when the
company will absorb a majority of the VIE's expected losses, receives a
majority of the VIE's expected residual returns or both. FIN 46 also
requires consolidation of existing, non-controlled affiliates if the VIE is
unable to finance its operations without investor support, or where the
other investors do not have exposure to the significant risks and rewards
of ownership. FIN 46 applies immediately to a VIE created or acquired after
January 31, 2003. For a VIE created before February 1, 2003, FIN 46 applies
in the first fiscal year or interim period beginning after March 15, 2004.
Application of FIN 46 is also required in financial statements that have
interests in structures that are commonly referred to as special-purpose
entities for periods ending after December 15, 2003. The adoption of FIN 46
will not have an impact on our financial position, results of operations or
cash flows.

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS
149 amends and clarifies accounting for derivative instruments, including
certain derivative instruments embedded in other contracts and for hedging
activities under SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities." SFAS 149 is generally effective for derivative
instruments, including derivative instruments embedded in certain
contracts, entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. The adoption of SFAS 149 did
not have an impact on our financial position, results of operations or cash
flows.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS 150"). The statement modifies the accounting for certain financial
instruments that, under previous guidance, issuers could account for as
equity. The new statement requires that those instruments be classified as
liabilities in a company's statement of financial position. This statement
is effective for our interim periods beginning after June 15, 2003. The
adoption of SFAS 150 did not have an impact on our financial position,
results of operations or cash flows.

8


In July 2003, the EITF reached a consensus on Issue No. 03-11,
"Reporting Gains and Losses on Derivative Instruments and Hedging
Activities, and Not Held for Trading Purposes" ("EITF 03-11"). EITF 03-11
addresses when gains and losses on derivative contracts not held for
trading purposes should be reported on a net basis. The adoption of EITF
03-11 did not have an impact on our financial position, results of
operations or cash flows.

In December 2003, the FASB issued SFAS No. 132 (revised 2003),
"Employers' Disclosure about Pensions and Other Postretirement Benefits"
("SFAS 132"). The revision of SFAS 132 provides for additional disclosures
including the description of the types of plan assets, investment strategy,
measurement date(s), plan obligations, cash flows, and components of net
periodic benefit cost recognized in interim periods. The revisions of SFAS
132 are effective for financial statements with fiscal years ending after
December 15, 2003 and interim periods beginning after December 15, 2003.
The adoption of the revised SFAS 132 did not have an impact on our
financial position, results of operations or cash flows.

6. STOCK-BASED COMPENSATION
------------------------

Our 1998 Non-Statutory Stock Option Plan provides for the issuance of
up to 1,400 shares of common stock to key employees, while the 1999
Non-Statutory Stock Option Plan for Non-Employee Directors allows for the
issuance of up to 200 shares of common stock. The 2000 Non-Statutory Stock
Option Plan provides for the issuance of up to 1,500 shares of common
stock. The 2003 Stock Incentive Plan provides for the issuance of up to
1,500 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 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 2004 and 2003: expected dividend yield of 0%,
expected volatility of 53% and 64%, respectively, risk-free interest rates
of 3.97% and 3.69%, respectively, and expected lives of six years.

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 123, our net (loss) income and net (loss) income per share would
have been adjusted to the pro forma amounts for the three months ended
February 29, 2004 and February 28, 2003, respectively, as indicated below:

2004 2003
-------- --------

Net (loss) income:
As reported $ (712) $ 4,589
Fair value method compensation cost, net 861 525
-------- --------
Pro forma $ (1,573) $ 4,064
======== ========

Net (loss) income per share, basic:
As reported $ (.04) $ .24
Pro forma $ (.08) $ .21

Net (loss) income per share, diluted:
As reported $ (.04) $ .23
Pro forma $ (.08) $ .20





9


7. EARNINGS PER SHARE
------------------

The following table presents the computation of per share earnings for
the three months ended February 29, 2004 and February 28, 2003,
respectively:

2004 2003
---------- ----------

NET (LOSS) INCOME $ (712) $ 4,589
========== ==========

NUMBER OF COMMON SHARES:
Weighted average outstanding 19,099 19,165
Issued upon assumed exercise of
outstanding stock options 712 688
Effect of issuance of restricted common
shares 70 96
---------- ----------
Weighted average and potential
dilutive outstanding (1) 19,881 19,949
========== ==========

NET (LOSS) INCOME PER COMMON SHARE:
Basic $ (.04) $ .24
========== ==========
Diluted $ (.04) $ .23
========== ==========

(1) Because their effects are anti-dilutive, excludes shares issuable
under stock option plans and restricted stock issuance whose grant
price was greater than the average market price of common shares
outstanding as follows: 62 shares in 2004 and 80 shares in 2003.

8. ADVERTISING EXPENSES
--------------------

We incur significant expenditures on television, radio and print
advertising to support our nationally branded over-the-counter ("OTC")
health care products and toiletries. Customers purchase products from us
with the understanding that the brands will be supported by our extensive
media advertising. This advertising supports the retailers' sales effort
and maintains the important brand franchise with the consuming public.
Accordingly, we consider our advertising program to be clearly implicit in
our sales arrangements with our customers. Therefore, we believe it is
appropriate to allocate a percentage of the necessary supporting
advertising expenses to each dollar of sales by charging a percentage of
sales on an interim basis based upon anticipated annual sales and
advertising expenditures (in accordance with APB 28) and adjusting that
accrual to the actual expenses incurred at the end of the year.

9. SHIPPING AND HANDLING
---------------------

Shipping and handling costs of $1,434 and $1,458 are included in
selling expenses for the three months ended February 29, 2004 and February
28, 2003, respectively.

10. PATENT, TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS
-----------------------------------------------------

The carrying value of trademarks, which are not subject to
amortization under the provisions of SFAS No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"), was $244,807 and $244,790 as of February
29, 2004 and November 30, 2003, respectively. The gross carrying amount of
intangible assets subject to amortization at both February 29, 2004 and
November 30, 2003, which consist primarily of non-compete agreements, was
$2,400. The related accumulated amortization of intangible assets at
February 29, 2004 and November 30, 2003 was $1,420 and $1,343,
respectively. Amortization of our intangible assets subject to amortization
under the provisions of SFAS 142 for the three months ended February 29,
2004 and February 28, 2003 was $77 and $85, respectively. Estimated annual
amortization expense for these assets for the years ended November 30,
2005, 2006, 2007, 2008 and 2009 is $290, $290, $123, $40 and $20,
respectively.

10


11. INVENTORIES
-----------

Inventories consisted of the following as of February 29, 2004 and
November 30, 2003:

2004 2003
---------- ----------

Raw materials and work in process $ 8,038 $ 9,740
Finished goods 11,218 9,507
Excess of current cost over LIFO values (1,688) (1,688)
---------- ----------
Total inventories $ 17,568 $ 17,559
========== ==========

12. ACCRUED LIABILITIES
-------------------

Accrued liabilities consisted of the following as of February 29, 2004
and November 30, 2003:

2004 2003
---------- ----------

Interest $ 1,217 $ 3,115
Salaries, wages and commissions 1,526 3,604
Product advertising and promotion 8,855 5,348
Product acquisitions and divestitures 205 205
Property and other taxes 149 354
Consulting fees 280 301
Insurance 683 1,151
Pension 998 1,040
Other 1,143 861
---------- ----------
Total accrued liabilities $ 15,056 $ 15,979
========== ==========

13. LONG-TERM DEBT
--------------

Long-term debt consisted of the following as of February 29, 2004 and
November 30, 2003:

2004 2003
---------- ----------
Revolving Credit Facility due 2009 at a
variable rate of 4.75% as of
February 29, 2004 $ 25,000 $ --
Term loan payable to banks at variable
rates of 3.42% and 3.39% as of
February 26, 2004 (termination date)
and November 30, 2003, respectively -- 7,750
Called - 8.875% Senior Subordinated
Notes, due 2008, plus unamortized
premium of $20 for 2004 and $138
for 2003 30,028 204,676
Floating Rate Senior Notes due 2010
at a variable rate of 4.12% as of
February 29, 2004 75,000 --
7.0% Senior Subordinated Notes due 2014 125,000 --
---------- ----------
Total long-term debt 255,028 212,426
Less: current maturities and called
debt 30,028 7,750
---------- ----------
Total long-term debt, net of current
maturities and called debt $ 225,000 $ 204,676
========== ==========

On February 26, 2004, we entered into a new Senior Secured Revolving
Credit Facility due February 26, 2009 (the "Revolving Credit Facility")
with Bank of America, N.A. that provided an initial borrowing capacity of
$25,000 and an additional $25,000, subject to successful syndication. On
March 9, 2004, we entered into a new commitment agreement with a syndicate
of commercial banks led by Bank of America, N.A., as agent, that enables us
to borrow up to a total of $50,000. Borrowings under our Revolving Credit
Facility bear interest at LIBOR plus applicable percentages of 1.75% to
2.50% or a base rate (the higher of the federal funds rate plus 0.5% or the
prime rate) plus applicable percentages of 0.25% to 1.0%. The applicable
percentages are calculated based on our leverage ratio. As of February 29,
2004, $25,000 had been borrowed under the Revolving Credit Facility and the
variable rate was 4.75%. Borrowings under our Revolving Credit Facility are
secured by substantially all of our assets, except real property, and
shares of capital stock of our domestic

11


subsidiaries held by us and by the assets of the guarantors (our domestic
subsidiaries). The Revolving Credit Facility contains covenants,
representations, warranties and other agreements by us that are customary
in credit agreements and security instruments relating to financings of
this type. The significant financial covenants include fixed charge
coverage ratio, leverage ratio, senior secured leverage ratio, net worth
and brand value calculations. On March 9, 2004, we repaid $15,000 of our
outstanding borrowings under our Revolving Credit Facility. As of April 1,
2004, the Revolving Credit Facility had an outstanding balance of $10,000.

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 included a $15,000
revolving credit line and a $45,000 term loan. The remaining balance of the
term loan was repaid as part of the refinancing transactions discussed
herein, and the revolving credit line was terminated on February 26, 2004.

On February 10, 2004, we commenced a cash tender offer and consent
solicitation for the $204,538 outstanding principal amount of our 8.875%
Senior Subordinated Notes due 2008 (the "8.875% Subordinated Notes"). The
consent solicitation expired on February 24, 2004, and a total of
approximately $174,530, or approximately 85.3% of the 8.875% Subordinated
Notes, were tendered and accepted for payment on February 26, 2004. The
remaining principal outstanding, call premium, accrued interest and
interest to call date amounting to $32,227 was placed in escrow with the
trustee of the indenture to fund the purchase of additional 8.875%
Subordinated Notes tendered prior to March 9, 2004, the expiration date of
the tender offer, and the redemption of the remaining 8.875% Subordinated
Notes that were not tendered in such offer in accordance with their terms
on April 1, 2004 at a redemption price of 102.9583% of their aggregate
principal amount. The cash placed in escrow used to pay these obligations
is included in restricted cash in the Condensed Consolidated Balance Sheet
(See Note 3).

On February 26, 2004, we completed our refinancing of the Credit
Facility and purchased approximately $174,530 of our 8.875% Subordinated
Notes that were tendered, which resulted in a loss on early extinguishment
of debt of $11,309 and a tax benefit of $3,958. In the second quarter of
fiscal 2004, we anticipate recording an additional loss on early
extinguishment of debt of approximately $1,600 and a related tax benefit of
$500 related to the redemption of the remaining $30,008 of our called
8.875% Subordinated Notes.

On February 26, 2004, we issued and sold $75,000 of Floating Rate
Senior Notes due March 1, 2010 (the "Floating Rate Notes") and $125,000 of
7.0% Senior Subordinated Notes due March 1, 2014 (the "7.0% Subordinated
Notes").

The Floating Rate Notes bear interest at a three-month LIBOR plus
3.00% per year (4.12% as of February 29, 2004). Interest payments are due
quarterly in arrears commencing on June 1, 2004. On March 8, 2004, we
entered into an interest rate cap agreement effective June 1, 2004 with
decreasing notional principal amounts and cap rates ranging from 4.0% to
5.0% over the life of the agreement. We paid a $1,375 premium to enter into
the interest rate cap agreement, which will be amortized over the life of
the agreement. The interest rate cap agreement terminates on March 1, 2010.
Our domestic subsidiaries are guarantors of the Floating Rate Notes. The
guarantees of the Floating Rate Notes will be unsecured senior obligations
of the guarantors and will rank equally with all of the current and future
unsecured senior debt of the guarantors. The guarantees of the Floating
Rate Notes will effectively rank junior to any secured debt of the
guarantors, including the guarantors' guarantee of our indebtedness under
the Revolving Credit Facility. At any time after March 1, 2005, we may
redeem any of the Floating Rate Notes upon not less than 30 nor more than
60 days' notice at redemption prices (expressed in percentages of principal
amount), plus accrued and unpaid interest, if any, and liquidation damages,
if any, to the applicable redemption rate, if redeemed during the
twelve-month periods beginning March 1, 2005 at 102.0%, March 1, 2006 at
101.0% and March 1, 2007 and thereafter at 100.0%. At any time prior to
March 1, 2005, we may redeem up to 35% of the aggregate principal amount of
the Floating Rate Notes (including any additional Floating Rate Notes) at a
redemption price of 100.0% of the principal amount thereof, plus a premium
equal to the interest rate per annum on the Floating Rate Notes applicable
on the date on which notice of the redemption is given, together with
accrued and unpaid interest and liquidated damages, if any, with the net
cash proceeds of one or more qualified equity offerings; provided, that (i)
at least 65% of the aggregate principal amount of Floating Rate Notes
remains outstanding immediately after the occurrence of each redemption
(excluding Floating Rate Notes held by us and our subsidiaries); and (ii)
the redemption must occur within 90 days of the date of the closing of such
qualified equity offering.

Interest payments on the 7.0% Subordinated Notes are due semi-annually
in arrears on March 1 and September 1, commencing on September 1, 2004. Our
domestic subsidiaries are guarantors of the 7.0% Subordinated Notes. The
guarantees of the 7.0% Subordinated Notes will be unsecured senior
subordinated obligations of the guarantors. At any time after March 1,
2009, we may redeem any of the 7.0% Subordinated Notes upon not less than
30 nor more than 60 days' notice at redemption prices (expressed in
percentages of principal amount), plus accrued and unpaid interest, if any,
and liquidation damages, if any, to the applicable redemption rate, if
redeemed during the twelve-month periods beginning March 1, 2009 at
103.500%, March 1, 2010 at 102.333%, March 1, 2011 at 101.167% and March 1,
2012 and thereafter at 100%. At any time prior to March 1, 2007, we may
redeem up to 35% of the aggregate principal amount of the 7.0%

12


Subordinated Notes (including any additional 7.0% Subordinated Notes) at a
redemption price of 107% of the principal amount thereof, plus accrued and
unpaid interest and liquidated damages, if any, thereon to the applicable
redemption rate, with the net cash proceeds of one or more qualified equity
offerings; provided, that (i) at least 65% of the aggregate principal
amount of the 7.0% Subordinated Notes remains outstanding immediately after
the occurrence of such redemption (excluding 7.0% Subordinated Notes held
by us and our subsidiaries); and (ii) the redemption must occur within 90
days of the date of the closing of such qualified equity offering.

The indentures governing the Floating Rate Notes and 7.0% Subordinated
Notes will, among other things, limit our ability and the ability of our
restricted subsidiaries to: (i) borrow money or sell preferred stock, (ii)
create liens, (iii) pay dividends on or redeem or repurchase stock, (iv)
make certain types of investments, (v) sell stock in our restricted
subsidiaries, (vi) restrict dividends or other payments from restricted
subsidiaries, (vii) enter into transactions with affiliates, (viii) issue
guarantees of debt and (ix) sell assets or merge with other companies. In
addition, if we experience specific kinds of changes in control, we must
offer to purchase the Floating Rate Notes and 7.0% Subordinated Notes at
101% of their principal amount plus accrued and unpaid interest.

Excluding the $30,028 of called debt, the future maturities of
long-term debt outstanding as of February 29, 2004 are as follows:

2005 $ --
2006 --
2007 --
2008 --
2009 25,000
Thereafter 200,000
----------
$ 225,000
==========

14. COMPREHENSIVE INCOME
--------------------

Comprehensive income consisted of the following components for the
three months ended February 29, 2004 and February 28, 2003, respectively:

2004 2003
---------- ----------

Net (loss) income $ (712) $ 4,589
Other - foreign currency
translation adjustment 270 364
---------- ----------
Total $ (442) $ 4,953
========== ==========

15. STOCK BUYBACK
-------------

In January 2004, our board of directors increased the total
authorization to repurchase our common stock under our stock buyback
program to $20,000. In the first quarter of fiscal 2004, we repurchased 16
shares for $319. All repurchased shares were retired and returned to
unissued. We, however, are limited in our ability to repurchase shares due
to restrictions under the terms of our Revolving Credit Facility, Floating
Rate Notes and 7.0% Subordinated Notes.

16. RETIREMENT PLANS AND POSTRETIREMENT HEALTH CARE BENEFITS
--------------------------------------------------------

RETIREMENT PLANS

We have a noncontributory defined benefit pension plan ("the Plan"),
which covers substantially all employees. The Plan provides benefits based
upon years of service and the employee's compensation. Our contributions
are based on computations by independent actuaries. Plan assets at February
29, 2004 and November 30, 2003 were invested primarily in United States
government and agency securities and corporate debt and equity securities.
In October 2000, our board of directors adopted an amendment to the Plan
that freezes benefits of the Plan and prohibits new entrants to the Plan
effective December 31, 2000.

13


Net periodic pension cost for the three months ended February 29, 2004
and February 28, 2003 comprised the following components:


2004 2003
---------- ----------
Service cost $ -- $ --
Interest cost on projected benefit
obligation 155 152
Actual return on plan assets (178) (157)
Net amortization and deferral 28 (36)
---------- ----------
Net pension cost (benefit) $ 5 $ (41)
========== ==========

No employer contributions were made for the three months ended
February 29, 2004 and February 28, 2003, and no employer contributions are
expected to be made in fiscal 2004.

POSTRETIREMENT HEALTH CARE BENEFITS

We maintain certain postretirement health care benefits for eligible
employees. Employees become eligible for these benefits if they meet
certain age and service requirements. We pay a portion of the cost of
medical benefits for certain retired employees over the age of 65.
Effective January 1, 1993, our contribution is a service-based percentage
of the full premium. We pay these benefits as claims are incurred. Employer
contributions expected for fiscal 2004 are approximately $70.

Net periodic postretirement health care benefits cost for the three
months ended February 29, 2004 and February 28, 2003, included the
following components:

2004 2003
---------- ----------
Service cost $ 16 $ 14
Interest cost on accumulated
postretirement benefit obligation 20 20
Amortization of prior service cost 4 4
Amortization of net gain (8) (7)
---------- ----------
Net periodic postretirement benefits
cost $ 32 $ 31
========== ==========

17. INCOME TAXES
------------

We account for income taxes using the asset and liability approach as
prescribed by SFAS No. 109, "Accounting for Income Taxes". This approach
requires recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been included in the
consolidated financial statements or tax returns. Using the enacted tax
rates in effect for the year in which the differences are expected to
reverse, deferred tax assets and liabilities are determined based on the
differences between the financial reporting and the tax basis of an asset
or liability. We record income tax expense in our consolidated financial
statements based on an estimated annual effective income tax rate. Our tax
rate for the three months ended February 29, 2004 was 35% as compared to
38% in the corresponding quarter of fiscal 2003, which reflects the
implementation of a number of foreign and state tax saving initiatives.

18. PRODUCT SEGMENT INFORMATION
---------------------------

Net sales of our domestic product categories within our single
healthcare business segment for the three months ended February 29, 2004
and February 28, 2003 are as follows:


2004 2003
---------- ----------
Topical analgesics $ 15,712 $ 13,572
Medicated skin care products 13,332 13,150
Dietary supplements 8,511 9,605
Medicated dandruff shampoos and
conditioner 9,221 8,171
Other OTC and toiletry products 8,830 8,182
---------- ----------
Total $ 55,606 $ 52,680
========== ==========

19. COMMITMENTS AND CONTINGENCIES
-----------------------------

GENERAL LITIGATION

As of April 1, 2004, we were named as a defendant in approximately 349
lawsuits involving claims by approximately 688 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
before United States District Judge Barbara Jacobs Rothstein (In Re
Phenylpropanolamine ("PPA") Products Liability Litigation, MDL No. 1407).
The remaining cases are state court cases that have been filed in a number
of different states.

We believe that approximately 214 or approximately 60% of the existing
lawsuits in which we are named as a defendant represent cases involving
alleged injuries by products manufactured and sold prior to our acquisition
of DEXATRIM in December 1998. We are being defended in these lawsuits and
are indemnified from liability by The DELACO Company, Inc. ("DELACO"),
successor to Thompson 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. We further understand that DELACO's
insurance carriers are disputing their responsibility for such coverage.
Moreover, on February 12, 2004, DELACO filed a Chapter 11 bankruptcy
petition in the United States Bankruptcy Court for the Southern District of
New York. Accordingly, it is uncertain whether DELACO will be able to
indemnify us for such claims and even if it

14


is able to do so, it is unlikely that DELACO will be able to indemnify us
beyond its insurance coverage. In addition, we cannot assure you that the
insurance maintained by DELACO will be sufficient to cover claims related
to products manufactured or sold prior to our acquisition of DEXATRIM or
that ultimately we will not be held liable for these claims. Our product
liability insurance, as described below, would not apply to claims arising
from products manufactured and sold prior to our acquisition of DEXATRIM.
In addition to indemnification from DELACO, we will also seek to defend
ourselves in these lawsuits on the basis that we did not manufacture and
sell products containing PPA prior to December 1998.

In the approximately 214 cases that have been filed against us for
products manufactured and sold prior to December 1998, approximately half
of the plaintiffs are in cases filed in states that we believe do not under
current law impose liability upon a successor. The remaining plaintiffs are
in cases filed in states that may in some circumstances permit liability
against a successor. However, although there can be no assurances, we do
not believe that successor liability would be imposed against us in these
cases. The reasons for our belief, among others, are that we did not
purchase all of DELACO's assets and DELACO continued to operate its
remaining business after December 1998; we did not cause DELACO's
bankruptcy; many plaintiffs included in cases filed in states that in some
circumstances impose successor liability are actually residents of other
states; and we believe that a remedy will be available to plaintiffs who
file claims in the DELACO bankruptcy.

As of April 1, 2004, in the approximately 135 lawsuits we are
defending, approximately 163 plaintiffs specifically allege ingestion of
DEXATRIM. The remaining plaintiffs either do not specifically allege
ingestion of DEXATRIM or have sued many manufacturers or seller of products
containing PPA without identifying the products they ingested.

On December 19, 2003, we entered into a memorandum of understanding
with the Plaintiffs' Steering Committee ("PSC") in In re
Phenylpropanolamine ("PPA") Products Liability Litigation, MDL 1407,
pending before the United States District Court for the Western District of
Washington (the "Memorandum of Understanding"). The Memorandum of
Understanding memorializes certain settlement terms concerning lawsuits
relating to DEXATRIM products containing PPA. We are currently negotiating
with the PSC on the terms of a settlement agreement that will supercede the
Memorandum of Understanding. The Memorandum of Understanding contemplates
that we will commence a national class action settlement of all Dexatrim
PPA claims. We will then seek final approval of the settlement terms at a
fairness hearing. Claims would be settled pursuant to an agreed upon
settlement matrix that is designed to evaluate and place settlement values
on cases. If the class settlement is approved, it is expected that a
judgment will be entered, and we will pay the finally determined amount of
the settlement into a trust fund. We will then publish notice of the final
settlement and details on how plaintiffs can submit claims and the
deadlines for making such claims. Claims would be settled in the class
action pursuant to an agreed upon settlement matrix that is designed to
evaluate and place settlement values on cases. If we are able to complete a
final settlement agreement and successfully obtain approval from the court
in each of the foregoing steps, which we presently believe we will be able
to do, it is expected that final approval of the class settlement and
funding of the settlement trust fund will occur during the second half of
2004.

On December 19, 2003, DELACO also entered into the Memorandum of
Understanding with the PSC. We understand that DELACO intends to implement
its contemplated settlement with the PSC through a liquidating Chapter 11
bankruptcy plan. If DELACO pursues the settlement through its bankruptcy
plan, we expect that the administrative process for DELACO's settlement
will be similar to the process in our class action. We will be required to
file a claim in DELACO's bankruptcy case in order to preserve our claims
for indemnification against DELACO. As part of this Chapter 11 plan, we
expect that after resolution of creditors' claims, DELACO will seek to
liquidate and distribute all of its assets and will dissolve as a company.

Based upon the Memorandum of Understanding and the settlement matrix,
Judge Rothstein has entered a stay of discovery in all federal court
DEXATRIM PPA cases to allow the PSC and us to negotiate a final settlement
agreement and for us to then file our class action settlement. We will seek
a similar stay in the state court cases. Approximately 70% of our cases are
included in the MDL. We expect many of our cases pending in state courts
will join in the settlement discussed above. Judge Rothstein ordered that
the DEXATRIM case scoring system and settlement matrix remain confidential
until a final settlement agreement is entered.

Since the terms of the preliminary settlement in the PPA litigation
are not final or binding, we cannot assure you that we will be able to
reach a final settlement or that if a final settlement is reached, the
terms will be approved by the court. If the settlement is approved, we
believe that the settlement will include a substantial majority of the
claims by users of DEXATRIM products containing PPA, but that some claims
may elect to "opt out" of any class settlement and will continue to pursue
claims for damages against us in separate lawsuits. We cannot estimate at
this time how many claims will opt out or whether such claims will result
in significant additional liability for us. To the extent the number of opt
outs are deemed excessive relative to the total number of claims, as
determined by the final settlement agreement, we reserve the right to
terminate the settlement.

15


Although we believe a liability existed as of February 29, 2004
related to our PPA litigation, since the terms of the settlement are
preliminary, we are not able to reasonably estimate the amount of such
liability at February 29, 2004 and have made no provision for this
liability in our condensed consolidated financial statements. In addition,
we currently expect to use most of our product liability insurance coverage
available for the PPA litigation and certain of our cash on hand to make
the initial funding of the settlement trust. To the extent the amount in
the settlement trust is ultimately insufficient to fully fund the
settlement, we may be required to make additional contributions to the
trust fund in the future. If we are required to fund significant other
liabilities beyond the initial settlement amount, either pursuant to the
terms of the settlement as a result of litigation or otherwise, we will
have significantly fewer sources of funds with which to satisfy such
liabilities, and we may be unable to do so. Moreover, if the settlement is
not approved, we may not have sufficient funds to satisfy all claims
against us.

We have reached an agreement with Kemper Indemnity Insurance Company
("Kemper") to settle Kemper's lawsuit that sought to rescind our policy for
$50,000 of excess coverage for product liability claims. After giving
effect to the settlement with Kemper, we will have available for the claims
against us related to the PPA litigation through our first three layers of
insurance coverage approximately $60,000 of the $77,000 of product
liability coverage provided by these policies. The $60,000 of available
coverage consists of $37,500 of insurance under the Kemper policy and
approximately $22,500 under policies with two other insurance companies.
Coverage under these policies is available to us 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 a number of claims relating to injuries
occurring prior to December 1998 for which we will seek indemnification
from DELACO and one claim in which there are multiple PPA manufacturers as
defendants that relate to injuries occurring after May 31, 2001. We believe
we have meritorious defenses to these claims and are aggressively defending
them. Our insurance policies are subject to certain other limitations that
are generally customary for policies of this type.

We continue to aggressively defend an action brought by Interstate
Fire & Casualty Company ("Interstate") to rescind its $25,000 of excess
coverage for product liability and pursue our available remedies at law
against Interstate. We cannot assure that we will be successful in
retaining such excess coverage. The Interstate policy is in excess of the
product liability insurance described above. In the event the $60,000 of
insurance funds are exhausted under the PPA settlement or otherwise,
coverage under the Interstate policy would not be available until we have
paid the $17,000 difference up to $77,000. We currently expect to use most
of our product liability insurance coverage available for the PPA
litigation to make the initial funding of the proposed PPA settlement
trust.

We maintain a significantly lower level of insurance coverage for all
other potential claims relating to our products including DEXATRIM products
containing ephedrine. Our existing product liability insurance coverage for
all of our other products, including DEXATRIM products containing
ephedrine, consists of $10,000 of self-insured coverage through our captive
insurance subsidiary, of which approximately $3,600 is currently funded,
and a total of $30,000 of excess coverage through third party insurers.

We have been named as defendant in two lawsuits alleging that the
plaintiffs were injured as a result of the ingestion of DEXATRIM containing
ephedrine. We have been named in an additional lawsuit alleging that the
plaintiff was injured as a result of the ingestion of DEXATRIM Natural, but
the allegations do not indicate whether the DEXATRIM Natural contained
ephedrine. We intend to vigorously defend all of these lawsuits.

We previously were named in a class action filed in the United States
District Court for the Southern District of New York seeking certification
of a class consisting of New York residents who have purchased DEXATRIM
Results or DEXATRIM Natural since January 2000. The class action lawsuit
sought compensatory and punitive damages arising out of allegedly false
advertising in connection with the sale of DEXATRIM Results and DEXATRIM
Natural products. None of the plaintiffs in this action alleged personal
injury as a result of the ingestion of a DEXATRIM product. On March 29,
2004, a stipulation was submitted to the court dismissing the case on
jurisdictional grounds. Pursuant to the stipulation, the plaintiffs may
re-file the class action in New York state court.

On December 30, 2003, the United States Food and Drug Administration
("FDA") issued a consumer alert on the safety of dietary supplements
containing ephedrine alkaloids and on February 6, 2004 published a final
rule with respect to these products. The final rule prohibits the sale of
dietary supplements containing ephedrine alkaloids because such supplements
present an unreasonable risk of illness or injury. The final rule becomes
effective on April 11, 2004. Although we discontinued the manufacturing and
shipment of DEXATRIM containing ephedrine in September 2002, the FDA's
final rule may result in additional lawsuits being filed against us
alleging damages related to the use or purchase of DEXATRIM containing
ephedrine.

16


We have been named as a defendant in a putative class action suit
filed in the Superior Court of the State of California for the County of
Los Angeles. The lawsuit seeks certification of classes consisting of
residents of the United States, or residents of the State of California,
who have purchased our BULLFROG sun care products during the past four
years. The lawsuit seeks injunctive relief and compensatory damages under
the California Business and Professions Code against us arising out of
alleged deceptive, untrue or misleading advertising, and breach of
warranty, in connection with the manufacturing, labeling, advertising,
promotion and sale of BULLFROG products. The plaintiff has stipulated that
the amount in controversy with respect to plaintiffs' individual claim and
each member of the proposed class does not exceed $75. We are investigating
this matter and intend to vigorously defend the lawsuit.

Other claims, suits and complaints arise in the ordinary course of our
business involving such matters as patents and trademarks, product
liability, environmental matters 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 financial
position, results of operations or cash flows if disposed of unfavorably.

REGULATORY

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, an 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.

In 1997, the FDA published a proposed rule on the use of dietary
supplements containing ephedrine alkaloids. In June 2002, the United States
Department of Health and Human Services ("HHS") proposed an expanded
scientific evaluation of ephedra which led to the issuance of a report by
the RAND-based Southern California Evidence-Based Practice Center (the
"RAND Report"). 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 connection with the RAND Report, HHS sought
public comment on whether additional measures are required concerning the
sale and distribution of dietary supplements containing ephedrine
alkaloids.

On December 30, 2003, the FDA issued a consumer alert on the safety of
dietary supplements containing ephedrine alkaloids and on February 6, 2004
published a final rule with respect to these products. The final rule
prohibits the sale of dietary supplements containing ephedrine alkaloids
because such supplements present an unreasonable risk of illness or injury.
The final rule becomes effective on April 11, 2004. Although we
discontinued the manufacturing and shipment of DEXATRIM containing
ephedrine in September 2002, the FDA's final rule may result in additional
lawsuits being filed against us alleging damages related to the use or
purchase of DEXATRIM containing ephedrine.

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 resulted in a return of
products from retailers in fiscal 2003 for which we initially provided a
$750 allowance. At this time, we believe we have received returns
representing substantially all DEXATRIM with ephedrine. In the fourth
quarter of fiscal 2003, the unused portion of the returns allowance for
DEXATRIM containing ephedrine of $235 was recorded as a reduction of cost
of sales.

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

17


could still market these products as homeopathic products and could also
reformulate them using ingredients included in the FDA monograph.

Certain of our topical analgesic products are currently marketed under
an FDA tentative final monograph. The FDA has recently proposed that the
final monograph exclude external analgesic products in patch, plaster, or
poultice form, unless the FDA receives additional data supporting the
safety and efficacy of these products. On October 14, 2003, we submitted to
the FDA information regarding the safety of our ICY HOT patches and
arguments to support our product's inclusion in the final monograph. We
have also participated in an industry effort coordinated by the Consumer
Healthcare Products Association ("CHPA") to establish with the FDA a
protocol of additional research that will allow the patches to be marketed
under the final monograph even if the final monograph does not explicitly
allow them. The CHPA submission to FDA was made on October 15, 2003. This
additional research may require a considerable amount of expensive testing
and data analysis by expert consultants. Some of this cost may be shared
with other patch manufacturers. We believe that the monograph is unlikely
to become final and take effect before November 2005. If neither action
described above is successful and the final monograph excludes such
products, we will have to file a new drug application ("NDA") in order to
continue to market the ICY HOT Patch or similar delivery systems under our
other topical analgesic brands. In such case, we would have to remove the
existing product from the market as of one year from the effective date of
the final monograph, pending FDA review and approval of an NDA. The
preparation of an NDA would likely take us six to 18 months and would be
expensive. It typically takes the FDA at least 12 months to rule on the NDA
once it is submitted.

We have responded to certain questions with respect to efficacy
received from the FDA in connection with clinical studies for pyrilamine
maleate, one of the active ingredients used in certain of the PAMPRIN and
PREMSYN PMS products. While we addressed all of the FDA questions in
detail, the final monograph for menstrual drug products, which has not yet
been issued, will determine if the FDA considers pyrilamine maleate safe
and effective for menstrual relief products. We have been actively
monitoring the process and do not believe that either PAMPRIN or PREMSYN
PMS will be materially adversely affected by the FDA review. We believe
that any adverse finding by the FDA would likewise affect our principal
competitors in the menstrual product category. We are also aware of the
FDA's concern about the potential toxicity due to concomitant use of OTC
and prescription drugs that contain the ingredient acetaminophen, an
ingredient also found in PAMPRIN and PREMSYN PMS. We are participating in
an industry-wide effort to reassure the FDA that the current recommended
dosing regimen is safe and effective and that proper labeling and public
education by both OTC and prescription drug companies are the best policies
to abate the FDA's concern. There can be no assurance as to what action, if
any, the FDA may take with respect to acetaminophen.

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

20. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
--------------------------------------------

The condensed consolidating financial statements, for the dates or
periods indicated, of Chattem, Inc. ("Chattem"), Signal Investment &
Management Co. ("Signal"), SunDex, LLC ("SunDex") and Chattem (Canada)
Holdings, Inc. ("Canada"), the guarantors of the long-term debt of Chattem,
and the non-guarantor direct and indirect wholly-owned subsidiaries of
Chattem are presented below. Signal, SunDex and Canada are wholly-owned
subsidiaries of Chattem; the guarantee of Signal, SunDex and Canada is full
and unconditional and joint and several. The guarantee of Signal, SunDex
and Canada as of February 29, 2004 arose in conjunction with Chattem's
issuance of the 8.875% Subordinated Notes, the Revolving Credit Facility,
the Floating Rate Notes and the 7.0% Subordinated Notes (See Note 13). The
guarantees' terms match the terms of the 8.875% Subordinated Notes, the
Revolving Credit Facility, the Floating Rate Notes and the 7.0%
Subordinated Notes. The maximum amount of future payments the guarantors
would be required to make under the guarantees as of February 29, 2004 is
$255,028.

18

Note 20
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS

FEBRUARY 29, 2004
(In thousands)

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

ASSETS
- ------
CURRENT ASSETS:
Cash and cash equivalents $ 19,800 $ 1,970 $ 7,513 $ -- $ 29,283
Restricted cash 32,227 -- -- -- 32,227
Accounts receivable, less allowances of $3,765 30,573 15,934 4,013 (15,934) 34,586
Interest receivable -- 619 -- (619) --
Inventories 12,744 2,018 2,806 -- 17,568
Refundable income taxes 8,166 -- 17 -- 8,183
Deferred income taxes 2,551 -- -- -- 2,551
Prepaid expenses and other current assets 1,834 -- 117 (667) 1,284
---------- ---------- ---------- ---------- ----------
Total current assets 107,895 20,541 14,466 (17,220) 125,682
---------- ---------- ---------- ---------- ----------

PROPERTY, PLANT AND EQUIPMENT, NET 27,257 775 357 -- 28,389
---------- ---------- ---------- ---------- ----------

OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product
rights, net 981 307,096 -- (62,290) 245,787
Debt issuance costs, net 6,432 -- -- -- 6,432
Investment in subsidiaries 244,509 33,000 66,024 (343,533) --
Note receivable -- 33,000 -- (33,000) --
Other 2,251 -- 500 -- 2,751
---------- ---------- ---------- ---------- ----------
Total other noncurrent assets 254,173 373,096 66,524 (438,823) 254,970
---------- ---------- ---------- ---------- ----------

TOTAL ASSETS $ 389,325 $ 394,412 $ 81,347 $ (456,043) $ 409,041
========== ========== ========== ========== ==========

LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Called debt $ 30,028 $ -- $ -- $ -- $ 30,028
Accounts payable and other 10,804 -- 942 -- 11,746
Accrued liabilities 27,785 1,947 2,544 (17,220) 15,056
---------- ---------- ---------- ---------- ----------
Total current liabilities 68,617 1,947 3,486 (17,220) 56,830
---------- ---------- ---------- ---------- ----------

LONG-TERM DEBT, less current maturities and
called debt 225,000 -- 33,000 (33,000) 225,000
---------- ---------- ---------- ---------- ----------

DEFERRED INCOME TAXES (531) 28,467 (48) -- 27,888
---------- ---------- ---------- ---------- ----------

OTHER NONCURRENT LIABILITIES 1,710 -- -- -- 1,710
---------- ---------- ---------- ---------- ----------

INTERCOMPANY ACCOUNTS (3,084) 1,504 1,580 -- --
---------- ---------- ---------- ---------- ----------

SHAREHOLDERS' EQUITY:
Preferred shares, without par value, authorized
1,000, none issued -- -- -- -- --
Common shares, without par value, authorized
50,000, issued 19,458 81,474 -- -- -- 81,474
Share capital of subsidiaries -- 330,586 38,647 (369,233) --
Retained earnings 21,562 31,908 4,759 (36,667) 21,562
---------- ---------- ---------- ---------- ----------
Total 103,036 362,494 43,406 (405,900) 103,036
---------- ---------- ---------- ---------- ----------
Unamortized value of restricted common shares
issued (3,233) -- -- -- (3,233)
Cumulative other comprehensive income:
Foreign currency translation adjustment (550) -- (77) 77 (550)
Minimum pension liability adjustment, net of
income taxes (1,640) -- -- -- (1,640)
---------- ---------- ---------- ---------- ----------
Total shareholders' equity 97,613 362,494 43,329 (405,823) 97,613
---------- ---------- ---------- ---------- ----------

TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 389,325 $ 394,412 $ 81,347 $ (456,043) $ 409,041
========== ========== ========== ========== ==========

19

Note 20
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS

NOVEMBER 30, 2003
(In thousands)

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

ASSETS
- ------
CURRENT ASSETS:
Cash and cash equivalents $ 18,702 $ 1,964 $ 6,265 $ -- $ 26,931
Accounts receivable, less allowances of $3,594 21,729 7,089 3,749 (7,089) 25,478
Inventories 12,670 2,040 2,849 -- 17,559
Refundable income taxes 4,414 -- 17 -- 4,431
Deferred income taxes 3,441 -- -- -- 3,441
Prepaid expenses and other current assets 4,401 -- 142 (1,167) 3,376
---------- ---------- ---------- ---------- ----------
Total current assets 65,357 11,093 13,022 (8,256) 81,216
---------- ---------- ---------- ---------- ----------

PROPERTY, PLANT AND EQUIPMENT, NET 27,595 775 352 -- 28,722
---------- ---------- ---------- ---------- ----------

OTHER NONCURRENT ASSETS:
Patents, trademarks and other purchased product
rights, net 1,057 307,080 -- (62,290) 245,847
Debt issuance costs, net 5,504 -- -- -- 5,504
Investment in subsidiaries 235,928 -- -- (235,928) --
Other 1,596 -- 500 -- 2,096
---------- ---------- ---------- ---------- ----------
Total other noncurrent assets 244,085 307,080 500 (298,218) 253,447
---------- ---------- ---------- ---------- ----------

TOTAL ASSETS $ 337,037 $ 318,948 $ 13,874 $ (306,474) $ 363,385
========== ========== ========== ========== ==========

LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
Current maturities of long-term debt $ 7,750 $ -- $ -- $ -- $ 7,750
Accounts payable and other 9,804 -- 1,120 -- 10,924
Accrued liabilities 21,417 628 2,190 (8,256) 15,979
---------- ---------- ---------- ---------- ----------
Total current liabilities 38,971 628 3,310 (8,256) 34,653
---------- ---------- ---------- ---------- ----------

LONG-TERM DEBT, less current maturities 204,676 -- -- -- 204,676
---------- ---------- ---------- ---------- ----------

DEFERRED INCOME TAXES 56 26,788 (48) -- 26,796
---------- ---------- ---------- ---------- ----------

OTHER NONCURRENT LIABILITIES 1,689 -- -- -- 1,689
---------- ---------- ---------- ---------- ----------

INTERCOMPANY ACCOUNTS (3,926) 3,469 457 -- --
---------- ---------- ---------- ---------- ----------

SHAREHOLDERS' EQUITY:
Preferred shares, without par value, authorized
1,000, none issued -- -- -- -- --
Common shares, without par value, authorized
50,000, issued 19,161 77,815 -- -- -- 77,815
Share capital of subsidiaries -- 263,704 6,504 (270,208) --
Retained earnings 22,274 24,359 3,998 (28,357) 22,274
---------- ---------- ---------- ---------- ----------
Total 100,089 288,063 10,502 (298,565) 100,089
---------- ---------- ---------- ---------- ----------
Unamortized value of restricted common shares
issued (2,058) -- -- -- (2,058)
Cumulative other comprehensive income:
Foreign currency translation adjustment (820) -- (347) 347 (820)
Minimum pension liability adjustment, net of
income taxes (1,640) -- -- -- (1,640)
---------- ---------- ---------- ---------- ----------
Total shareholders' equity 95,571 288,063 10,155 (298,218) 95,571
---------- ---------- ---------- ---------- ----------

TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 337,037 $ 318,948 $ 13,874 $ (306,474) $ 363,385
========== ========== ========== ========== ==========

20

Note 20
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

FOR THE THREE MONTHS FEBRUARY 29, 2004
(Unaudited and in thousands)

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

TOTAL REVENUES $ 49,908 $ 16,549 $ 4,172 $ (9,392) $ 61,237
---------- ---------- ---------- ---------- ----------

COSTS AND EXPENSES:
Cost of sales 13,702 2,249 1,549 (548) 16,952
Advertising and promotion 16,376 1,177 979 -- 18,532
Selling, general and administrative 10,661 46 122 -- 10,829
Equity in subsidiary income (8,309) -- -- 8,309 --
---------- ---------- ---------- ---------- ----------
Total costs and expenses 32,430 3,472 2,650 7,761 46,313
---------- ---------- ---------- ---------- ----------

INCOME FROM OPERATIONS 17,478 13,077 1,522 (17,153) 14,924
---------- ---------- ---------- ---------- ----------

OTHER INCOME (EXPENSE):
Interest expense (4,763) -- (611) 619 (4,755)
Investment and other income, net 27 620 17 (619) 45
Loss on early extinguishment of debt (11,309) -- -- -- (11,309)
Royalties (7,525) (1,319) -- 8,844 --
Corporate allocations 788 (759) (29) -- --
---------- ---------- ---------- ---------- ----------
Total other income (expense) (22,782) (1,458) (623) 8,844 (16,019)
---------- ---------- ---------- ---------- ----------

(LOSS) INCOME BEFORE INCOME TAXES (5,304) 11,619 899 (8,309) (1,095)

(BENEFIT FROM) PROVISION FOR INCOME TAXES (4,592) 4,067 142 -- (383)
---------- ---------- ---------- ---------- ----------

NET (LOSS) INCOME $ (712) $ 7,552 $ 757 $ (8,309) $ (712)
========== ========== ========== ========== ==========








21

Note 20
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

FOR THE THREE MONTHS FEBRUARY 28, 2003
(Unaudited and in thousands)

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

TOTAL REVENUES $ 44,884 $ 12,758 $ 4,617 $ (3,834) $ 58,425
---------- ---------- ---------- ---------- ----------

COSTS AND EXPENSES:
Cost of sales 14,032 2,701 1,940 (982) 17,691
Advertising and promotion 13,740 3,280 1,385 -- 18,405
Selling, general and administrative 9,227 58 529 -- 9,814
Equity in subsidiary income (3,947) -- -- 3,947 --
---------- ---------- ---------- ---------- ----------
Total costs and expenses 33,052 6,039 3,854 2,965 45,910
---------- ---------- ---------- ---------- ----------

INCOME FROM OPERATIONS 11,832 6,719 763 (6,799) 12,515
---------- ---------- ---------- ---------- ----------

OTHER INCOME (EXPENSE):
Interest expense (5,147) -- -- -- (5,147)
Investment and other income, net 25 1 8 -- 34
Royalties (2,262) (500) (90) 2,852 --
Corporate allocations 915 (887) (28) -- --
---------- ---------- ---------- ---------- ----------
Total other income (expense) (6,469) (1,386) (110) 2,852 (5,113)
---------- ---------- ---------- ---------- ----------

INCOME BEFORE INCOME TAXES 5,363 5,333 653 (3,947) 7,402

PROVISION FOR INCOME TAXES 774 1,900 139 -- 2,813
---------- ---------- ---------- ---------- ----------

NET INCOME $ 4,589 $ 3,433 $ 514 $ (3,947) $ 4,589
========== ========== ========== ========== ==========






22

Note 20
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED FEBRUARY 29, 2004
(Unaudited and in thousands)

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

OPERATING ACTIVITIES:
Net (loss) income $ (712) $ 7,552 $ 757 $ (8,309) $ (712)
Adjustments to reconcile net (loss) income to
net cash provided by operating activities:
Depreciation and amortization 1,519 -- 18 -- 1,537
Deferred income taxes 303 1,679 -- -- 1,982
Tax benefit realized from stock option plans 1,083 -- -- -- 1,083
Loss on early extinguishment of debt 11,309 -- -- -- 11,309
Equity in subsidiary income (8,309) -- -- 8,309 --
Changes in operating assets and liabilities:
Accounts receivable (8,844) (8,845) (264) 8,845 (9,108)
Interest receivable -- (619) -- 619 --
Inventories (74) 22 43 -- (9)
Refundable income taxes (3,752) -- -- -- (3,752)
Prepaid expenses and other current assets 2,567 -- 25 (500) 2,092
Accounts payable and accrued liabilities 7,368 1,319 176 (8,964) (101)
---------- ---------- ---------- ---------- ----------
Net cash provided by operating activities 2,458 1,108 755 -- 4,321
---------- ---------- ---------- ---------- ----------

INVESTING ACTIVITIES:
Purchases of property, plant and equipment (485) -- (6) -- (491)
Purchases of patents, trademarks and other product
rights -- (17) -- -- (17)
Increase in note receivable -- (33,000) -- 33,000 --
(Increase) decrease in other assets, net (760) -- 270 -- (490)
---------- ---------- ---------- ---------- ----------
Net cash (used in) provided by investing
activities (1,245) (33,017) 264 33,000 (998)
---------- ---------- ---------- ---------- ----------

FINANCING ACTIVITIES:
Repayment of long-term debt (182,280) -- -- -- (182,280)
Proceeds from long-term debt 200,000 -- -- -- 200,000
Proceeds from borrowings under revolving credit
facility 25,000 -- -- -- 25,000
Proceeds from exercise of stock options 1,453 -- -- -- 1,453
Repurchase of common shares (319) -- -- -- (319)
Increase in debt issuance costs (5,678) -- -- -- (5,678)
Retirement of debt issuance costs (6,946) -- -- -- (6,946)
Restricted cash (32,227) -- -- -- (32,227)
Intercompany debt proceeds, net -- -- 33,000 (33,000) --
Changes in intercompany accounts 882 31,915 (32,797) -- --
---------- ---------- ---------- ---------- ----------
Net cash (used in) provided by financing
activities (115) 31,915 203 (33,000) (997)
---------- ---------- ---------- ---------- ----------

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND
CASH EQUIVALENTS
-- -- 26 -- 26
---------- ---------- ---------- ---------- ----------

CASH AND CASH EQUIVALENTS:
Increase for the period 1,098 6 1,248 -- 2,352
At beginning of period 18,702 1,964 6,265 -- 26,931
---------- ---------- ---------- ---------- ----------
At end of period $ 19,800 $ 1,970 $ 7,513 $ -- $ 29,283
========== ========== ========== ========== ==========

23

Note 20
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED FEBRUARY 28, 2003
(Unaudited and in thousands)

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

OPERATING ACTIVITIES:
Net income $ 4,589 $ 3,433 $ 514 $ (3,947) $ 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 taxes 2,832 (1,880) -- -- 952
Tax benefit realized from stock option plans 143 -- -- -- 143
Other, net (134) -- 5 -- (129)
Equity in subsidiary income (3,947) -- -- 3,947 --
Changes in operating assets and liabilities:
Accounts receivable (6,665) -- (105) -- (6,770)
Inventories (1,016) 130 (230) -- (1,116)
Refundable income taxes (1,134) -- -- -- (1,134)
Prepaid expenses and other current assets 239 -- 14 -- 253
Accounts payable and accrued liabilities 10,842 -- (797) -- 10,045
---------- ---------- ---------- ---------- ----------
Net cash provided by (used in) operating
activities 7,214 1,683 (565) -- 8,332
---------- ---------- ---------- ---------- ----------

INVESTING ACTIVITIES:
Purchases of property, plant and equipment (1,429) -- (35) -- (1,464)
Decrease 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)
Changes in intercompany accounts (515) (1,386) 1,901 -- --
Dividends paid 1,000 (1,000) -- -- --
---------- ---------- ---------- ---------- ----------
Net cash (used in) provided by financing
activities (2,684) (2,386) 1,901 -- (3,169)
---------- ---------- ---------- ---------- ----------

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 1,138 3,281 -- 15,924
---------- ---------- ---------- ---------- ----------
At end of period $ 15,562 $ 435 $ 4,729 $ -- $ 20,726
========== ========== ========== ========== ==========

24


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 2003
Annual Report on Form 10-K filed with the Securities and Exchange Commission.
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.

OVERVIEW
- --------

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, medicated skin care products,
medicated dandruff shampoos and conditioner, dietary supplements, and other OTC
and toiletry products. Our portfolio of products includes well-recognized brands
such as:

o Topical analgesics such as ICY HOT, ASPERCREME and FLEXALL;

o Medicated skin care products such as GOLD BOND medicated skin care
powder, cream, lotion, first aid, and foot care products; and
PHISODERM medicated acne treatment products and skin cleansers;

o SELSUN BLUE medicated dandruff shampoos and conditioner;

o Dietary supplements including DEXATRIM, GARLIQUE and NEW PHASE; and

o Other OTC and toiletry products such as PAMPRIN and PREMSYN PMS,
menstrual analgesics; HERPECIN-L, a lip care product; BENZODENT, a
dental analgesic cream; and toiletries such as BULLFROG, a line of
sunblocks; ULTRASWIM, chlorine-removing shampoo; and SUN-IN, a hair
lightener.

Our products typically target niche markets that are often outside the core
product areas of larger companies where we believe we can achieve and sustain
significant market penetration through innovation and strong advertising and
promotion support. Many of our products are among the U.S. market leaders in
their respective categories. For example, our portfolio of topical analgesic
brands and our GOLD BOND medicated body powders have the leading U.S. market
share in these categories. We support our brands through extensive and
cost-effective advertising and promotion, the expenditures for which represented
approximately 30% of our total revenues in the first quarter of fiscal 2004. We
sell our products nationally through mass merchandiser, drug and food channels
principally utilizing our own sales force.

Our strategy to achieve future growth is to generate new sales through
strong marketing and promotional programs, new product development, acquisitions
of new brands, development of strategic marketing alliances and expansion of our
international business. As previously high-growth brands mature, sales increases
will become even more dependent on the development of successful line
extensions, international expansion and acquisitions. During the first quarter
of fiscal 2004, we introduced the DEXATRIM All In One Bar, SELSUN BLUE
Conditioner, PAMPRIN All Day, BULLFROG SuperBlock Spray Lotion and PHISODERM
CLEAR CONFIDENCE Self Heating Daily Scrub and Herbal Astringent. 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 or earnings. As a
result, we may experience a short-term impact on our profitability due to line
extensions and acquisitions.

In March 2002, we acquired worldwide rights (except in India) to
manufacture, sell and market SELSUN BLUE, which is marketed internationally as
SELSUN, plus related intellectual property and certain manufacturing equipment
from Abbott Laboratories ("Abbott"). Abbott, or manufacturers under contract to
Abbott, manufactured SELSUN BLUE for us domestically until June 2003 and
internationally until the end of March 2004. We have entered into an amendment
to the manufacturing agreement with Abbott under which Abbott will continue to
manufacture SELSUN for us for the European, Middle East and several Latin
American markets for up to an additional two year period ending March 2006 at
agreed upon rates, which vary by market. Abbott will also continue to serve as
our distributor for SELSUN in certain foreign countries under separate
distribution agreements. All of our North American SELSUN BLUE product lines are
presently being manufactured at our Chattanooga facilities. Abbott is also
marketing, selling and distributing SELSUN 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 pays us an initial royalty equal to 28% of
international sales of SELSUN 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

25


and marketing responsibility in such countries. Abbott pays all costs and
expenses related to the manufacture, marketing and sales of SELSUN 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. We
then record these international sales directly as well as the costs and expenses
associated with these sales. In certain international markets, we have licensed
SELSUN to a distributor and receive a royalty based on a percentage of the
distributor sales of SELSUN in that market. We have completed the transition in
substantially all of the significant markets and expect to complete the
transition for the remaining key markets by the end of May 2004.

In January 2004, our board of directors increased the total authorization
to repurchase our common stock under our stock buyback program to $20.0 million.
For the three months ended February 29, 2004, we repurchased 16,000 shares for
$0.3 million. The remaining availability under the board authorization was $19.7
million as of February 29, 2004. We, however, are limited in our ability to
repurchase shares due to restrictions under the terms of our Revolving Credit
Facility, Floating Rate Notes and 7.0% Subordinated Notes, as described below.

EBITDA, earnings before interest, taxes, depreciation and amortization, is
a key non-GAAP financial measure used by us to measure operating performance but
may not be comparable to a similarly titled measure reported by other companies.
The most directly comparable GAAP financial measure is net income. EBITDA is
used to supplement net income as an indicator of operating performance and not
as an alternative to measures defined and required by accounting principles
generally accepted in the United States. We consider EBITDA an important
indicator of our operational strength and performance, including our ability to
pay interest, service debt and fund capital expenditures. EBITDA is also one
measure used in the calculation of certain ratios to determine our compliance
with the terms of our Revolving Credit Facility, as described below.

Our net (loss) income margin (net (loss) income/total revenues) was (1.2%)
and 7.9% for the first quarter of fiscal 2004 and 2003, respectively. Our net
income (excluding debt extinguishment charges) margin (net income (excluding
debt extinguishment charges)/total revenues) was 10.8% for the first quarter of
fiscal 2004. We consider disclosure of net income (excluding debt extinguishment
charges) to be useful information for comparison with net income without the
effect of debt extinguishment charges in prior periods. A reconciliation of net
income (excluding debt extinguishment charges) to net loss for the three months
ended February 29, 2004 is presented in the following table:

February 29,
2004
--------
(dollars in thousands)
Net loss $ (712)
Add:
Loss on early extinguishment of debt 11,309
Benefit from income taxes (3,958)
--------
Net income (excluding debt extinguishment
charges) $ 6,639
========

Our EBITDA margin (EBITDA/total revenues) was 26.4% and 23.4% for the first
quarter of fiscal 2004 and 2003, respectively. A reconciliation of EBITDA to net
(loss) income is presented in the following table:


For the Three Months Ended
---------------------------------------------------------
Dollar Percentage
February 29, February 28, Increase Increase
2004 2003 (Decrease) (Decrease)
---------- ---------- ---------- ----------
(dollars in thousands)

Net (loss) income $ (712) $ 4,589 $ (5,301) (115.5%)
Add:
(Benefit from) provision for income taxes (383) 2,813 (3,196) (113.6)
Interest expense, net (includes loss on
early extinguishment of debt in 2004) 16,019 5,113 10,906 213.3
Depreciation and amortization less
amounts included in interest 1,268 1,134 134 11.8
---------- ---------- ----------
EBITDA $ 16,192 $ 13,649 $ 2,543 18.6
========== ========== ==========


On December 30, 2003, the United States Food and Drug Administration
("FDA") issued a consumer alert on the safety of dietary supplements containing
ephedrine alkaloids and on February 6, 2004 published a final rule with respect
to these products. The final rule prohibits the sale of dietary supplements
containing ephedrine alkaloids because such supplements present an unreasonable
risk of illness or injury. The final rule becomes effective on April 11, 2004.
Although we discontinued

26


the manufacturing and shipment of DEXATRIM containing ephedrine in September
2002, the FDA's final rule may result in additional lawsuits being filed against
us alleging damages related to the use or purchase of DEXATRIM containing
ephedrine.

On December 19, 2003, we entered into a memorandum of understanding with
the Plaintiffs' Steering Committee ("PSC") in IN RE PHENYLPROPANOLAMINE ("PPA")
PRODUCTS LIABILITY LITIGATION, MDL 1407, pending before the United States
District Court for the Western District of Washingtion (the "Memorandum of
Understanding"). The Memorandum of Understanding memorializes certain settlement
terms concerning lawsuits relating to DEXATRIM products containing PPA. We are
currently negotiating with the PSC on the terms of a settlement agreement that
will supercede the Memorandum of Understanding. Since the terms of the
preliminary settlement in the PPA litigation are not final or binding, we cannot
assure that we will be able to reach a final settlement or that if a final
settlement is reached, the terms will be approved by the court. If the
settlement is approved, we believe that the settlement will include a
substantial majority of the claims by users of DEXATRIM products containing PPA,
but that some claims may elect to "opt out" of any class settlement and will
continue to pursue claims for damages against us in separate lawsuits. We cannot
estimate at this time how many claims will opt out or whether such claims will
result in significant additional liability for us. To the extent the number of
opt outs are deemed excessive relative to the total number of claims, as
determined by the final settlement agreement, we reserve the right to terminate
the settlement.

Although we believe a liability existed as of February 29, 2004 related to
our PPA litigation, since the terms of the settlement are preliminary, we are
not able to reasonably estimate the amount of such liability as of February 29,
2004 and have made no provision for this liability in our condensed consolidated
financial statements. However, if the settlement is approved based on the
proposed terms and information currently known to us about the pending cases, we
estimate that we may record, during fiscal 2004, a charge, net of insurance
recovery, of approximately $20.0-25.0 million, or an after tax charge of
$13.0-16.3 million (approximately $.65-.82 per share), for settlement costs,
administrative expenses and costs of defense related to resolving the PPA
litigation during fiscal 2004. In addition, we currently expect to use most of
our available product liability insurance coverage available for PPA litigation
and certain of our cash on hand to make the initial funding of the settlement
trust. To the extent the amount in the settlement trust is ultimately
insufficient to fully fund the settlement, we may be required to make additional
contributions to the trust fund in the future. If we are required to fund
significant other liabilities beyond the initial settlement amount, either
pursuant to the terms of the settlement, as a result of litigation or otherwise,
we will have significantly fewer sources of funds with which to satisfy such
liabilities, and we may be unable to do so. Moreover, if the settlement is not
approved, we may not have sufficient funds to satisfy all claims against us.

We have reached an agreement with Kemper Indemnity Insurance Company
("Kemper") to settle Kemper's lawsuit that sought to rescind our policy for
$50.0 million of excess coverage for product liability claims. After giving
effect to the settlement with Kemper, we will have available for the claims
against us related to the PPA litigation, through our first three layers of
insurance coverage, subject to certain limitations, approximately $60.0 million
of the $77.0 million of product liability coverage provided by these insurance
policies. The $60.0 million of available coverage consists of $37.5 million of
insurance under the Kemper policy and approximately $22.5 million under policies
with two other insurance companies.

We continue to aggressively defend an action brought by Interstate Fire &
Casualty Company ("Interstate") to rescind its $25.0 million of excess coverage
for product liability and pursue our available remedies at law against
Interstate. The Interstate policy is in excess of the product liability
insurance available from Kemper and the two other insurance companies referred
to above. In the event the $60.0 million of insurance funds are exhausted under
the contemplated PPA litigation settlement or otherwise, coverage under the
Interstate policy would not be available until we have paid the $17.0 million
difference up to $77.0 million. We currently expect to use most of our product
liability insurance coverage available for the PPA litigation to make the
initial funding of the proposed PPA settlement trust.

RECENT DEVELOPMENTS
- -------------------

On February 10, 2004, we commenced a cash tender offer and consent
solicitation for the $204.5 million outstanding principal amount of our 8.875%
Senior Subordinated Notes due 2008 ( the "8.875% Subordinated Notes"). In
connection with the tender offer, we solicited and received the consent of the
holders of the 8.875% Subordinated Notes to eliminate substantially all of the
restrictive covenants in the indenture governing the 8.875% Subordinated Notes.
The consent solicitation expired on February 24, 2004, and a total of
approximately $174.5 million, or approximately 85.3% of the 8.875% Subordinated
Notes, were tendered and accepted for payment on February 26, 2004. The
remaining principal outstanding, call premium, accrued interest and interest to
call date amounting to $32.2 million was placed in escrow with the trustee of
the indenture to fund the purchase of additional 8.875% Subordinated Notes
tendered prior to March 9, 2004, the expiration date of the tender offer, and
the redemption of the remaining 8.875% Subordinated Notes that were not tendered
in such offer in accordance with their terms on April 1, 2004 at a redemption
price of 102.9583% of their aggregate principal amount. The cash placed in
escrow used to pay these obligations is included in restricted cash in the
Condensed Consolidated Balance Sheet.

On February 13, 2004, we announced our plans to sell $75.0 million of
Floating Rate Senior Notes due 2010 (the "Floating Rate Notes") and $125.0
million of 7.0% Senior Subordinated Fixed Rate Notes due 2014 (the "7.0%
Subordinated

27


Notes"), subject to market and other conditions (the "Offering"). On February
26, 2004, we completed the Offering and issued and sold $75.0 million of the
Floating Rate Notes and $125.0 million of 7.0% Subordinated Notes. We used the
proceeds of the Offering, together with borrowings under a new $50.0 million
Revolving Credit Facility, described below, to refinance our existing debt.

On February 26, 2004, we entered into a new Senior Secured Revolving Credit
Facility due February 26, 2009 (the "Revolving Credit Facility") with Bank of
America, N.A. that provided an initial borrowing capacity of $25.0 million and
an additional $25.0 million, subject to successful syndication. On March 9,
2004, we entered into a new commitment agreement with a syndicate of commercial
banks led by Bank of America, N.A., as agent, that enables us to borrow up to a
total of $50.0 million. Borrowings under the Revolving Credit Facility are
secured by substantially all of our assets, except real property, and shares of
capital stock of our domestic subsidiaries held by us and by the assets of the
guarantors (our domestic subsidiaries). The remaining balance of the term loan
under our prior $60.0 million senior secured credit facility from a syndicate of
commercial banks led by Bank of America, N.A., as agent (the "Credit Facility")
was repaid on February 26, 2004 as part of the refinancing transaction and the
revolving credit line under the Credit Facility was terminated on February 26,
2004.

The refinancing of the Credit Facility and the purchase of approximately
$174.5 million of 8.875% Subordinated Notes on February 26, 2004 resulted in a
loss on early extinguishment of debt of $11.3 million and a tax benefit of $4.0
million. In the second quarter of fiscal 2004, we anticipate recording an
additional loss on early extinguishment of debt of approximately $1.6 million
and a related tax benefit of $0.5 million related to the redemption of the
remaining $30.0 million of our called 8.875% Subordinated Notes.

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

The following table sets forth, net (loss) income and for the periods
indicated, certain items from our Condensed Consolidated Statements of
Operations expressed as a percentage of total revenues:

For the Three Months Ended
-----------------------------
February 29, February 28,
2004 2003
---------- ----------
TOTAL REVENUES 100.0% 100.0%
---------- ----------

COSTS AND EXPENSES:
Cost of sales 27.7 30.3
Advertising and promotion 30.2 31.5
Selling, general and administrative 17.7 16.8
---------- ----------
Total costs and expenses 75.6 78.6
---------- ----------

INCOME FROM OPERATIONS 24.4 21.4
---------- ----------

OTHER INCOME (EXPENSE):
Interest expense (7.8) (8.8)
Investment and other income, net 0.1 0.1
Loss on early extinguishment of debt (18.5) --
---------- ----------
Total other income (expense) (26.2) (8.7)
---------- ----------

(LOSS) INCOME BEFORE INCOME TAXES (1.8) 12.7

(BENEFIT FROM) PROVISION FOR INCOME TAXES (0.6) 4.8
---------- ----------

NET (LOSS) INCOME (1.2%) 7.9%
========== ==========

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

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 29, 2004 condensed consolidated
financial statements:

28

ALLOWANCE FOR DOUBTFUL ACCOUNTS

As of February 29, 2004, an estimate was made of the collectibility of the
outstanding accounts receivable balances. This estimate requires the utilization
of outside credit services, knowledge about the customer and the customer's
industry, new developments in the customer's industry and operating results of
the customer as well as general economic conditions and historical trends. When
all these facts are compiled, a judgment as to the collectibility of the
individual account is made. Many factors can impact this estimate, including
those noted in this paragraph. The adequacy of the estimated allowance may be
impacted by the deterioration in the financial condition of a large customer,
weakness in the economic environment resulting in a higher level of customer
bankruptcy filings or delinquencies and the competitive environment in which the
customer operates.

REVENUE RECOGNITION

Revenue is recognized when our products are shipped to our customers. It is
generally our policy across all classes of customers that all sales are final.
As is common in the consumer products industry, customers return products for a
variety of reasons including products damaged in transit, discontinuance of a
particular size or form of product and shipping errors. As sales are recorded,
we accrue an estimated amount for product returns as a reduction of these sales
based upon our historical experience and any known specific events that affect
the accrual. We charge the allowance account resulting from this accrual with
any authorized deduction from remittance by the customer or product returns upon
receipt of the product.

In accordance with industry practice, we allow our customers to return
unsold sun care products (i.e. BULLFROG line of products) at the end of the sun
care season. We record the sales at the time the products are shipped and title
transfers. At the time of shipment, we also record a reduction in sales and an
allowance on our consolidated balance sheet for anticipated returns based upon
an estimated return level. The level of returns may fluctuate from our estimates
due to several factors including weather conditions, customer inventory levels
and competitive conditions. Each percentage point change in our return rate
would impact our net sales by approximately $0.1 million. During the first
quarter of fiscal 2004, we revised our estimate of returns related to our
BULLFROG line of products by approximately $0.3 million, which was included as
an increase in net sales in the 2004 condensed consolidated financial
statements.

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, display activity and participations in
advertising vehicles provided uniquely 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 promotional program are used to
estimate the total cost of the program, which is recorded as a reduction of
sales. 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 changes
in the accrual.

INCOME TAXES

We account for income taxes using the asset and liability approach as
prescribed by Statement of Financial Accounting Standards ("SFAS") No. 109,
"Accounting for Income Taxes". This approach requires recognition of deferred
tax assets and liabilities for the expected future tax consequences of events
that have been included in the consolidated financial statements or tax returns.
Using the enacted tax rates in effect for the year in which the differences are
expected to reverse, deferred tax assets and liabilities are determined based on
the differences between the financial reporting and the tax basis of an asset or
liability. We record income tax expense in our consolidated financial statements
based on an estimated annual effective income tax rate. Our tax rate for the
three months ended February 29, 2004 was 35% as compared to 38% in the
corresponding quarter of fiscal 2003, which reflects the implementation of a
number of foreign and state tax saving initiatives.

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, 2003 filed with the Securities and Exchange
Commission.
29


COMPARISON OF THREE MONTHS ENDED FEBRUARY 29, 2004 AND FEBRUARY 28, 2003
- ------------------------------------------------------------------------

To facilitate discussion of our operating results for the three months
ended February 29, 2004 and February 28, 2003, we have included the following
selected data from our Condensed Consolidated Statements of Operations:


Increase (Decrease)
------------------------
2004 2003 Amount Percentage
---------- ---------- ---------- ----------
(dollars in thousands)

Domestic net sales $ 55,606 $ 52,680 $ 2,926 5.6%
International revenues (including royalties) 5,631 5,745 (114) (2.0)
Total revenues 61,237 58,425 2,812 4.8
Cost of sales 16,952 17,691 (739) (4.2)
Advertising and promotion expense 18,532 18,405 127 0.7
Selling, general and administrative expense 10,829 9,814 1,015 10.3
Interest expense 4,755 5,147 (392) (7.6)
Loss on early extinguishment of debt (11,309) -- nm nm
Net (loss) income (712) 4,589 (5,301) (115.5)


DOMESTIC NET SALES

Domestic net sales for the three months ended February 29, 2004 increased
$2.9 million or 5.6% as compared to the comparable period of 2003. A comparison
of domestic net sales for the categories of products included in our portfolio
of OTC healthcare products is as follows:


Increase (Decrease)
--------------------------
2004 2003 Amount Percentage
---------- ---------- ---------- ----------
(dollars in thousands)

Topical analgesics $ 15,712 $ 13,572 $ 2,140 15.8%
Medicated skin care products 13,332 13,150 182 1.4
Dietary supplements 8,511 9,605 (1,094) (11.4)
Medicated dandruff shampoos and
conditioner 9,221 8,171 1,050 12.9
Other OTC and toiletry products 8,830 8,182 648 7.9
---------- ---------- ----------
Total $ 55,606 $ 52,680 $ 2,926 5.6
========== ========== ==========


The increases in the domestic net sales for topical analgesics, medicated
skin care products, medicated dandruff shampoos and conditioner and other OTC
and toiletry products were offset by a decrease in the dietary supplements
category. Net sales growth in the topical analgesics category was led by a 32%
increase in sales of ICY HOT, which continued to benefit from the successful
introduction of the ICY HOT Back Patch, and a 30% increase in CAPZASIN. This was
partially offset by a decline in sales of FLEXALL as competition from inside and
outside the category increased. Net sales growth in the medicated skin care
products category resulted from a 2% increase in the GOLD BOND franchise. GOLD
BOND sales growth was attributable to 15%, 40% and 28% increases from the
lotion, cream and foot care lines, respectively, and was partially offset by
declines in the first aid portion of the business, which was launched a year
ago. The increase in the lotion line of products was attributable to the
successful launch of GOLD BOND ULTIMATE Healing Skin Therapy Lotion in the third
quarter of fiscal 2003. Domestic net sales of SELSUN BLUE medicated dandruff
shampoo increased due to a strong advertising campaign and the initial shipments
of SELSUN BLUE conditioner. The increase in net sales of other OTC and toiletry
products was due primarily to sales increases of PAMPRIN, which introduced
PAMPRIN All Day in the first quarter of fiscal 2004, and BULLFROG. The increase
in sales of BULLFROG was primarily attributed to increased distribution and
early retail orders.

Net sales for the dietary supplements category declined primarily due to a
47% drop in DEXATRIM sales from last year. Sales of DEXATRIM were impacted by
the overall decline in the diet pill market driven by negative ephedrine
publicity and the emergence of low carbohydrate diet products. The decline in
net sales of DEXATRIM was partially offset by the introduction of the DEXATRIM
All In One Bar, which experienced better than expected initial sell-in at retail
accounts, as well as increased sales of GARLIQUE and NEW PHASE. The increase in
net sales of GARLIQUE and NEW PHASE was primarily attributable to effective
media campaigns and in the case of NEW PHASE increased distribution. With the
exception of PAMPRIN, PREMSYN PMS, PHISODERM, FLEXALL, ASPERCREME, CAPZASIN and
SPORTSCREME, domestic sales variances were principally the result of changes in
unit sales volumes. PAMPRIN, PREMSYN PMS, PHISODERM, FLEXALL, ASPERCREME,
CAPZASIN and SPORTSCREME sales increased partially due to a unit sales price
increase.

30


INTERNATIONAL REVENUES

For the first quarter of fiscal 2004, international revenues decreased $0.1
million or 2.0% as compared to the first quarter of fiscal 2003. Our Canadian
subsidiary experienced a 3.5% sales increase primarily as a result of SELSUN
sales. Our U.K. subsidiary experienced a 20.0% sales decrease principally due to
the termination of a European distributor. Other international revenues,
including royalties from the sales of SELSUN, increased 29.3% primarily as a
result of SELSUN sales. Sales variances for international operations were
principally the result of changes in unit sales volumes.

COST OF SALES

Cost of sales as a percentage of total revenues was 27.7% for the first
quarter of fiscal 2004 as compared to 30.3% for the first quarter of fiscal
2003. Cost of sales in the first quarter of fiscal 2004 decreased $0.7 million
due to a fiscal 2003 charge of approximately $0.8 million related to the
DEXATRIM allowance for product returns containing ephedrine. The decreased cost
also resulted from the transition of the North American manufacturing of SELSUN
BLUE to our facility in Chattanooga and from increased sales of our higher
margin products.

ADVERTISING AND PROMOTION EXPENSE

Advertising and promotion expenses in the first quarter of fiscal 2004
increased $0.1 million or 0.7% as compared to the same quarter of fiscal 2003
and were 30.2% of total revenues for the three months ended February 29, 2004
compared to 31.5% for the comparable period of fiscal 2003. Increases in
advertising and promotion expenditures in the current period were recorded for
ICY HOT, PAMPRIN and the GOLD BOND cream, lotion and foot care lines. Decreases
in advertising and promotion expenditures were recognized for the balance of the
topical analgesic brands, PHISODERM, DEXATRIM, HERPECIN-L, NEW PHASE, GARLIQUE
and the remaining GOLD BOND products.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSE

Selling, general and administrative expenses increased $1.0 million or
10.3% as compared to the same quarter of fiscal 2003. Selling, general and
administrative expenses were 17.7% and 16.8% of total revenues for the first
quarter of fiscal 2004 and 2003, respectively. The increase in selling, general
and administrative expenses in the first quarter of fiscal 2004 was largely a
result of increased compensation expenses, litigation charges related to
DEXATRIM and an increase in product development expenses partially offset by the
reduction of expenses related to executive and director life insurance policies.

INTEREST EXPENSE

Interest expense decreased $0.4 million or 7.6% in the first quarter of
fiscal 2004 as compared to the same quarter of fiscal 2003. The decrease was
largely the result of lower outstanding balances under our Credit Facility
partially offset by the prepayment of interest related to the 8.875%
Subordinated Notes purchased in the tender offer. Until our indebtedness is
reduced substantially, interest expense will continue to represent a significant
percentage of our total revenues.

LOSS ON EARLY EXTINGUISHMENT OF DEBT

During the first quarter of fiscal 2004, we retired $174.5 million
principal amount of our 8.875% Subordinated Notes and the remaining outstanding
balance of our Credit Facility, which resulted in a loss on early extinguishment
of debt of $11.3 million and a related tax benefit of $4.0 million.

LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------

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

Cash of $4.3 million and $8.3 million was provided by operations for the
three months ended February 29, 2004 and February 28, 2003, respectively. The
decrease in cash flows from operations over the prior year was attributable to a
decrease in accounts payable and accrued liabilities primarily as a result of
our refinancing transactions, which resulted in the payment of $6.3 million of
interest in the first quarter of fiscal 2004 that has been historically paid in
the second quarter. A loss on early extinguishment of debt of $11.3 million and
a tax benefit of $4.0 million was recorded in the first quarter of fiscal 2004.
In addition, accounts receivable increased due to an increase in sales of
seasonal products, which have longer dated terms, as compared to the prior year.

31


Investing activities used cash of $1.0 million and $0.5 million in three
months ended February 29, 2004 and February 28, 2003, respectively. The increase
in usage of cash in the first quarter of fiscal 2004 was primarily due to the
increase in cash surrender value related to executive and director insurance
policies.

Financing activities used cash of $1.0 million and $3.2 million in the
three months ended February 29, 2004 and February 28, 2003, respectively. The
decrease in cash used in the current period was largely the result of the
remaining $7.8 million balance of the Credit Facility being repaid and the
tender offer and purchase of approximately $174.5 million of the 8.875%
Subordinated Notes offset by the proceeds received from the Revolving Credit
Facility of $25.0 million, the Floating Rate Notes of $75.0 million and the 7.0%
Subordinated Notes of $125.0 million. Debt issuance costs of $6.9 million were
paid and written off related to the Credit Facility and the portion of the
8.875% Subordinated Notes purchased in the tender offer. Debt issuance costs of
$5.7 million were recorded in the Condensed Consolidated Balance Sheet related
to the Revolving Credit Facility, the Floating Rate Notes and the 7.0%
Subordinated Notes. In addition, $32.2 million was placed in an escrow account,
which is included in restricted cash in the Condensed Consolidated Balance Sheet
as of February 29, 2004, to fund the purchase of the additional 8.875%
Subordinated Notes tendered prior to March 9, 2004, the expiration date of the
tender offer, and the redemption of the approximately $30.0 million of 8.875%
Subordinated Notes that were not tendered in such offer, plus the related
interest and call premium of $2.2 million due and paid on April 1, 2004.

In the second quarter of fiscal 2004, we anticipate recording an additional
loss on early extinguishment of debt of approximately $1.6 million and a related
tax benefit of $0.5 million related to the redemption of the remaining $30.0
million of our called 8.875% Subordinated Notes.

On March 9, 2004, we repaid $15.0 million of our outstanding borrowings
under our Revolving Credit Facility. As of April 1, 2004, total debt consisted
of our Revolving Credit Facility of $10.0 million outstanding with available
borrowings up to $50.0 million, Floating Rate Notes of $75.0 million and 7.0%
Subordinated Notes of $125.0 million. Borrowings under our Revolving Credit
Facility bear interest at LIBOR plus applicable percentages of 1.75% to 2.50% or
a base rate (the higher of the federal funds rate plus 0.5% or the prime rate)
plus applicable percentages of 0.25% to 1.0% (4.75% as of February 29, 2004).
The applicable percentages are calculated based on our leverage ratio. The
Floating Rate Notes bear interest at a three-month LIBOR plus 3.00% per year
(4.12% as of February 29, 2004). On March 8, 2004, we entered into an interest
rate cap agreement effective June 1, 2004 with decreasing notional principal
amounts and cap rates ranging from 4.0% to 5.0% over the life of the agreement.
We paid a $1.4 million premium to enter into the interest rate cap agreement,
which will be amortized over the life of the agreement. The interest rate cap
agreement terminates on March 1, 2010.

On December 19, 2003, we entered into a Memorandum of Understanding with
the PSC, which memorializes certain settlement terms concerning lawsuits
relating to DEXATRIM products containing PPA. We are currently negotiating with
the PSC on the terms of a settlement agreement that will supercede the
Memorandum of Understanding. Since the terms of the preliminary settlement in
the DEXATRIM litigation are not final or binding, we cannot assure you that we
will be able to reach a final settlement or that if a final settlement is
reached, the terms will be approved by the court. If the settlement is approved,
we believe that the settlement will include a substantial majority of the claims
by users of DEXATRIM products containing PPA, but that some claims may elect to
"opt out" of any class settlement and will continue to pursue claims for damages
against us in separate lawsuits. We cannot estimate at this time how many claims
will opt out or whether such claims will result in significant additional
liability for us. To the extent the number of opt outs are deemed excessive
relative to the total number of claims as determined by the final settlement
agreement, we reserve the right to terminate the settlement.

DELACO filed a Chapter 11 bankruptcy petition on February 12, 2004 in the
United States Bankruptcy Court for the Southern District of New York. We
understand that DELACO intends to implement its contemplated settlement with the
PSC through a liquidating Chapter 11 bankruptcy plan. If DELACO pursues the
settlement through its bankruptcy plan, we expect that the administrative
process for DELACO's settlement will be similar to the process in our class
action. We will be required to file a claim in DELACO's bankruptcy case in order
to preserve our claims for indemnification against DELACO. As part of this
Chapter 11 plan, we expect that after resolution of creditors' claims, DELACO
will seek to liquidate and distribute all of its assets and will dissolve as a
company.

Although we believe a liability existed as of February 29, 2004 related to
PPA litigation, since the terms of the settlement are preliminary, we are not
able to reasonably estimate the amount of such liability as of February 29, 2004
and have made no provision for this liability in our condensed consolidated
financial statements. However, if the settlement is approved based on the
proposed terms and information currently known to us about the pending cases, we
estimate that we will record, during fiscal 2004, a charge, net of insurance
recovery, of approximately $20.0-25.0 million, or an after tax charge of
$13.0-16.3 million (approximately $.65-.82 per share), for settlement costs,
administrative expenses and costs of defense related to resolving the PPA
litigation. In addition, we currently expect to use most of our product
liability insurance coverage available for the PPA litigation and certain of our
cash on hand to make the initial funding of the settlement trust. To the extent
the amount in the settlement trust fund is ultimately insufficient to fully fund
the settlement, we may be required to make additional contributions to the trust
fund in the future. If we are required to fund significant other liabilities
beyond the initial settlement amount, either

32


pursuant to the terms of the settlement, as a result of litigation or otherwise,
we will have significantly fewer sources of funds with which to satisfy such
liabilities, and we may be unable to do so. Moreover, if the settlement is not
approved, we may not have sufficient funds to satisfy all claims against us.

We have reached an agreement with Kemper to settle Kemper's lawsuit that
sought to rescind our policy for $50.0 million of excess coverage for product
liability claims. After giving effect to the settlement with Kemper, we will
have available for the claims against us related to the PPA litigation, through
our first three layers of insurance coverage, subject to certain limitations,
approximately $60.0 million of the $77.0 million of product liability coverage
provided by these policies. The $60.0 million of available funds consists of
$37.5 million of insurance under the Kemper policy and approximately $22.5
million under policies with two other insurance companies.

We continue to aggressively defend an action brought by Interstate to
rescind its $25.0 million of excess coverage for product liability and pursue
our available remedies at law against Interstate. The Interstate policy is in
excess of the product liability insurance described above. In the event the
$60.0 million of insurance funds are exhausted under the PPA litigation
settlement or otherwise, coverage under the Interstate policy would not be
available until we have paid the $17.0 million difference up to $77.0 million.
We currently expect to use most of our product liability insurance coverage
available for the PPA litigation to make the initial funding of the proposed PPA
settlement trust.

In January 2004, our board of directors increased the total authorization
to repurchase our common stock under our stock buyback program to $20.0 million.
For the three months ended February 29, 2004, we repurchased 16,000 shares for
$0.3 million. The remaining availability under the board authorization was $19.7
million as of February 29, 2004. We, however, are limited in our ability to
repurchase shares due to restrictions under the terms of our Revolving Credit
Facility, Floating Rate Notes and 7.0% Subordinated Notes.

We believe that cash provided by operating activities, our cash and cash
equivalents balance and funds available under our Revolving Credit Facility will
be sufficient to fund our capital expenditures, debt service and working capital
requirements for the foreseeable future as our business is currently conducted.
It is likely that any acquisitions we make in the future will require us to
obtain additional financing.

CONTRACTUAL OBLIGATIONS
- -----------------------

The following data summarizes our contractual obligations as of February
29, 2004 excluding the $15.0 million repaid on our Revolving Credit Facility on
March 9, 2004 and the called 8.875% Subordinated Notes of $30.0 million and the
related interest that was redeemed and paid from the restricted cash held in
escrow on April 1, 2004. We had no commercial obligations as of February 29,
2004.

PAYMENTS DUE BY
-----------------------------------------------------------------------
Within
Remaining After
Contractual Obligations: Total Nine Months 2-3 years 4-5 years 5 years
----------- ----------- ----------- ----------- -----------
(dollars in thousands)

Long-term debt $ 210,000 $ -- $ -- $ -- $ 210,000
Interest related to debt(1) 108,415 9,236 24,630 24,630 49,919
Operating leases 2,567 305 584 486 1,192
----------- ----------- ----------- ----------- -----------
Total $ 320,982 $ 9,541 $ 25,214 $ 25,116 $ 261,111
=========== =========== =========== =========== ===========

- ---------------------
(1) Assumes interest rates equate to the interest rates as of February 29, 2004
through maturity.

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

Historically, our primary foreign operations have been conducted through
our Canadian and U.K. 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
29, 2004 and February 28, 2003, these subsidiaries accounted for 7% and 8% of
total revenues, respectively, and 3% of total assets for both periods,
respectively. It has not been our practice to hedge our assets and liabilities
in Canada and the U.K. or our intercompany transactions due to the inherent
risks associated with foreign currency hedging transactions and the timing of
payments between us and our foreign subsidiaries. Following our acquisition of
SELSUN BLUE, which is sold in more than 90 foreign countries, our international
business operations have expanded significantly, which will increase our
exposure to fluctuations in foreign exchange rates. During the first three
months of fiscal 2004, a portion of these foreign sales was reflected as
royalties, which have been paid to us in U.S. dollars. In addition, Abbott has
continued to supply a portion of our international product where

33


appropriate and bill us in U.S. dollars. Beginning April 1, 2004, we will be
billed in local currencies. Historically, gains or losses from foreign currency
transactions have not had a material impact on our operating results. Gains of
$34,000 and $0.1 million for the three months ended February 29, 2004 and
February 28, 2003, respectively, resulted from foreign currency transactions and
are included in selling, general and administration expenses in the Condensed
Consolidated Statements of Operations.

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

In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). We adopted
SFAS 143 on December 1, 2002. SFAS 143 establishes accounting standards for the
recognition and measurement of an asset retirement obligation and its associated
asset retirement cost. It also provides accounting guidance for legal
obligations associated with the retirement of tangible long-lived assets. The
adoption of SFAS 143 did not have an impact on our financial position, results
of operations or cash flows.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" ("SFAS 145"). We adopted SFAS 145 on December 1, 2002. SFAS 145
requires 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 SFAS No. 4, "Reporting Gains and Losses from Extinguishment of
Debt". We are also required to reclassify any gain or loss on extinguishment of
debt previously classified as an extraordinary item in prior periods presented.
SFAS 145 also provides accounting standards for certain lease modifications that
have economic effects similar to sale-leaseback transactions and various other
technical corrections. The adoption of SFAS 145 did not have an impact on our
financial position, results of operations or cash flows, except for the loss on
early extinguishment of debt of $11,309 in the first quarter of fiscal 2004,
which was classified in the condensed consolidated financial statements in
accordance with the provisions of SFAS 145.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). We adopted SFAS 146
on January 1, 2003. SFAS 146 supercedes Emerging Issues Task Force ("EITF")
Issue No. 94-3. SFAS 146 requires that the liability for a cost associated with
an exit or disposal activity be recognized when the liability is incurred, not
at the date of an entity's commitment to an exit or disposal plan. SFAS 146 is
to be applied prospectively to exit or disposal activities initiated after
December 31, 2002. The adoption of SFAS 146 did not have an impact on our
financial position, results of operations or cash flows.

In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 supercedes
Interpretation No. 34, "Disclosure of Indirect Guarantees of Indebtedness of
Others," and provides guidance on the recognition and disclosures to be made by
a guarantor in its interim and annual financial statements about its obligations
under certain guarantees. The initial recognition and measurement provisions of
FIN 45 are effective for guarantees issued or modified after December 31, 2002
and are to be applied prospectively. The disclosure requirements are effective
for financial statements for interim or annual periods ending after December 15,
2002. We had no instruments or guarantees that required additional or enhanced
disclosure under FIN 45 at February 29, 2004, except as disclosed in Note 20,
and no guarantees issued or modified after December 31, 2002 that required
recognition and measurement in accordance with the provisions of FIN 45. The
adoption of FIN 45 did not have an impact on our financial position, results of
operations or cash flows.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure" ("SFAS 148"). SFAS 148 amends SFAS No.
123, "Accounting for Stock-Based Compensation" ("SFAS 123") to provide
alternative methods of transition for a voluntary change to the fair-value-based
method of accounting for stock-based employee compensation. SFAS 148 also amends
Accounting Principles Board Opinion No. 28, "Interim Financial Reporting" ("APB
28"), 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 transition guidance and annual disclosure
provisions of SFAS 148 are effective for fiscal years ending December 31, 2002.
We implemented the interim disclosure provision in our first quarter of fiscal
2003. The adoption of SFAS 148 did not have an impact on our financial position,
results of operations or cash flows.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 requires a company to consolidate
a variable interest entity ("VIE"), as defined, when the company will absorb a
majority of the VIE's expected losses, receives a majority of the VIE's expected
residual returns or both. FIN 46 also requires consolidation of existing,
non-controlled affiliates if the VIE is unable to finance its operations without
investor support, or where the other investors do not have exposure to the
significant risks and rewards of ownership. FIN 46 applies immediately to a VIE
created or acquired after January 31, 2003. For a VIE created before February 1,
2003, FIN 46 applies in the first fiscal year or interim period beginning after
March 15, 2004. Application of FIN 46 is also required in financial statements
that have interests in structures that are commonly referred to as
special-purpose entities for periods ending after December 15, 2003. The
adoption of FIN 46 will not have an impact on our financial position, results of
operations or cash flows.

34


In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities under SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
149 is generally effective for derivative instruments, including derivative
instruments embedded in certain contracts, entered into or modified after June
30, 2003 and for hedging relationships designated after June 30, 2003. The
adoption of SFAS 149 did not have an impact on our financial position, results
of operations or cash flows.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS 150"). The statement modifies the accounting for certain financial
instruments that, under previous guidance, issuers could account for as equity.
The new statement requires that those instruments be classified as liabilities
in a company's statement of financial position. This statement is effective for
our interim periods beginning after June 15, 2003. The adoption of SFAS 150 did
not have an impact on our financial position, results of operations or cash
flows.

In July 2003, the EITF reached a consensus on Issue No. 03-11, "Reporting
Gains and Losses on Derivative Instruments and Hedging Activities, and Not Held
for Trading Purposes" ("EITF 03-11"). EITF 03-11 addresses when gains and losses
on derivative contracts not held for trading purposes should be reported on a
net basis. The adoption of EITF 03-11 did not have an impact on our financial
position, results of operations or cash flows.

In December 2003, the FASB issued SFAS No. 132 (revised 2003), "Employers'
Disclosure about Pensions and Other Postretirement Benefits" ("SFAS 132"). The
revision of SFAS 132 provides for additional disclosures including the
description of the types of plan assets, investment strategy, measurement
date(s), plan obligations, cash flows, and components of net periodic benefit
cost recognized in interim periods. The revisions of SFAS 132 are effective for
financial statements with fiscal years ending after December 15, 2003 and
interim periods beginning after December 15, 2003. The adoption of the revised
SFAS 132 did not have an impact on our financial position, results of operations
or cash flows.

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

Statements in this Quarterly Report on Form 10-Q which are not historical
facts are forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. These forward-looking statements
involve risks, uncertainties and assumptions that could cause actual outcomes
and results to differ materially from those expressed or projected.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

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

Our exposure to interest rate risk currently consists of our Floating Rate
Notes and our Revolving Credit Facility. The aggregate balance outstanding under
the Floating Rate Notes as of February 29, 2004 was $75.0 million. The Floating
Rate Notes bear interest at a three-month LIBOR plus 3.00% per year (4.12% as of
February 29, 2004). Loans under our Revolving Credit Facility bear interest at
LIBOR plus applicable percentages of 1.75% to 2.50% or a base rate (the higher
of the federal funds rate plus 0.5% or the prime rate) plus applicable
percentages of 0.25% to 1.0%. The applicable percentages are calculated based on
our leverage ratio. As of February 29, 2004, $25.0 million had been borrowed
under the Revolving Credit Facility and the variable rate on the Revolving
Credit Facility was 4.75%. The 7.0% Subordinated Notes and our 8.875%
Subordinated Notes are fixed interest rate obligations. On March 8, 2004, we
entered into an interest rate cap agreement effective June 1, 2004 with
decreasing notional principal amounts and cap rates ranging from 4.0% to 5.0%
over the life of the agreement. The interest rate cap agreement terminates on
March 1, 2010. The impact on our results of operations of a one-point rate
change on the balance currently outstanding of our Floating Rate Notes and our
Revolving Credit Facility for the next twelve months would be approximately
$650, net of tax.

We are subject to risk from changes in the foreign exchange rates relating
to our Canadian and U.K. subsidiaries. Assets and liabilities of these
subsidiaries are translated to U.S. dollars at year-end exchange rates. Income
and expense items are translated at average rates of exchange prevailing during
the year. Translation adjustments are accumulated as a separate component of
shareholders' equity. Gains and losses, which result from foreign currency
transactions, are included in the Condensed Consolidated Statements of
Operations. During the first quarter of fiscal 2004, pursuant to our
manufacturing agreement with Abbott, we were billed in U.S. dollars for
purchases of SELSUN for foreign markets. In many cases in the future, we will be
billed in the respective foreign currency. The potential loss resulting from a
hypothetical 10.0% adverse change in the quoted foreign currency exchange rate
amounts to approximately $0.9 million as of February 29, 2004.

35


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

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

(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)-15(e) and 15(d)-15(e)) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act") as of February 29, 2004 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.
















36


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

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

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

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
- -------------------------------------------------

In connection with the tender offer for our approximately $204.5 million of
8.875% Subordinated Notes, we obtained the consent of the holders of 8.875%
Subordinated Notes to eliminate substantially all of the restrictive
covenants in the indenture governing the 8.875% Subordinated Notes.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES
- ---------------------------------------

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -----------------------------------------------------------

None.

ITEM 5. OTHER INFORMATION
- -------------------------

None.

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

(a) Exhibits:

Certification required by Rule 13a-14(a) under the Securities Exchange
Act of 1934 (Exhibits 31.1 and 31.2).

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

(b) The following Form 8-K reports were filed with the Securities and
Exchange Commission during the three months ended February 29, 2004:

Form 8-K, filed February 17, 2004, announcing revised projected
results for the first quarter of fiscal 2004.

Form 8-K, filed February 17, 2004, announcing intention to place $75.0
million aggregate principal amount of senior floating rate notes due
2010 and $125.0 million aggregate principal amount of senior
subordinated fixed rate notes due 2014.

Form 8-K, filed January 22, 2004, containing a copy of our press
release announcing our financial results for the fourth fiscal quarter
of 2003.

Form 8-K, filed December 19, 2003, announcing the entrance into a
Memorandum of Understanding dated December 19, 2003 with Plaintiffs'
Steering Committee in In re Phenylpropanalomine (PPA) products
liability litigation, MDL 1407, pending before the United States
District Court for the Western District of Washington and preliminary
results for the fourth fiscal quarter of 2003.

37


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


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



CHATTEM, INC.
(Registrant)




Dated: April 9, 2004 /s/ A. Alexander Taylor II
------------- --------------------------------------
A. Alexander Taylor II
President, Chief Operating Officer and Director
(Chief Operating Officer)



Dated: April 9, 2004 /s/ Richard D. Moss
------------- --------------------------------------
Richard D. Moss
Vice President and Chief Financial Officer
(Principal Financial Officer)



38


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



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

31.1 Certification required by Rule 13a-14(a) under the Securities
Exchange Act of 1934

31.2 Certification required by Rule 13a-14(a) under the Securities
Exchange Act of 1934

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


















39