Chattem, Inc. F2Q08 (Qtr End 05/31/08) Earnings Call Transcript

Chattem, Inc. (CHTT)

Q2 2008 Earnings Call

July 10, 2008 9:00 am ET

Executives

Bob Bosworth – President & COO

Zan Guerry – Chairman & CEO

Robert Long – VP Finance

Analysts

Bill Chappell – SunTrust Robinson Humphrey

Doug Lane – Jefferies & Company

Christian Hoffman - Lehman Brothers

Jason Gere – Wachovia Capital Markets

Andrew Wolf – BB&T Capital Markets

Alice Longley – Buckingham Research Group

Gary Giblen – Goldsmith & Harris

Presentation

Operator

Good morning everyone and welcome to the Chattem’s second quarter and first six months of fiscal 2008 earnings conference call. [Operator Instructions] Prior to today’s discussion the company has asked for this forward-looking statement to be read.

Statements concerning the company’s business outlook, anticipated profitability, sales or expenses and sales growth, together with other statements made in this presentation that are not historical facts including management’s beliefs and expectations are forward-looking statements as that term is defined under Federal Security laws.

It is possible that actual results may differ materially from the statements made in this presentation. All forward-looking statements are subject to risks and uncertainties which could cause actual results to differ materially from those projected including those risk factors described in the company’s filings with the Securities and Exchange Commission.

Further forward-looking statements speak only as of the date they are made and we undertake no obligation to update publically any of these in light of new information or further events. A reconciliation of the non-GAAP financial measures contained in this presentation to the most comparable GAAP financial measures is contained in our earnings release for the second quarter and first six months of fiscal 2008, which can be found on the Investor Relations section of the company’s website at www.chattem.com.

Now I would like to turn the presentation over to Chattem’s President and Chief Operating Officer Bob Bosworth; please go ahead sir.

Bob Bosworth

Good morning everyone, welcome again to our second quarter conference call. As always we’re very much appreciative of your interest in Chattem and your participation on these calls. I am joined today by Zan Guerry, our Chairman and Chief Executive Officer, and Robert Long, Vice President of Finance. Today we’re going to review our strong results for the second quarter and for the six months ended May 31, 2008. We’re going to provide an update on the positive outlook for the balance of the year and then touch on certain key issues that exist in the current environment. Before we start though a few points regarding the call and the information we’re going to provide.

First Zan is going to comment briefly on the performance of and the outlook for our brands and for our business; the key elements of what we do. At the completion of his remarks, I’ll provide some additional commentary on the results for the quarter and our updated guidance for 2008, supplementing these comments with our perspective on key issues confronting the company and the industry. We’ll then conclude the presentation and open the floor for questions.

We’re going to limit the call out of respect for your time to one hour and to the extent there are specific questions regarding detailed line items and the financial statements or other issues provided in the release, or to the extent your questions have not been answered, I would just ask that you refer them to Robert Long, who’s number is listed in the press release and on the website as well. We can answer those questions following the call.

Third, in discussing earnings per share on this call, all EPS data will be before FAS 123 charges and debt extinguishment charges both of which are non-cash items and the one-time charge related to the recall of Icy Hot Heat Therapy back in the first quarter. We do believe this adjusted EPS information best reflects the operating performance of Chattem.

Finally in reference to guidance, we’ll be affirming earnings per share guidance for 2008 but as in the past we’ll not be providing quarterly guidance or revenue guidance. With all this said we still remain committed to helping you understand the manner in which we think about the business, approach the business and operate the business within the context of the current environment.

I will now turn it over to our Chairman and Chief Executive Officer, Zan Guerry.

Zan Guerry

Thank you Bob, good morning and welcome. In a world dominated by bad news and very bad news, we will bring you a lot of very good news this morning including strong earnings per share growth, some excellent consumer sales, i.e. Nielson’s, exciting new line extensions for next year and some very strong financial performance measures.

Let’s start with EPS. Hagstrom, Warren Buffet quoted “In the short run, the market is a voting machine but long-term it is a weighing machine.” That statement captures exactly our long-term focus and how Bob and I and others try and grow the company by focusing on cash earnings per share growing as rapidly as possible.

Right now the voters I don’t think are recognizing our accomplishments, as evidenced by our purchase of over 400,000 shares in the recent period. I have always found that if we focused on our job of running the company and growing earnings, the stock price recognition will come as it has many times before.

For earnings per share we achieved a 28% increase to $2.12. This increase exactly matches our five year earnings per share growth rate from 2002 to 2007 of 28%; quite amazing in the health and beauty aide industry. As always, when giving you a perspective of our business I will refer to the performance of our brands with a focus on our Big 6 in terms of consumer or Nielson sales.

This tells you how they’re doing right now, it gives us insight into what’s happening with our new products which are out there and it gives us a look at competition. In looking at these results we often short cut and talk about the latest four weeks versus a year ago, but in fact reading Nielson’s is a lot more complicated then simply looking at four week increases. As a management team, to properly assess our business, we look at 13 week Nielson’s, we look at 52 week Nielson’s, we look at the last 13 periods and scan them period to period which often if even more important in terms of realizing insights into the business. We take into account seasonality of our brands for which there is quite a bit for a few, the role of advertising and promotion programs not only of ourselves and others, distribution levels for new products and also the competition. So it is a very detailed analysis that we go through in trying to come up with a review of our performance.

With this perspective we do our best to objectively and accurately give you our take on our performance. So let’s do that. First the Nielson’s that are seen in the public capture only about 60% of our business as they are not capturing Wal-Mart, Costco, and Dollar General and some others. If you look at the numbers that we see they’re always about 1% higher then the numbers that are seen out in the trade. Furthermore we make an immediate adjustment for Heat Therapy and Pro Therapy; both essentially discontinued, not quite discontinued, but both were money losers. And that’s about a 3% adjustment that we make as we look at our Nielson’s.

So if we start with total consumer sales and make these adjustments, our total consumer sales for the last four weeks are up 7% versus a year ago and for our Big 6 brands we’re up slightly over 10% versus a year ago, which are very strong increases in this environment. Now let’s look at each of our six brands individually and we will see some extremely strong numbers particularly on our very largest brands.

Gold Brand, our largest brand, is having an amazing year. Four week sales are up 21%, 13 week sales are up 16% and this is being led by the tremendous momentum of our lotion business which is up 63% for the last four weeks reflecting the success of Gold Bond Restoring Lotion plus the continued increases from Gold Bond Healing and Softening; a truly outstanding accomplishment in the lotion business for Gold Bond.

Icy Hot, our second largest brand is up 12% for the four weeks and 10% for 13 weeks, excluding Heat Therapy. This reflects the success of the new Vanishing Scent and new PM patches plus growth in our Icy Hot Cream business. For comparison, Bengay is down 8% for 13 weeks and ThermaCare is down 14% for 13 weeks.

ACT our third largest brand is up 17% for four weeks and 22% for 13 weeks. Cortizone, the fourth largest, is up 9% for four weeks and 13% for 13 weeks, led by the new Cortizone Intensive Healing product which is having a very strong showing. Selsun blue is essentially flat with the growth in Natural offsetting some of the decline in Selsun Salon. Selsun blue franchise including Natural is actually up 10%.

Unisom of the Big 6 is the only one down, its down 9% versus a year ago, but if we look at the last 13 period Unisom is showing some growth particularly over the last six or seven four-week periods and as we project and look at where the things appear to go, Unisom should start showing some increases by as early as the next four-week period led by the success of the new Sleep [Melt] product.

All in all quite a strong performance from our Big 6 brands. Quickly mentioning some of our other brands we do see some much improved results. As you note some of the smaller brands have dragged down the performance of the Big 6. Dexatrim in particular has been our largest decliner, but is now showing some period-to-period strength and has an excellent chance of being essentially flat by this fall versus being down 30% during the first part of this year.

Aspercreme is up 30% and is in continuing momentum led by its new Aspercreme Heat product. And finally BullFrog which had been slow during April, May had a very strong June which is obviously a critical month for sun blocks being up 12%.

This analysis of our brands is a little longer then normal but there seems to have been some misunderstanding, accidental or not, of some of our Nielson’s results so I wanted to give you a complete picture. This is our most exciting and energetic time of the year at Chattem. Our marketing people, sales and everybody; we’re finalizing our new products and marketing plans for next year which we’ll present at our always exciting National Sales Force Meeting in three weeks.

As you have heard, much of the success this year is behind the new products such as the Gold Bond Restoring, Cortizone Intensive Healing, Icy Hot PM, Aspercreme Heat. We expect to have even more successful new products next year based on our extensive market research for these new products which will be presented in three weeks to our sales force.

Why is it so important for our big brands to be growing so strongly? Because that is where the trade—that’s where our new product focus is and that is where the trade likes—they like new products from winning brands. So it’s very important when we had Gold Bond and ACT and Icy Hot growing. It’s very important because that’s where we’re bringing most of our new line extensions.

For next year we will present three new Gold Bond items which are very exciting; a couple in the lotion area and one in another area. Icy Hot should have an even stronger new product lineup for next year. We have developed three new innovative products each of which has tested as strong or stronger then our back patch business which is quite substantial.

Our Cortizone following the success of Intensive Healing has two new strong ideas, again which has tested very well. Selsun blue and Selsun blue Natural have two new line extensions based on some very strong consumer insight that we came up with over the last year. And ACT, in this case, certainly last but—last and most has potentially the largest of the new product introductions by far of all the brands for next year. So it is a very exciting lineup.

With our current momentum plus the new products for next year, we should achieve high single-digit growth in sales or more for 2009. In the fall, as always, we will give you our range for earnings per share for next year. For several reasons we are several months ahead of our numbers for next year in terms of looking at them and viewing them, and I can safely say that we see another very strong year shaping up for 2009.

It’s been a pleasure to have this amount of good news to report to you and I will turn it over to Bob to give you some more financial measures. Thank you.

Bob Bosworth

Thanks Zan and as Zan has indicated through discussions about the Nielson data related to our big and some smaller brands as well and taken a look at the outlook for 2009, early basis, and as we detailed in the earnings release made earlier this morning, the second quarter and the first half of 2008 were very good from a variety of perspectives and it also provides a platform for the continued growth of Chattem through the balance of 2008 and into 2009.

While the performance and the guidance are relatively self-explanatory based on the press release and Zan’s comments, a few additional comments on the financial results and guidance are appropriate. First total revenues did reach record levels of $117 million in the second quarter and $237 million for the first half of 2008. If as Zan talked about from a Nielson basis, you exclude Icy Hot Heat Therapy which was recalled it the first quarter of this year, and Pro Therapy which is now in very, very limited distribution and neither of which was profitable and then adjusting for the additional month of sales in 2008 from the brands acquired from J&J in January, 2007, total revenues grew by 6% and 9% for the quarter and the half respectively.

This is consistent with our stated goal of, over time, and I emphasize over time, achieving mid to high single-digit growth. So we feel very comfortable with the revenue picture for 2008 and as we look into 2009.

Second, adjusted earnings per share were $1.10 and $2.12 per share for the quarter and the half respectively, these increases of 24% and 28% for the quarter and six months respectively, exceeded as has always been the case the revenue increases. Similarly EBITDA, excluding the one-time product recall expenses grew by 15% for the quarter and 21% for the six months and represented very strong EBITDA margins of just over 35% for the quarter and almost 34% for the six months. Importantly these operating margins were achieved while continuing to support the brands very strongly with advertising and promotion expenditures.

A fourth point is we continue to generate very good cash flow and we used the cash to first, as Zan mentioned, repurchase stock at the end of the quarter and into the first couple weeks of June. We purchased 184,000 shares at a total cost of $12.3 million in May in the second quarter and then when combined with the purchases made in early June and a nominal amount purchased earlier in the year, we bought a total of 418,000 shares for an aggregate purchase price of about $26.3 million or $62.94 a share.

Second we’ve used our cash flow to repay debt. As of May 31, total debt to EBITDA represented 3.3x trailing 12 months EBITDA with an expectation that we will be below 3.0x by the end of the year assuming no additional share repurchases or acquisitions.

Fifth point, it must be reiterated that we do generate a cash tax shield associated with the amortization of intangibles for tax but not book purposes, in the amount of $0.24 per quarter or $0.48 for the six months. So in terms of cash earnings per share those numbers should be added to the totals.

Finally as you will note in the litigation footnote in the 10-Q filed earlier today, we recently received notice of 17 claims through a Plaintiff law firm related to Dexatrim with Ephedrine; a product that we discontinued selling in September, 2002, almost six years ago. While the claims allege a causal relationship between Dexatrim with Ephedrine and pulmonary arterial hypertension, we believe we have very strong defenses to those claims. For example, no substantive clinical data exists to support causation. If lawsuits are filed and they have not been filed at this point, we do intend to defend these claims vigorously.

At this time since we’re very early in the process, we can’t discuss the details of these claims further, but would expect to have further clarity by the time the next earnings call if not earlier. We do not however, believe this will have a significant impact on our ongoing business.

As we now turn from the occurrences of the second quarter and the first half, looking to the outlook for 2008, as we look at the results for the first half, the momentum of the business that we currently are enjoying we are maintaining the guidance range of $4.00 to $4.20 per share trending toward the upper end of that range. The $4.00 to $4.20 range would reflect a 19% to 25% increase over the adjusted earnings per share of $3.36 achieved in 2007.

Again it’s also very important to note that this guidance excludes the cash tax shield of approximately $18.6 million or $0.95 per share for 2008. This cash tax shield combined with a strong earnings performance should allow us to achieve the goal of free cash flow of $90 million to $95 million for the year with that cash flow being used to opportunistically repurchase shares and to reduce debt. The reduction from the original expectation of $90 million to $100 million is largely related to the one-time Heat Therapy recall charges and incremental interest expense associated with the repurchases of stock made in May and June.

And again in reference to both the earnings per share and cash flow, the guidance does not include our account for expenses related to the claims I mentioned a moment ago. Turning for a moment from Chattem’s specific situation to some factors affecting the industry as a whole and obviously Chattem to some extent, I’d like to touch on four points.

First of all, Zan has touched on it, the Nielson issue and how to address Nielson’s is a very important one. I think he covered that in detail in terms of how we should look at the Nielson data as they come out. It is much more complex then a simple top line story taken from the very basic information. Second another issue that has arisen and is very real in our economy, while consumer confidence is eroded, our business hasn’t been material or subject to recessionary pressures and as our key products are not generally discretionary purchases. The ailments our products address, itch, pain, dandruff, sleeplessness, do not decline with the downturn in the economy. We have seen this historically and we’re seeing that today as well.

Second, private label products have been a question that has been raised periodically and they have crept up in market share in certain of our categories but have not impacted us significantly. Simply, the stronger the brand loyalty, the better and more unique the product, and the greater the degree of problem solution orientation of the brand, the less likely the consumer is to switch from them. Since we are focused precisely on product innovation, on product quality and on building loyalty through our advertising, switches to private label have not tended to be a significant issue for us.

The final point that I’d make that is reality in this marketplace; input costs have indeed risen particularly in situations in which petroleum is a significant factor. We have however been able to mitigate these increases in purchased material and freight costs through negotiations and innovation. A couple of examples would be consolidation of freight with certain of our key customers. We have product or packaging design changes that allow us to save money and then we do engage, and always engage, in continuing negotiation with our suppliers. This has been and will be a priority for our operations people both historically and looking forward.

In addition to mitigating the cost increases with these efforts, we also have offset these costs through very selective price increases that we took in mid-April of about 5.4% on items representing just over 15% of total revenue. As I said this took place in the middle of April. We will continue to assess the appropriateness of price increases over the balance of the year and into 2009.

Finally while we will not address any specific acquisition opportunities we do continue to see such opportunities as we are known to be an acquirer of quality HBC products. Moreover we are in a position both financially and operationally to make an acquisition were we able to find one which met our very strict criteria.

With that I’ll just say the first half of the year has been very good from a business perspective. It provides and excellent foundation for the balance of 2008 and beyond and with that quick summary, I’ll open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Bill Chappell – SunTrust Robinson Humphrey

Bill Chappell – SunTrust Robinson Humphrey

Just to get into some of the product lines can you maybe give us a little more color both on the BullFrog business and then on the Dexatrim business, I understand BullFrog was a little bit had to do with the timing of shipments but can you maybe talk about sell-through or was there any weather impact. And then with Dexatrim have we started to see the easier comps or when will we start to see that?

Zan Guerry

BullFrog as I mentioned in June is where the Nielson’s really begin to get important and we were up 11%. There was an account—one of the things with BullFrog is accounts sometimes manage inventory differently and so we’re seeing consumer sales of BullFrog being very strong and very solid. Because of some de-inventorying in the trade on a couple of accounts, BullFrog in total which is in our forecast is underperforming a little bit net net BullFrog is in fine shape.

Dexatrim, and I alluded to it, we are going to begin to see—the diet market is hard to forecast, but clearly the big comps are coming down pretty quickly. As I mentioned they dropped dramatically in the fall. We still have some comps that are challenging through August, but by fall we see them drop dramatically and we see, as I mentioned our period-to-period is looking pretty strong on Dexatrim. We’re up significantly over where we were earlier in the year.

So Dexatrim as I mentioned it looks like, and again I really will put caveats, but from what we’re seeing, we see a much more positive September, October, November, December period and actually in our new products I failed to mention, we probably have the best Dexatrim new product we had since maybe even Dexatrim Natural back a number of years ago. So we’ve got some very exciting science behind it and we’re not going to tell you that Dexatrim is going to be up next year but it might. So I think those we feel much better about both of those.

Bill Chappell – SunTrust Robinson Humphrey

As a follow-up on inventory, that was up pretty substantially on a year-over-year basis, how should we look at that?

Bob Bosworth

Here’s the way to look at inventory, first of all as compared to last year, last year we were in the process of transitioning from J&J’s manufacturing distribution to our own inventory and distribution. We were experiencing as you will recall, some out-of-stocks as we were trying to keep up with shipments through J&J at that time, so inventory was artificially low at that point in time. We should see some reduction in inventory over the next six months but not to the extent that you saw between May of last year and May of this year.

Bill Chappell – SunTrust Robinson Humphrey

I know you don’t talk specifically about acquisitions but with the potential of ThermaCare being on the block would that be something even of interest or does that matter to you who owns that business if you’re not a buyer of it?

Zan Guerry

I think you were right that we don’t comment on acquisitions. I don’t think—I think it’s easy to say we don’t have a big point of view on who owns it as you’ve noted. That whole heat segment has kind of got a little bit of a cloud, a fairly big cloud over it with a lot of focus on any product that [inaudible] that has some chance of burning and the FDA seems to be focused on that. I would say we’re going to be very cautious about that.

Operator

Your next question comes from the line of Doug Lane – Jefferies & Company

Doug Lane – Jefferies & Company

Bob I think you had talked on the price increases that you had taken an average of 5.1% on 15% of the business, can you give us some color on the criteria for when and where you decide to take the price increases?

Bob Bosworth

I’ll give you a general comment; first of all my comment was actually 5.4% just to clarify that piece of it, on about 15% of the business. What we will do, when we increase prices we have two considerations, one which is the trade which actually has been receptive to price increases. The second is we look at the consumer to determine the impact of the price increase might have on them. As you cross over dollar price points there is some risk, retail dollar price points, there is some risk that you adversely affect demand. So we’ll take that into consideration when we make these price increases.

The second is we’ll look at also competitive activity to see how they are responding in terms of prices. And then we will address each SKU and each brand individually.

Doug Lane – Jefferies & Company

Okay so there’s a lot of criteria, it’s not just strictly cost pressures then?

Bob Bosworth

No, there are other factors.

Zan Guerry

That is another factor, but—and this is a particularly dynamic time as everybody knows in our economy in terms of what is going to go on in terms of further cost pressures, less cost pressures, but the consumer—with our brands doing so well, and the consumer under such threat, we are going to be, we’re going to wait and get a fair amount of information and data. The last thing is, I continue to say, we’re managing Gold Bond, Icy Hot, and all of our other brands for the next 10 years and for the long term and we want to focus on growing those brands and so we will carefully view what we think the consumers—if we have to say above all we are a consumer company that’s why we’re successful we will view them and we are thinking about that very carefully.

Doug Lane – Jefferies & Company

Are there any other input cost pressures other then packaging costs?

Bob Bosworth

The biggest one would be advertising costs. That would be the other big input cost that we have if you will.

Zan Guerry

But we’re managing that very well. I would say packaging driven is the focus.

Bob Bosworth

Packaging costs would be the biggest one. The other thing that we, and every company is also running into, is increased freight costs which can be up 30% to 40%. Again, we tried to mitigate that through consolidating freight shipments and those kinds of things. But we are able to manage those costs within the confines of the guidance that we’ve given to you.

Doug Lane – Jefferies & Company

Can you give us the four week and 13 week data for Selsun blue and the 13 week data for Unisom?

Zan Guerry

For Selsun blue, as I mentioned it is basically—the entire Selsun franchise is relatively flat, it is flat. If you look at the Selsun blue part and exclude Selsun Salon, Selsun blue is up 12% for the 13 weeks and 11% for the four weeks. There’s a little complication I mentioned on Unisom that we are going against some—Unisom, the comparisons drop dramatically next month. There were some competitive out-of-stock issues last year which gave us kind of a one-time bump but your answer is, its about down about 9% for those four and 13 weeks but for the July comparisons we are actually, this month of June, we are outselling what we sold July a year ago. So that 9% down should flatten out or hopefully increase in July Nielson.

Bob Bosworth

And for clarity, Zan is referencing the Nielson including Wal-Mart data and the information that’s out there in the public domain is Nielson only which wouldn’t include the spike in Wal-Mart sales last year.

Doug Lane – Jefferies & Company

ACT continues to show very strong scanner data numbers and yet the oral care segment was up only 12% in the quarter, any reasons for the disconnect?

Bob Bosworth

The timing of shipments is really the only factor that comes into it. You will have some things, [Benzodent and Herpison] are in there, there’s a little bit of decline in those two brands so that will have some impact as well. But I think the key element over the long-term is how ACT itself—the key element in that segment is how ACT itself is performing.

Operator

Your next question comes from the line of Christian Hoffman - Lehman Brothers

Christian Hoffman - Lehman Brothers

In terms of the pricing increase that you took is there going to be any timing impact from that in terms of people maybe placing orders before the pricing increase?

Bob Bosworth

We took the price increase on April 13^th I believe so any pre-buying would have taken place before that. It wasn’t a significant number though.

Christian Hoffman - Lehman Brothers

And also in terms of timing, were any advertising or promotional expenses shifted to the third quarter?

Bob Bosworth

No, nothing was shifted to the third quarter. I think an important point to note though as you look at advertising and promotion expense, the biggest part of which is advertising, we accrue that over the year based on expected spending for the year divided by expected sales for the year. So what you see reported isn’t necessarily indicative of what we are spending.

The second thing I will say is this year we are spending more in the May, June period then we did last year as it coincided with our new product launches and with some of our other businesses as well.

Christian Hoffman - Lehman Brothers

Could we get the repurchase capacity on under your senior sub notes in terms of stock?

Bob Bosworth

Its $80 million or $90 million for the year.

Christian Hoffman - Lehman Brothers

Could we just maybe get some basic color on the M&A environment?

Zan Guerry

I don’t think it’s changed much for the period. We’re seeing I’d say a slight increase in activity. I think that the pressure—one thing I did mention is we’re seeing a lot of weakness. As we look at competitive brands I mentioned a couple of them, but I could have mentioned 20 of them. There are a lot of companies not doing very well in this environment and so I think we’re going to see some pressures on companies to do something. I think if we went to the investment banks of the world they would probably tell you that they think the next year or two is going to be a probably slightly enhanced opportunity for acquisitions which is why we’re always balancing how much stock to buyback with making sure we keep flexibility to make appropriate acquisitions which is the best use of our capital. But I would say it’s kind of moderate now.

Christian Hoffman - Lehman Brothers

I know the Icy Hot Pro Therapy line is relatively minor, but do you see those headwinds kind of continuing at the same level through the balance of the year?

Zan Guerry

Well actually no but its kind of interesting, that headwind goes—and for us its simple, we just take 3% and say well 3% of our money-losing business is good when you’re money losing kind of disappears but to specifically answer your question Pro Therapy does dwindle significantly next year. But Heat Therapy actually had a pretty good fall so when you put the two together, we’re probably going to be living with a—we just take whatever number I see and add 3% and know that that’s—and actually when we do our business we exclude Heat Therapy and Pro Therapy so the numbers I see on all of our business exclude those things.

Operator

Your next question comes from the line of Jason Gere – Wachovia Capital Markets

Jason Gere – Wachovia Capital Markets

If you could talk, I know your products are more recession-proof, I was wondering if you could talk about the categories and maybe with retailers in particular, are you seeing—can you identify where you’re seeing a little bit of category softness and are retailers kind of changing in terms of de-stocking to any degree and where you might see that occurring?

Zan Guerry

I think Bob said we’re seeing some inching up in some private label, we’re not seeing, in the categories we compete in, we’re not seeing a whole lot of action that affects us or is affecting competitors. If you think about it, the higher the price point and the more people use, the more pressures you’re going to have and so an example would be something like ThermaCare where you have a fairly high price point and you get one use, that’s going to be a little more subject to price pressures then a product like Icy Hot Cream where you buy a tube and you may use it for three or four months and you want your Icy Hot Cream. So we’ve looked at this. Its interesting, its dollars different many times because consumers buy dollars and so the difference in a package—if there’s a package that has a $1 difference it may make no difference particularly if they don’t use it up. If there’s $4 difference—so the higher the price package you might see some of that.

We’ve seen a little—if you said which of our brands has seen the most of all it would be Capzasin, which happens to be the most expensive. We’re dealing with that and have dealt with it in a couple of different ways and we have another new Capzasin product coming for next year which specifically addresses that issue. So I think that’s—globally there’s not an issue. Isolated instances, you see a little bit of that and we’re trying to address where ever we see that.

Bob Bosworth

And that’s coming from the consumer perspective and the trade perspective, a year-and-a-half, two years ago; they went through a big inventory de-stocking, SKU rationalization piece, so in many ways that action had been taken previously. We have not seen that taking place with any of our products in particular in any categories with the one exception of BullFrog at Wal-Mart where it’s pretty widely known that they cut back on inventory purchases of seasonal items. That would be the only place we saw from a trade perspective.

Jason Gere – Wachovia Capital Markets

Would you say on a whole though your market share, if you look across your categories, you’re gaining share at this point and can you identify opportunities maybe where you are seeing some increased shelf space or SKUs?

Zan Guerry

We are gaining share in Gold Bond Lotion, its—I looked at that again last night. We’re up over a share point in Gold Bond Lotion, we’re gaining share, we’re gaining share with Icy Hot going up 12%, Bengay and ThermaCare going down. We’re gaining share with Icy Hot. ACT is gaining share. So we’re up on some of the brands. Cortizone is gaining significant share, 1%, 1.5% shares on a number of brands and Unisom versus—and this is the share picture, Unisom versus that comparison a year ago in our world is down a little bit, but Unisom share since December is actually up.

So we’re not losing share anywhere and we’re gaining—we’re actually gaining share in Dexatrim if you believe that. Its just that that market, if you want to see a terrible comparison unless something changes, and this is again where you see period-to-period you need to look at it, in the diet market Allie which had its all-time record month I think next month or the next, its down a little bit. At the rate its selling right now it could be down 75% versus a year ago. So that will—so those are the kind of dynamics but because we see the 13 periods we can take into account.

Jason Gere – Wachovia Capital Markets

One thing I just wanted to clarify that you were saying earlier about the new product launch, I know you are pretty excited about 2009, you were talking—I thought I heard you say something about high single-digit growth that would be—can you give a little bit more color on that? Does that exclude maybe what could be in the residual impact from Heat Therapy or that would come through next year?

Zan Guerry

That is probably—there won’t be much—Heat Therapy for next year begins to drop off and basically what’s that’s saying is that our current six brands are growing at 10% plus right now. We’ve got line extensions on all of them that are significant so that gives you that. And the ones that have been dragging it down like Dexatrim in particular, we see doing better so those are relatively conservative numbers that I gave you. But it’s based on—if you’re growing at 10% and you have all these new line extensions—and some of the line extensions we have now are still fairly early.

I mean this Gold Bond Restoring Lotion is only in its third or fourth month and it’s already outselling Softening Lotion which is up versus a year ago and so we’ve got more momentum to go from there. Unisom Sleep [Melts] are beginning to build. It took awhile to get distribution there. It’s beginning to build there. So we have some stuff coming in the back half of the year. So our marketing plans for next year taking all that into account are pretty strong. Plus as I mentioned, I’d reiterate we’ve got some really big news coming on ACT next year which has the potential to be very significant.

Jason Gere – Wachovia Capital Markets

I guess I just wanted to clarify when you said the high single-digit that was referring to the Big 6 brands?

Zan Guerry

No that was the total business.

Jason Gere – Wachovia Capital Markets

Total Chattem?

Zan Guerry

Yes.

Jason Gere - Wachovia Capital Markets

Okay because I know your guidance had been mid to high single-digit kind of longer term so I guess I was just trying to construct it into the same framework as this year where if you strip out Heat Therapy and Pro Therapy, yes you are kind of in that I would say 6% range or something like that. So obviously it’s a step-up and I guess—

Zan Guerry

I think what we’re saying is that yes, we’re right now at—if we strip out Heat Therapy we’re at 7& right now and what we see in terms of comparisons is we see comparisons getting easier for some of the brands that are bringing us down like Dexatrim and Unisom and we see, as a matter of fact even potential mild growth on those and then we see a continuation and actually a pick-up in growth for—we think Icy Hot will do better next year then this year with its three new products.

We think Gold Bond, I don’t know if it’s going to do a whole lot better then 21% but it should hold on. ACT should do significantly better then what its doing with the new products. Cortizone should hold onto its growth and we think Selsun blue will be up next year with the two new line extensions and the lack of Selsun Salon comparisons because Natural is doing very well. So the world can change but we’re feeling pretty positive about everything right now.

Operator

Your next question comes from the line of Andrew Wolf – BB&T Capital Markets

Andrew Wolf – BB&T Capital Markets

On the numbers you were quoting at the beginning are those strictly Nielson’s or are they Nielson’s with your Wal-Mart information blended in?

Zan Guerry

We only give Nielson with Wal-Mart because that is our business so every number I’ve given you—now when I give you share information or competitive, I don’t have Nielson for those so that’s the—any number that comes out of my mouth includes our entire business as we look at it and then competitive numbers that I give you don’t include Wal-Mart because I don’t have numbers for how Tylenol or Listerine is doing at Wal-Mart. So that’s for clarification.

Andrew Wolf – BB&T Capital Markets

But when you say, it’s as much as you can measure because you still don’t measure Club and some other channels right? I was actually going to ask you what percent—when you throw in Wal-Mart what percent of your full distribution are you actually giving us?

Bob Bosworth

It’s going to be in the mid-90s.

Zan Guerry

Mid-90’s. We’re getting a little bit of Club, but the dollar stores which are actually increasing. We held our Monday morning meeting this week and we’re having a lot more SKUs in dollar stores so that may be begin to be something that we talk to you about but at this stage its not material enough to make a big deal about it. But it may become more material.

Bob Bosworth

And it is growing faster then the Nielson’s and Wal-Mart business.

Andrew Wolf – BB&T Capital Markets

Club and Dollar?

Bob Bosworth

Club and Dollar, we only get factory sales on those so its--

Andrew Wolf – BB&T Capital Markets

That was actually my last point, the question I wanted to ask just on this point was it sounds like you’re seeing some shift in channel, where the product is actually being sold through, could you elaborate on that?

Zan Guerry

These are minor shifts. These are very minor shifts, its still the bulk is going through and when we [maz masses] growing faster but its not so much faster that today when we get our total numbers, they may be 1.2% better then the Nielson’s that you see. A year ago maybe they were 0.8% better so it’s a minor—to us as we look at ourselves its important but its not any momentous change in shifts of where people are buying ACT or Icy Hot.

Andrew Wolf – BB&T Capital Markets

On gross margin, the gross margin expansion, could you either quantify or add some color on how that broke down between bringing some products in-house from J&J versus the price increases maybe versus anything else having a better mix?

Bob Bosworth

The practical side is the price increases were small enough that it didn’t have a really significant impact on gross margin. The biggest part was having six months of Cortizone and Balmex and the packaging of Unisom brought in-house. That is the biggest part of the increase that you’re seeing.

Andrew Wolf – BB&T Capital Markets

On the new product launches, I counted 12; it seems like a record and there’s probably more or there could be more, so the question is, is 12 the number or is there more then that? Is that a record and is that—what can the current internal resources that you have in R&D and marketing support—I know you’ve talked a lot about internal leverage--

Zan Guerry

We wouldn’t be launching if we couldn’t support them. We are launching—I would say is it a record? It is at the peak of things of but its not---and again it depends on new products versus SKUs. For example in Icy Hot, there would be three new—a couple of which are one SKU kind of things whereas on—and the same would be true of Selsun it is one SKU for Natural and one SKU—as you move to the lotion and the mouthwash kind of business, you may have a product but it may several sizes or colors or flavors so you get more units but in our world its only one thing.

And you’re right, it’s at that top end of aggressive but we’ve been working a lot further out. As a matter of fact we’re doing—our people are just doing a phenomenal job. We’re already producing [annomatic] advertising for these products that we won’t run till next April to May to kind of even get a better handle on how to allocate our resources. The Gold Bond items and the Icy Hot items proved [annomatic] kind of—or commercials this week.

So we are, when I mentioned that we’re getting ahead part of it is the trade is forcing us to get ahead and part of it is with very challenging resource allocation decisions. How much money do we put behind ACT for next year versus Gold Bond? When you have four or five winners going forward, it makes it more challenging to decide who get the most money. So we’re working way ahead of schedule on those items. But we don’t see any problem delivering that.

Bob Bosworth

And I would add that too, previously in other conference call we said the most difficult issue that we were facing in terms of people, was finding qualified product development people. We’ve added three high profile, good quality product development people to the staff which is what is allowing us to get ahead in terms of new product thought processes going out a couple of years.

Operator

Your next question comes from the line of Alice Longley – Buckingham Research Group

Alice Longley – Buckingham Research Group

I think you said in the call that you are spending more in advertising in May and June, or you did, is there any reason to expect your sales in the rest of the year to be up more then they were in the second quarter? Is the support accelerated to the point where your sales might be up more in the second half? We understand the reasons for the sales being up 3.3% but it’s so light for you.

Zan Guerry

With June up 7% in our world and 10% for the big brands I don’t know that we’re going to see—I commented with all the new products next year, you may see some enhancement on that. We had a great June, there’s just no way of saying it and is the rest of the year going to be better then June? I don’t know. We think it’s going to be good but I think we’ve seen that advertising on our new products work very well. Some of the seasonal things—the seasons change which is also another factor. Summer time is Gold Bond time and its Cortizone time and so we have a lot of things—I think it’s just kind of—should continue. I don’t see any dramatic—Unisom probably would be the example that might pick-up because the Sleep [Melts] is kind of building.

Alice Longley – Buckingham Research Group

Inventories being high at the end of May, did that have anything to do with having more inventory in preparation for sales expected to be stronger in June?

Zan Guerry

That was comparison versus a year ago when we were trying to do the transition and we were struggling hour to hour to stay in stock particularly two or three of those brands. It was the most challenging management of out-of-stocks in history so we were at all time record lows as much as zero on some brands a year ago so that’s primarily that comparison.

Alice Longley – Buckingham Research Group

Could you reiterate your gross margin guidance for the year, the gross margins ended up being quite a bit higher then I thought and I’m wondering if you might exceed the top end of your guidance for this year?

Bob Bosworth

Our guidance that we’ve given is 70% to 72% trending toward the upper end of that range and I think 72% again would be—you would not see 72% for the balance of the year. It would be slightly below that would be my guess based on what we’re seeing in terms of price increases in the marketplace.

Operator

Your final question comes from the line of Gary Giblen – Goldsmith & Harris

Gary Giblen – Goldsmith & Harris

It seems as though there’s considerably more promotion on Chattem products and competitive products when you just look at stores and coupon drops, FSIs, so is that the case and to what extent would that affect gross margins going forward?

Zan Guerry

Well it wouldn’t affect gross margins, I think what we’re doing is—there’s more advertising on our brands then competitors I think because successful brands have the ability to do that. There’s no appreciable pick-up in promotion. Some brands, now that we have ACT, ACT may be looks a little more promotion-oriented, but we’ve done nothing to change our promotion philosophy. I think we spent a lot of time, we are noted for the efficient spending and allocation of our advertising dollars. We’ve been doing that for a long time. I think our sales department has done a great job of bringing in new talent and analyzing the effectiveness of different promotions and what works best and I think that’s an area that we’ve seen improvement in and we are making some tactical adjustments but in terms of dollars not much.

And I think for next year you’ll see more again, tactical adjustments in terms of is it better to run retailer programs? Is it better to run FSIs? Actually we are trending towards more retailer programs and we’re trending towards allocating a little more money to certain brands which our analysis have shown are particularly effective for promotion. We’re just kind of fine tuning our basic philosophy of we’re an advertising-driven business and we use promotion as a kind of a fine tuning tool.

Gary Giblen – Goldsmith & Harris

It seems as though some new products are either not getting distribution or like the CVS not taking Selsun Naturals or even losing distribution. I saw some PM products that seem to be disappearing from Wal-Mart but are they just being reset or are there any distribution losses in new products?

Zan Guerry

Actually in the area of distribution and I use distribution—I’ll use a broader term, shelf presence, that’s probably been the biggest success that we’ve had across the board. There are always frustrations. We have one account that doesn’t have the Unisom Sleep [Melts] which frustrates us. And we’ll have one account that doesn’t do this. But across the board, if you look across the board ACT merchandising presence is very strong. We had a big push—one of the reasons is driving a big push to getting more 33 oz. representation.

If you look at Gold Bond in particular at Wal-Mart or at other accounts we’re seeing tremendous growth in Gold Bond. Icy Hot because it’s doing well has a very strong presence. Cortizone, we’re a very strong presence. And again I made the point is your strong brands are going to gain merchandising and do that if you have a brand that’s going down, or flat, you’re going to have a little bit of struggle. We think we’re turning Selsun blue around but that would be an area—there is at least one account that’s not carrying Selsun Natural that we think should. Selsun Natural is doing very well and Unisom there’s one account—but net net, our focus on advertising and growing the business—you probably can’t find—I was visiting with our head of sales yesterday as we’re preparing for the National Sales Meeting, I doubt you can find another consumer products company in America who can tell you their top four products are all growing at 10%, 12%, 15%, 21%.

Nobody is doing that and that really is paying off that investment of the last two years in advertising and new products is paying big dividends. So we are in very good shape and we think we will, for next year, we’ll gain shelf presence on Icy Hot, we’ll gain more on Gold Bond, we’ll gain a lot on ACT, we’ll gain more on Cortizone, we think we’ll hold shelf space on Selsun and we’ll hold shelf space on Unisom and probably—four our Big 6. We feel good on that front.

Gary Giblen – Goldsmith & Harris

I understand you’re saying if things look good on a total distribution basis, that you’re pleased with that. Have there been any products that—Class of 2008 product that went on the shelf and then were either curtailed or eliminated, anything like that?

Zan Guerry

I wouldn’t say curtailed, I would say if we ranked them, Restoring and Intensive Healing by Cortizone would be the biggest successes. I would say the PM Lotion would be less of a success then we hoped. It’s still okay. I think the Aspercreme Heat has surprised us a little bit on the upside. Net net if you put all the new product launches together, I would say they are upside of what we would have anticipated in total with most of them beating our expectations. The only one I can think of would be the Icy Hot PM Lotion is not quite—but Vanishing Scent is kind of more then making up for that.

Gary Giblen – Goldsmith & Harris

What’s the latest to the day I guess on Icy Hot recall potential lawsuits?

Bob Bosworth

We’ve had two suits filed, have not seen a lot of activity in that area. So that would be the total right now.

Operator

This concludes the question-and-answer portion of the call. I would now like to turn it over to Mr. Bob Bosworth for closing remarks.

Bob Bosworth

Again just closing with three summary points, first we are very pleased with where we ended the first half of the year and looking forward to the second half and into next year. Second part is we are always committed to growing this business in revenues and profitability and third we do appreciate your participation on the call and look forward to the next one. Thanks.

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