Chattem, Inc. F3Q08 (Qtr End 08/31/08) Earnings Call Transcript

Chattem, Inc. (CHTT)

F3Q08 Earnings Call

September 25, 2008 8:30 am ET

Executives

Bob Bosworth – President and Chief Operating Officer

Zan Guerry – Chairman and Chief Executive Officer

Robert Long – Vice President of Finance and Chief Financial Officer

Analysts

Bill Chappell - Suntrust Robinson

Jon Andersen - William Blair & Company, LLC

Jason Gere - Wachovia Capital Markets, LLC

Alice Longley - Buckingham Research

Andrew Wolf - BB&T Capital Markets

Jeff Rode - Segall Bryant

Presentation

Operator

Welcome to Chattem's third quarter and first nine months of fiscal 2008 earnings conference call. (Operator Instructions) Prior to today's discussion, the company has asked for its 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 might differ materially from the statements made in the 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 publicly any of these in light of new information or future events.

A reconciliation of the non-GAAP financial measures contained in this presentation for the most comparable GAAP financial measures is contained in our earnings release for the third quarter and first nine months of fiscal 2008, which can be found in the Investor Relations section of the company's website at www.Chattem.com.

Now I would like to turn the call over to Chattem's President and Chief Operating Officer, Bob Bosworth.

Bob Bosworth

I'm joined by Zan Guerry, our Chairman and Chief Executive Officer, and also by Robert Long, our newly promoted Vice President and Chief Financial Officer. Today we're going to review our strong results for the third quarter and nine months ended August 31st. We're going to provide an update on guidance for the balance of fiscal 2008, talk some about the initial guidance related to the very positive outlook for 2009, and also touch briefly on certain key issues related to the consumer products environment.

Before we start, though, a few points regarding the call and the information to be provided. First, Zan will comment briefly on the performance of and the outlook for our brands and our business. At the completion of his remarks, I will provide some limited additional commentary on the results for the quarter, talk about the updated guidance for 2008 and the guidance for 2009, and we'll supplement these comments with our perspective on key issues confronting the company and the industry. We'll then conclude the performance and open the floor for questions.

We're going to limit the call to one hour and to the extent there's specific questions regarding detailed line items on the financial statements provided in the release or to the extent your questions have not been answered during that timeframe, I'd ask that you refer them to Robert, whose number is listed in the press release.

The third point I'd make is in discussing earnings per share in this call all adjusted EPS data will be before FAS 123R charges and debt extinguishment charges, both non-cash items, the litigation settlement, which we'll discuss, and the one-time charge related to the recall of Icy Hot Heat Therapy. We do believe this adjusted EPS information best reflects the operating performance of Chattem.

In reference to guidance, we will be providing updated earnings per share guidance for 2008 and initial EPS guidance for 2009 but, as in the past, we'll not be providing quarterly guidance or revenue guidance.

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

Zan Guerry

In a stressed-out world that could use some good news, Bob and I are going to report to you some outstanding results and, even more importantly, we're going to present our new products for next year as well as some strong EPS guidance for next year.

As we've continued to produce superior results now for over five years, people have actually begun asking us how we're able to achieve these results. I would suggest three primary reasons.

First is our culture of teamwork and cooperation, which we've spoken about on many occasions.

Second is what I would call strategic doing. Herb Kelleher, the CEO of Southwest Airlines, when asked why he didn't do more planning and a strategic plan, he said, "We do things. We do things around here."

And I've kind of coined the phrase "strategic doing" and I think, as you follow Chattem over the years, you can see that indeed we are always bringing new products to market, bringing innovative advertising displays, improved merchandising. You know, our team of talented managers is out there doing things. Some years ago in the famous book, "In Search of Excellence," the words "bias for action" was one of the key phrases, and I think indeed at Chattem we have a bias for action.

Third is a combination of staying close to the consumer and bringing true innovations to solve unmet need. Lastly, the CEO of Procter & Gamble just recently put out a book called, "Game Changer," that identified those two areas as the key to the future success of Procter & Gamble. That is essentially what we've been doing and are doing constantly as we move forward.

Almost every one of my meetings this week in some sense revolved around understanding the consumer, testing our commercials, testing new products, reviewing home use tests, setting up focus groups, meeting with R&D to uncover new innovations, new ways to meet consumers. So that's what we do, and that execution, strategic execution of getting close to the consumer with innovation is what has driven and will hopefully continue to drive our results.

With this intro, I wanted to briefly review the current state of our business and then discuss our new products.

Overall the current growth of Chattem is very strong. Our primary measure, as I mention on every call, are our consumer sales as measured by Nielsen, which many of you have access to, plus we add Wal-Mart POS and combine those together and that is our main measure. We analyze these results very carefully. We look at 4-week results, 13 weeks, 52 weeks, trends period-to-period to gauge our brand strengths. The key results of this analysis for our latest Nielsens are as follows:

The latest four weeks, Chattem's total business - ACT, Heat Therapy and Pro-Therapy  is up 7.2%, which is the largest increase this year for our total business.

Our big six brands, as we continually talk about, are up 10% for the latest four weeks and for the latest 13 weeks.

Our five largest brands, which account for the bulk of new products, which I'll speak about in a minute for next year, are up as follows: Gold Bond is up 10% and 12% for the four and 13 weeks, respectively. Icy Hot Heat Therapy is up 16%, ACT Plus, 23%, Cortizone Plus, 11%, and Selsun is down 2% although the Selsun Blue part of it is up and we are still - Selsun Salon is a little bit of a drag. So our base top brands are very strong. With our four largest brands all up double digits, this is a great asset as we go to the trade with new products.

Two other points about our existing business. One is we've had this little ankle weight around us called Dexatrim, which has been down 20%, 30%, sometimes more percent period-to-period. Now it's at its best position versus year ago, down approximately 5% from a year ago and, hold your breath, we might even show Dexatrim growing next year with some of the new products.

And then the other comment I would make is that we are gaining market share versus our branded competitors almost in every category. It's really, as you dig into the market research and you look at the other lotion brands, the other topical analgesics, the other dandruff and mouthwash brands, it would surprise you how many of the major brands are down 2% to 10% in this market. So with our brands growing and their brands going down, we are indeed gaining share.

With that update on our existing business, let's turn to our 2009 new products.

Overall, we have 15 new products for next year. This morning I will briefly cover our major launches, which include four Gold Bond items, three Icy Hot, a whole new line of four SKUs from ACT under the name ACT Total Care, two Cortizone-10 items and two Selsun Blue items.

All of our new products, plus - all of these new products plus a few others by Dexatrim, Kaopectate, and Balmex - have been put on the Chattem website, including a picture of each product plus some brief commentary so that you can look at the products yourself and learn a little bit more about them as you contemplate this area. You can access this. It is now up and running on our website and you can access this video after our call.

This is clearly our best new product line I've ever - with by far the most upside. The products are backed by extremely extensive market research. So with that as background, let's start. And I'm going to go in order of the size of the brand.

Gold Bond, our largest brand, has, as I mentioned, four new SKUs. Probably the biggest single area of growth for Chattem over the last several years has been the lotion business, starting with healing then restoring, softening and we have two new items - Gold Bond Soothing and Gold Bond Protection.

The Soothing SKU is focused on the nearly half of the population that has sensitive skin, irritated skin. It's an outstanding formula with lots of natural anti-inflammatories and has tested every bit as well if not better than some of our other products. So we think that is a very big upside to continue the growth of the lotion business.

Protection in the hand and body lotion market, SPF in products is becoming more and more the norm, particularly summertime use, a lighter formula. We have an anti-oxidant based SPF product. It provides protection for your skin particularly during the summer. So we're very pleased with that.

Gold Bond has been very strong in the foot category with our sprays and powders and cream, and we're introducing a very exciting new entry into the foot category, a foot pain relief product which combines the skin technology of Gold Bond with the pain relief technology of Icy Hot. The amount of consumers who are on their feet and suffering foot pain is extraordinary, and this would be the first and only product targeted really at tired, achy, painful feet.

And then the fourth Gold Bond item, we had the successful Gold Bond cream which, if you go to the store, is in the first aid section with Cortizone, Benadryl. We're adding a larger size, a lotion which can be used on more situations, broader areas of itchy, irritated skin, poison ivy, things like that. This has been a growing area in first aid and we think this new product will add to our presence in first aid.

So that's Gold Bond.

Icy Hot, again, if you go over the five-year period, has been a tremendous engine of growth. The patches, the sleeve, the XL back patch, vanishing scent, it's been driven by innovation and new products.

This year, as I mentioned, Icy Hot is doing very well. I would say our new products, the PM products, have been more marginally successful. They didn't bring the kind of breakthrough technology that we like to bring.

For 2009 we are bringing two which I'm going to announce today and a third which we'll announce later. I think breakthrough technology in all of the products; we're very excited about that.

The first I'll talk about is the Icy Hot Medicated Roll. If you think of an ACE bandage-type texture, it's the type texture in that area, but this you can tear easily and so you can use it anywhere, anytime for on-the-go pain relief. You can take this roll, tear it off, put it around your elbow, your wrist, your knee, your ankle, whatever hurts. You can use it more like a form on your shoulder or neck. So it's very versatile. People we gave this to in home use tests just loved it, and they used it all over and it was pain relief at their control.

The second idea is the Icy Hot No-Mess Applicator. This is, if you think of the roll-on deodorant-type of product where you can roll on Icy Hot, we've got a very - we've tested several delivery systems of this to where it's very pleasant for the person to kind of massage this into their - whatever muscle they want to. We've got a good delivery system there. And again, this tested extremely strong.

And then we have another Icy Hot item which we'll ship later in the year which we will update you on probably at our next call or some time after that which we think has similar kind of technology.

After hearing Gold Bond and Icy Hot, normally we'd be pretty excited to have any of that, and now I come to ACT, which has the greatest upside of all of our new products next year. We're introducing a plan called ACT Total Care. If some of you remember the introduction of Colgate Total toothpaste, it was the first toothpaste that did everything - plaque, gingivitis, strengthen cavities, strengthen teeth, I mean, the whole line up. It does the total thing.

Well, ACT Total Care is the first and only mouthwash that addresses all of those things. It restores enamel, strengthens teeth, plaque, gingivitis, kills germs, prevents cavities, freshens breath. Kind of think back to the days of Nyquil, the sniffly, sneezing, coughing, do everything. This is everything in one mouthwash.

It has tested with consumers extraordinary well. We've shot commercials in a preliminary nature. Those have tested well. Our sales people have reported on numerous occasions it was the best sales call they've made in the history of their 20 or 25 years at Chattem. The trade is excited. They're looking for innovation and new news into the oral care category, and we're just getting an unbelievable trade reception.

And to put a little icing on this already great cake, just last week we signed Christie Brinkley as the spokesperson for the ACT brand, focusing on ACT Total Care. Chattem uses spokespeople very infrequently, but I think very effectively. Shaquille O'Neal has obviously been instrumental in helping build the Icy Hot brand. We think Christie Brinkley brings every bit as much to the mouthwash category. It's all about the total health of your mouth, total care of your mouth. Who better stands for freshness, total health than Christie Brinkley, who basically built the Cover Girl franchise?

Our trade partners are similarly excited, and I think starting in February and early March you will see displays of ACT Total Care in almost every major retailer with Christie's Brinkley's smiling face on those displays. So it is a very exciting intro, with great trade reception.

I will also mention at this time that the trade reception, as I indicated, when your brands are growing, the trade is very - and they're successful - they're always more receptive. The truth is we've had great reception to every one of these items that I mentioned. I think ACT has been unusually receptive, but all of them we've had great reception from.

Cortizone, as you know, this year the growth has been led largely by the new Intensive Healing Cortizone SKU, which tested very well. We are bringing two new Cortizone SKUs this year. One is what we call the Cortizone Cooling Gel, focused a little more on the summertime use, bug bites, poison ivy, itchy, where you want quick relief but you also kind of want a cooling sensation. It has tested every bit as well as the Intensive Healing, so we have high hopes for that.

And perhaps the, you know, we test all our products with consumers and every one of these has tested high. Perhaps the sleeper in this thing was Cortizone Easy Relief, which is the ability, with a similar kind of no-mess applicator, to be able to put Cortizone on and carry it around conveniently and use it. That was one of our very high scoring products. So I think Cortizone is in good shape.

When I mentioned our five brands, the only brand, top five, that wasn't growing that had new products was Selsun, which is just down slightly. I just met our marketing manager for Selsun in the hall and our new commercial for our two new products on Selsun was the highest scoring commercial in Selsun Blue's history. These are what we would call Selsun itchy, dry scalp, both under the Selsun Blue franchise and under the Selsun Blue Natural franchise.

As you talk to consumers, 40% to 50% have what you would call some of the symptoms of dandruff - itchy, dry scalp - but they either don't consider themselves having dandruff or they truly don't have dandruff, it's just an itchy, dry scalp. This insight, by getting close to the consumer, has led us to an innovative new product focused on this direct group of people. So I think that is a very good upside and I would anticipate Selsun Blue franchise, you know, showing growth, too.

So that's our lineup. As I mentioned, there are a few others you can see on the website for Kaopectate and Dexatrim which I won't cover today.

In conclusion, we have very strong brand momentum plus exciting future upsides due to our extremely talented team of employees executing our strategy of bringing innovation to the consumer. When you're able to do this, you can report a 29% increase in nine-month earnings per share, raise guidance for this year, and put out strong growth guidance for next year.

Finally, as we've talked about so often, we are cash flow managers, and I will Bob detail some of the results we have achieved and will continue to achieve in terms of balance sheet strength for expected future acquisitions.

It's been a pleasure speaking with you this morning. I'm going to turn it over to Bob.

Bob Bosworth

As Zan's indicated in his - we detailed in the earnings release made earlier this morning, the third quarter and the first nine months of 2008 were very good from a variety of perspectives and most importantly provide the platform for the continued growth of the business through the balance of 2008 and into 2009.

While much of this information is relatively self-explanatory, a few comments on the financial results and the guidance are appropriate.

First of all, historic results - Q3 and the first nine months of 2008 - total revenues reached record levels of $112 million and $349 million for the third quarter and nine months of 2008, respectively. This represented increases of 3% and 8% for the three months and nine months.

If you exclude the Icy Hot Heat Therapy which was recalled in the first quarter of 2008 and Icy Hot Pro-Therapy, which is now in very, very limited distribution, and if we adjust for the additional month of sales that we had in 2008 from the brands acquired from JNJ in January of 2007, total revenues grew by 4% and 9% for the quarter and nine months respectively. This is completely consistent with our stated goal of achieving mid to high single digit organic growth over time.

Our adjusted earnings per share, as Zan mentioned, were very strong - $1.17 for the third quarter, $3.29 for the first nine months, which represent very strong increases of 30% for the quarter and 29% for the nine months.

Similarly, EBITDA, excluding the one-time product recall expenses and the litigation settlement, which we'll talk about in a moment, grew by 16% for the quarter and 19% for the nine months, and represented EBITDA margins of 37% for the quarter and almost 35% for the nine months. These excellent operating margins were achieved - and this is important - while continuing to support the brands strongly with advertising and promotion expense.

The income statement dynamics that led to these earnings results as it relates to gross margin, advertising and promotion and SG&A were generally consistent with our previous targets, but they do warrant two comments.

First and significantly, while A&P represented 23.9% of sales for the quarter, which is below our stated range of 25% to 27%, this did not reflect a reduction in advertising expense. In fact, the accrual rate and spending rate for this key item in our marketing mix remained as planned or increased slightly throughout the year. The reduction in A&P expense as a percentage of sales in the quarter related solely to a revision and reduction in expectations for the relatively less-productive promotion expense for the year and a true-up of that accrual rate.

Second, SG&A expenses as a percentage of sales were up slightly due to an increase of freight expense of close to half a point year-over-year.

As Zan mentioned, we continued to generate extremely good cash flow. In the first nine months of the year we used cash to first repurchase stock, with 418,000 shares purchased for a total cost of $26 million or an average price of $62.94 per share. Second, we paid down debt of about $48 million in the first nine months of 2008, resulting in the early achievement of our goal of a 3.0 times debt to EBITDA ratio, and this was again achieved in spite of the repurchase of stock mentioned a moment ago. So we generated about $74 million in free cash flow in the first nine months of the year.

I must say that the cash flow is in part as a result of the cash tax shield associated with the amortization of intangibles and the purchase call options related to the convertible debt for tax but not book purposes in the amount of $0.24 per quarter or $0.72 for the nine months. Again, that number does not run through the P&L but is incremental cash earnings per share.

Finally, in reference to the Dexatrim litigation, we have reached an agreement to settle all known claims related to Dexatrim products which were discontinued about six years ago. Specifically, the settlement is in the aggregate amount of $13.25 million for 26 claims, all from the same attorney and nine of which were made subsequent to the end of the second quarter. This settlement will be funded in part by about $2.6 million from a previously established settlement trust, and the remaining settlement amount and the legal fees, totaling about $11.2 million or $7.3 million after tax, will be funded by Chattem.

A couple of comments are necessary here. While the claims alleged a causal relationship between Dexatrim and pulmonary arterial hypertension, we believed and continue to believe there were and are very strong defenses to those claims, including, for example, the fact that no substantive clinical data exists to support causation, product identification was not evident in most cases, and that temporal or passage of time issues existed.

In spite of this, a decision was made to settle all outstanding claims to avoid the legal cost of defense, and perhaps more importantly, the opportunity cost and diversion of management's time and attention from our highest and best use of building this business in pursing acquisitions. It was a very challenging decision to settle under such circumstances, but we fully believe it was the right one.

So that covers the first nine months of the year and the Dexatrim situation, which we raised initially at the last call.

Moving ahead to the balance of 2008 and 2009, let me make the following comments:

As we consider the results for the first nine months of this year and the momentum of the business, we're increasing the guidance range of $4.00 to $4.20 per share, trending toward the upper end of that range, to a new range of $4.20 per share to $4.25 per share. The $4.20 to $4.25 range would reflect a 25% to 26% increase over the adjusted earnings per share of $3.36 achieved in 2007.

It's also very important to note again that this guidance excludes the cash tax shield of approximately $19 million or $0.95 per share for 2008. This cash tax shield, combined with a strong earnings performance should allow us to maintain or even slightly beat our goal of total debt to EBITDA of 3.0 times, even after the funding of the share repurchase and the litigation settlement costs I mentioned a moment ago.

As a reminder, this earnings per share guidance does not include FAS 123R and debt extinguishment expenses - again, both non-cash charges - the one-time Icy Hot recall expense and litigation costs and expenses.

So we feel very good about the balance of 2008. We feel very good about the results and momentum for this year.

Turning for a moment to the very exciting outlook for 2009, we expect to capitalize on the momentum of the existing business, which is very good, and also the strong new product lineup extension - line extension lineup of which Zan spoke a moment ago to achieve sales growth at the upper end of our goal of mid to high single-digit organic growth rate over time. This should produce earnings per share in the range of $4.80 to $5.00 per share, an increase of 14% to 18% over the midpoint of the 2008 guidance.

These data, for your information, are predicated on income statement detail of gross margin in the 70% to 72% range, A&P increasing significantly in absolute dollars and perhaps even increasing slightly as a percentage of sales as we support these new line extensions, but remaining in the aforementioned 25% to 27% of sales range. SG&A expense of about 13% to 14% of sales should take place, and then we should have reduced interest expense as a result of the deleveraging of the balance sheet. Finally, the tax rate should be in the range of 36% to 36.5%.

In addition to the very positive sales and earnings growth, as Zan mentioned, cash flow will remain both strong and a priority for the company. Based on this guidance and on the cash tax shield, which generates that $19 million, free cash flow should be in the $100 million to $110 million range, which should effectively eliminate all of our existing bank and [term V] borrowings and reduce total debt to EBITDA below two times by the end of 2009. This, of course, excludes any acquisitions we might make or share repurchases.

So we have a very good, very strong outlook for 2009 coming off our 2008 performance, and I believe we can achieve this in the context of existing consumer product industry concerns, which I'll mention for a moment.

Three things that we hear constantly are consumer confidence - and while consumer confidence has eroded, our business has not been materially subject to recessionary pressures. Our key products are not generally discretionary purchases, as the ailments our products address  itch, pain, dandruff and sleeplessness - do not decline with a downturn in the economy.

The second thing we've heard a lot about - private label. And private label products have crept up in market share in certain of our categories, but it's generally not impacted us significantly, with our share actually increasing during this time, again, as Zan mentioned, in key categories. Simply, the stronger brand loyalty, the better and more unique the product, the greater the degree of problem-solution orientation of the brand, the less likely the consumer is to switch from it. Since we're focused directly on product innovation, on product quality and on building loyalty through our advertising, switching to private label has not tended to be a significant issue.

Finally, input costs have indeed risen, particularly in situations in which petroleum is a significant factor, but we have been able to mitigate these increases in purchased material and freight costs through negotiation and innovation, which is and always has been a priority for our operations people.

Also, the impact of rising input costs has been partially offset through very selective price increases. We mentioned previously we took an increase of about 5.5% on items representing about 15% of revenues back in April, and we have announced to the trade further price increases, which are still conservative in the industry, of about 7% on products representing about 9% of our portfolio, which will take effect around the first of the calendar year.

Moving one step beyond the industry, I'd just like to make a quick comment about acquisitions. While we will not address any specific acquisitions, we continue to see opportunities as we are known to be an acquirer of quality HBA products and, whether they're large companies selling businesses or small entrepreneurs, they know to look to Chattem to make acquisitions of strong brands.

In fact, we are seeing a reasonably good flow of opportunities, and perhaps even more importantly, we are in extremely good position, both financially and operationally, to make an acquisition were we to find one which meets our fairly strict criteria.

In conclusion I'd just say the first nine months of the year have been very good from a business perspective. We've been able to raise guidance for 2008 given the strength in performance of our brands. 2009 promises to be another great year with a great lineup of product line extensions, and we are in a good position to make acquisitions.

With that summary, I will now open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your next question comes from Bill Chappell - Suntrust Robinson.

Bill Chappell - Suntrust Robinson

I guess a couple things on the third quarter P&L. On gross margin, down sequentially, is that more due to commodity costs or is it just more due to product mix?

Bob Bosworth

It is mostly due to product mix. It's down 0.7 of a percentage point. It's mostly product mix, with a little bit of increased material cost in there.

Bill Chappell - Suntrust Robinson

And with price increases that you're putting through, what's your thought of gross margin on a full year basis for '09 versus '08?

Bob Bosworth

Well, our perspective on it is, as I said, 70% to 72%, which would be the range that we've identified that we would like to operate in.

The second piece of it, though, is we do believe, as you look at it, with moderating raw material price increases, that we're able to offset those with the price increases that we've put in place or have planned to put in place. So I think we're fairly comfortable with where we are.

Bill Chappell - Suntrust Robinson

And in terms of the A&P accrual, I'm not sure I fully understand that, but could you maybe give us an idea of what the catch-up was in the quarter and how that affected the EPS?

Bob Bosworth

Yes. The specific answer to that is we accrue advertising expense, as we've spoken about before. We also accrue what we refer to as special events money, which are the payments made to the trade in terms of promotional costs. We evaluate that at the end of each quarter and have determined that we are not going to spend as much of that relatively unproductive promotion expense this year as we had originally anticipated.

That resulted in a true-up of the accrual rate. The amount was almost $900,000 in the quarter. If you sort of adjusted for that, that would have brought the A&P as a percentage of sales up to 24.5% to 25% and would have represented about $0.03.

Bill Chappell - Suntrust Robinson

And then looking to next year, two quick questions. I don't remember. Did you reiterate that you're comfortable with high single digit organic growth? And then, with the new products, are you getting incremental shelf space for most of these products or is it cannibalizing your existing products? How should we look at that?

Bob Bosworth

Let me comment on the first part of it and let Zan comment on the second part.

Yes, exactly what I said is that we have this long-term goal of mid to high single digit organic growth, and this year we're going to be trending toward the upper end of that range.

Zan Guerry

And then, Bill, on your question, as I mentioned, the trade reception has been outstanding across the board, and almost without exception this is all new distribution without giving up hardly anything. ACT, I think that's completely true. Generally that will be true for Icy Hot. Selsun Blue, there's still a little bit of Selsun Salon distribution that is kind of trading out. The Cortizone, all the Cortizone SKUs are doing very well. The Gold Bond, those lotions are coming in as additions, as is the foot. So it's probably 90% plus not having to trade out because the truth is we don't have any unsuccessful products to trade out.

In the Dexatrim area there will be a little bit of trading out with our new product, which you can see on our website, which we're pretty excited about for Dexatrim. But overall it's a very positive reception by the trade of these new SKUs.

Bill Chappell - Suntrust Robinson

Well, just to follow up there, for something like ACT getting new shelf space, where are you - are you gaining share from Scope and Listerine or are they just expanding the overall category?

Zan Guerry

Well, you know, all these categories have various unproductive SKUs, and some of the bigger lines have numerous unproductive SKUs. So it can - it's not we're looking for 20 new spaces. If you look at a mouthwash category, it can come from a variety, perhaps one from Scope, perhaps one from Listerine. There's some marginal players in these categories who are kind of - and I think what's happening is the marginal players in categories are disappearing. You don't want to be the number 10 mouthwash. So it really was relatively - each account, there's a different answer on where they got it.

And the other thing that we found both for ACT and Gold Bond, which has been really successful, is that it's not as much getting the new SKUs, which is important. We've seen significant increases in the placement of our product in terms of a planogram. It is really astounding the difference between putting Icy Hot or Gold Bond or ACT kind of eye level or a prime location in shelf placement versus being on the top or the bottom.

And we've had lots of individual successes and are continuing this. ACT in particular and the Gold Bond are continuing to move to more prime locations, and we have numerous accounts where we see, have seen and will expect to see strong increases.

Operator

Your next question comes from Jon Andersen - William Blair & Company, LLC.

Jon Andersen - William Blair & Company, LLC

Sticking with the new products for a minute, is it fair to assume that the 15 new products or line extensions will be able to be afforded with similar levels of alleging support, traditional levels of advertising support?

And then second, in terms of the timing of those launches, does this look like kind of a traditional year, where most of the new products are shipped in Q1 or can you help us think about the timing of the launches for '09?

Zan Guerry

Yes. That's the simplest answer - yes. Most of this is shipped out in Q1, so most of the advertising will break as early as March in some cases and April in other cases. But most of it is a Q1.

It's challenging to support new launches with advertising. We think we have a - we've worked very hard on a plan to give all of them their day in court and their success, and yes, we can do it.

As brands get bigger - let's take a Cortizone as an illustration. It has gotten bigger; the budge is bigger. We can shift some of the advertising that was on the other SKUs to the new SKUs. And so we can introduce Cortizone Intensive Healing - I mean, Cortizone Cooling and Cortizone NoMess, same with Selsun Dry Itchy - we just can shift the money that we were spending on our other ones and focus.

And that's pretty much tradition as far as the way consumer package goods, I think, in terms of finding new money. And we are looking at some pretty strong sales increases for next year and we might even have upsides off that. ACT is the place where you'll see the budget increasing.

The other thing we do is we've been quoted as feeding the winners, starve the losers. We really think of the year as a six to seven-month, put it out there and kind of see. What we always know is some of these new products will do better than we expect. A few will probably not do as well. And so we'll be running very strong advertising March through June behind all of the new products. We'll take kind of a hiatus, if you wish, and then we'll come back. And that gives us the ability to reshuffle some of the advertising if we see a particular opportunity.

So in a sense we, I think, this has been our most studied year in terms of how to do it, but I'm very pleased with the amount of media that we're going to be able to put behind all of these launches.

Jon Andersen - William Blair & Company, LLC

You mentioned earlier that Dexatrim has been something of an ankle weight in fiscal 2008 given the competitive launch of Alli. As you look out to 2009, do you see anything on the horizon there from a competitive standpoint in terms of launches that could have a material impact on one or more of your categories?

Zan Guerry

We're not hearing or seeing anything. As you know, Alli is fading dramatically from some of its early things, both in spending and in sales. We're not hearing of anything new coming in. And while Alli certainly was partly responsible for the decline, new products, when you bring in new innovation into a market, which we have on occasion done on Dexatrim and on occasion we haven't, this is probably our most innovative new product we've ever brought, certainly our most clinically studied new product. We're very proud, going back to the Dexatrim Natural success.

But this is a complex [seven] which is clinically proven to help you lose three times more weight, 80% from body fat. A lot of technology in this product for claims that we've not been able to make before. And we've got some, I think, really innovative advertising behind it. So it's probably our best opportunity in terms of low competition as well as being able to make some strong claims that previously we've not been able to do.

Operator

Your next question comes from Jason Gere - Wachovia Capital Markets, LLC.

Jason Gere - Wachovia Capital Markets, LLC

I guess I was just trying to think about your appetite for risk with innovative products, especially in this soft environment. It sounds like most of the products coming out are good line extensions. Curious a little bit more about the medicated roll that came out. But I guess in terms of talking through with your retailers, the thought of what consumers want these days, are they looking for that trade up or are they looking for really what gets the job done? I was just wondering if - that is the first question, if you could just talk maybe a little bit more about your risk aversion.

Zan Guerry

Well, as a general rule, we always like risk aversion and, as a cash flow manager, we do that.

I think the more you know of a product, the more market research you have that helps. The more it is an established understandable product, again, the safer you are. So we pick up in our research a lot of that thing.

As I look at the SKUs, most of these feel and look very similar to past successes. And so, when you have a past success to go on and then you measure your current products under the same standards and they measure as high as the past success, it gives you confidence.

So, for example, the Gold Bond products, we measure those versus past successes of Gold Bond because they're all more of the same kind of thing, and all of those stand up to that situation. We measure the Icy Hot relative to the Icy Hot back patch, the vanishing scent. So we have guidelines for those. For the Selsun, we have the Selsun Blue Natural that we can look to as a guideline.

Probably the only one we don't have a significant guideline although we sort of do - actually we do - ACT Total Care. We can look at ACT Restoring and say okay, Restoring brought these benefits, and we looked at the tests of ACT Total Care in terms of how it scored in concept, how the products scored versus that.

So we have - you mentioned the roll. We can test it against the back patch. We also, from consumers, get a lot of - definitely we'd buy, how much they like the product, and these are our most-liked products. So I don't view - I'd be hard pressed to tell you - I'd have to think about that  which one I would consider risky of these new products.

Probably the one, if you ask risk perspective personally, since it's something new, the foot pain could be big upside, but there's not an established foot pain market, so you could say that one. And therefore we are managing our spending against that very carefully because that has kind of explosive upside. But it does have the risk of we're trying to - anytime you try and change consumer habits with something, that's a little more challenging.

But overall, I think our risk profile is the best I've seen on our products.

Jason Gere - Wachovia Capital Markets, LLC

I was wondering if you could maybe talk a little bit about the international business. That seems to be kind of, I guess, the weaker area, and I'm not sure how much of that was - is that currency or is it just - I know it's a small piece of the portfolio, but I was just wondering if you can give a little color why the trends were down year-over-year?

Bob Bosworth

Just two quick things there. First of all, it is the smallest part of our business, and we've established before the thought process that we're going to grow that slowly and carefully as we look at that component of our business.

The second thing that I'd say, if you look at international revenues for the first nine months versus the first three months, you get a different picture. And one of the things to understand  and I think we said this in the first quarter, when it was very strong - that when you ship through distributors, you often have lumpy, lumpy shipments.

So I'd say that quarter-to-quarter variations aren't something significant to look at. It's merely the timing of shipments that take place because of the way we run that business. But I don't think there's anything that you should read into third quarter results in terms of overall international growth.

Jason Gere - Wachovia Capital Markets, LLC

Do you know offhand how much was currency that was in there, how much is organic? I guess I'm just trying to think about going forward with obviously the strength of the dollar. Obviously, your approach to grow the business more slowly, just how we should think about that for modeling purposes.

Bob Bosworth

Well, for modeling purposes, again, now we're predicting both business and currency. Let me acknowledge the difficulty in doing that.

The currency impact is maybe 3% of sales, and so it's not a huge deal. It's not even that much of sales. But in terms of profitability it's even less as it is the relatively unprofitable part of our business. So I wouldn't look at currency as being a major factor.

Jason Gere - Wachovia Capital Markets, LLC

Just on the new pricing that you're going to be taking for January 1st, I'm not sure if you can talk about the categories per se where you're taking that but, I guess, just in terms of your conversations with retailers, you know, I know that commodities are still up but I was just wondering if you were taking these prices more for infra costs or if these are just categories where you haven't taken it in a couple of years and you felt that this was the time to do it? And maybe what the competitive response has been in those categories.

Bob Bosworth

Let me comment briefly on it, and Zan may want to augment this.

First of all, in general we have taken a very conservative approach to price increases. We have both the retailer - which has been very accepting of price increases - and the consumer, which we're sensitive to in this environment. So as we've taken price increases, we have been more conservative than some of our competitors. You can find within oral care, within the dandruff shampoo categories in particular, increases that were well above anything that we've taken. So we have taken a conservative approach.

We've taken a very selective approach in certain items within certain of the categories, again looking at the consumer impact that it might have. Probably the biggest one we've taken in overall increase would be in sun care, where the increase in input cost has been significant to us and to everybody else in terms of sunscreens and the oils involved as well.

Overall, though, I'd say that the competitive landscape is their increases have been greater than ours and we are sitting back watching the impact of those increases on the marketplace.

Operator

Your next question comes from Alice Longley - Buckingham Research.

Alice Longley - Buckingham Research

Could you comment on accounts receivable and inventories, which were both in the high teens year-over-year?

Bob Bosworth

Well, in terms of receivables, we are 99% current, so there's no magic to that number. It's simply the timing of shipments and collections. Again, 99% plus current. So there are no issues to be looked at there.

The second thing, in terms of inventory, we were at this point last year looking at trying to keep up with demand as we were transitioning from outside manufacturing with [Theisman] and JNJ to internal manufacturing. Actually, if you look quarter-to-quarter sequentially, inventories are actually down. So we are comfortable now with where the inventory levels sit.

Alice Longley - Buckingham Research

If receivables are up that much and it's an issue of timing, does that indicate that you did a lot of shipping at the end of the quarter and maybe we can have some acceleration in sales?

Robert Long

Another point in that receivables number, that is the line item that includes the settlement trust receivable, that $2.5, $2.6 million. So there is a component there, as well.

Alice Longley - Buckingham Research

And then in the advertising ratio, can you tell us how much of that line is advertising versus promotions? Is it 70% advertising and 30% promotions or what's the rough ratio?

Bob Bosworth

Some of these questions, Alice, we'll be glad to take off line, but in general the way to think about it in that line - and you're given to allocating some expenses, like the marketing department  probably two-thirds, one-third advertising, promotion.

Alice Longley - Buckingham Research

Okay, so it's about two-third, one-third?

Bob Bosworth

That's a rough approximation. You've got some internal allocations in that line, but that is it.

Alice Longley - Buckingham Research

And then in the guidance for fiscal 2009, will gross margins go up again, do you think?

Bob Bosworth

What we've said in that our gross margin is going to be in the range of 70% to 72%. We believe that we can offset any increase or mitigate any raw material input increases we might have with these relatively small price increases that we have.

Alice Longley - Buckingham Research

And will that ad promo ratio be up - or let me ask, do you think operating margins - what will happen with operating margins in '09, up, down, sideways?

Bob Bosworth

Again, we've put ranges around each of the components of the income statement which we are comfortable with. What we're charged with is managing those individual ratios to get down to that earnings per share number, which we've indicated is that $4.80 to $5.00 a share.

Alice Longley - Buckingham Research

What was that exactly? I'm trying to figure out what the - you've given us some guidance for sales, and I guess we can figure out free cash flow and interest expense, but do operating margins go up or down or sideways, do you think, next year roughly?

Bob Bosworth

Roughly, I don't think there's going to be a significant change in operating margins.

Alice Longley - Buckingham Research

So it's really sales plus interest expense going down?

Bob Bosworth

Roughly.

Alice Longley - Buckingham Research

When you talk about sales next year being toward the upper end of your guidance, will that, do you think, be a clean number so it's not excluding this, that or the other, but sales should actually be reported up something like 7% to 8%?

Bob Bosworth

And that's an important point. Let me address that one pretty directly. We've had these comparisons with Heat Therapy and Pro-Therapy that we've had to discuss over the past  and discuss appropriately, I might add - over the last year or so. Those negative comparison, particularly with Pro-Therapy, will have worn off almost completely. Pro-Therapy will still have some negative comparison, but we're talking about being in the upper - trending toward the upper end of the mid to high single digit organic growth rate on a clean reported basis.

Zan Guerry

It's not challenging - I mean, we manage historically conservatively and, you know, it's not challenging if we're sitting here with our current business growing in total 7%, our big brands growing 10%, and you introduce 15 new products, all of which have been tested extensively, and you add ACT Total Care in as a wild card. We could give you some pretty high numbers if we want to. So, I mean, it's not going to be challenging if these things work to get to any of those numbers.

So in these budgeted numbers we've given you in the outlook, we are not assuming huge successes. We hope for huge successes. We plan for huge successes. But we manage things, as I've mentioned, as a value investor and so we're giving you kind of conservative numbers. But it's not challenging for us to give you yes, we should have some pretty strong sales growth for next year.

Alice Longley - Buckingham Research

I missed a number when you told us consumer sales Nielsen plus Wal-Mart. What was up 7% for what period?

Zan Guerry

The numbers I gave was if you take the total business, including Dexatrim, including everything, we were up for the last four weeks 7.2% and our big brands were up in total 10%. So that's where we sit today. We've actually over the last couple weeks even seen a little more momentum tick up, not dramatically but, you know, we watch, because of consumer sentiment, we get weekly sales from our major customers.

And so the Nielsens I gave you were two week ago Nielsens. We watch every week, so we're seeing at least as strong if not slightly stronger results from our key customers over the last couple weeks.

Alice Longley - Buckingham Research

But that 7% excludes Heat Therapy and Pro-Therapy?

Zan Guerry

Yes. Which, you know, that's the only way we can look at it because if we budget, you know, how are we going to do next year versus this year, since we don't have any Heat Therapy or ProTherapy, what we're looking at is how are the brands we have doing.

Alice Longley - Buckingham Research

And that four-week period was through early September?

Zan Guerry

I'm sorry, what was that?

Alice Longley - Buckingham Research

That four-week period was through, what, September 6th or something?

Robert Long

Yes, September 6, Alice.

Zan Guerry

September 6th.

Alice Longley - Buckingham Research

And then my last question was pricing of this ACT Total Care versus Crest Pro Health. I mean, where will that be priced versus, let's say, Crest Pro Health, which also offers a lot of benefits? Is it at a discount or the same level?

Zan Guerry

It's not at a discount. Let's say it's not at a discount. ACT Restoring is not at a discount, either. We're bringing superior benefits to the market. So from what we can tell, thinking of Crest Pro Health, we would be in their vicinity.

There's a lot of stuff, this is one category - one reason why I hesitate is there's some categories that are more heavily promoted, this being one of them, so there's what the price says on the shelf and then what the average price that things are sold at. And so we've got some pretty extensive - we view this as one of the biggest upsides in Chattem's history, this launch, and so we will be investing more heavily in certain promotions, particularly trial size and other things. So we will make the price should not be a factor in the success of Total Care early on.

Alice Longley - Buckingham Research

So that, with the coupons and whatever the consumer's going to get, it will be a discount to, say, Crest Pro Health.

Zan Guerry

Probably.

Alice Longley - Buckingham Research

She'll see that it's cheaper?

Bob Bosworth

They'll see opportunities to buy it for less. And we have, what increasingly - this happens with all consumer manufacturers, the trade, when they find something they like, they really work with you and they like to bring innovative programs.

So we have, for each of our major retailers, very strong but very different programs. Some retailers are very big on different things. You have different display configurations. Some accounts are really big into displays, others are more trying to get product - Try Me Free type of products, try three ounces free. So each major account has a somewhat different but fairly exciting into for Total Care and pricing is always a part of that.

Operator

Your next question comes from Andrew Wolf - BB&T Capital Markets.

Andrew Wolf - BB&T Capital Markets

First, just, Zan, with what you're saying on current trends at the consumer level and Dexatrim maybe heading towards a flattening out, is it fair to assume that your Q4 factory sales growth rate year-over-year will pick up from what we just saw so that this will be the nadir or the lowest sales growth for awhile?

Zan Guerry

Certainly for 2009, that is true. We've been extensively looking at 2009 versus 2008, and I think that statement is exactly true. Everything we're seeing in the fourth quarter would support that.

Andrew Wolf - BB&T Capital Markets

On the pricing, I thought I heard Bob say 7% on 9% of the portfolio?

Bob Bosworth

Yes.

Andrew Wolf - BB&T Capital Markets

And then there was something before that, maybe I didn't hear it. But could you just say what percent of - what kind of pricing you're getting on across your entire sales base currently and what you think that'll be in '09?

Bob Bosworth

Let me be very specific about it. We took 5.5% on 15% of the portfolio in April of this year, and we are going to take 7% increase on 9% of the portfolio in January, essentially, this year. If you look a the total impact on revenues for next year, it's less than 1% of sales.

Zan Guerry

And as Bob said, we are flexible. I mean, if somebody would tell us whether oil is going to be $80 or $180, we could probably give you a better pricing thing. We felt that some of our competitors potentially overreacted to - they must have been reading what Goldman said about the price of oil and overreacted. And we are staying close to our consumers and saying, you know, these consumers, we don't want them - they've got enough bad news to deal with. We don't want to see them going out and having their basics go up in price unless we have to.

And fortunately we have a lot of things working for us - strong growth, ability to control prices, strong gross margins, etc. - so we've been able so far - we can change that point of view. I mean, certainly we could have taken a more aggressive approach to pricing and, depending on how the market looks in terms of recession, depression, oil, I mean, we can respond. You have 90 days in kind of lead time. There's nothing that says you have to do it.

So we've kind of adopted a wait and see, I hope things improve, I hope we get a more stable world. We may or may not get a more stable world, but it would be nice. And then we think our pricing strategy was very appropriate. If we get some weird thing, we do have ability to respond more aggressively probably than we have.

Andrew Wolf - BB&T Capital Markets

It sounds as if you think that maybe your relative pricing relative to other branded manufacturers and marketers might have improved, given some of the overreacted. Am I hearing that right?

Zan Guerry

Yes, I think you could safely say that.

Andrew Wolf - BB&T Capital Markets

My last question, it just relates to a follow up on an earlier query on what you're seeing out there with competitive forays against Chattem brands. And I just wanted to ask you if you could give a little flavor for the process for you at Chattem, how you discover that or how your competitors discover that about the 15 in brands you just announced to us today. In other words, how likely you are to be in a position to really know ahead of time. Is there a lot of trade chatter that's specific or is it more general? How is that discovery of competitive forays that are coming at you? Could you just give a little color on that?

Zan Guerry

One reason why we delay that until this time is people can be fast, but I don't think anybody can ship another product January 1st based on what I told you today about any of our new products, so we hold it as late as possible. Yes, there is trade chatter, particularly big items. You may not find, if there's a small item, you may not hear about it. But the things that would be material, there's trade chatter, particularly the closer they are to shipping.

And so we're unlikely to find - if there was a major new something in any of our categories coming in January 2009, we would almost assuredly have heard about that somehow and we are not aware - if there's a minor thing, Aveeno introducing a new flavor of lotion, we may or may not know that. But we pick up and I'm sure they do, too. They probably didn't just now discover that we're shipping such and such.

And again, most of the technology we're bringing takes, if they think the Icy Hot Medicated Roll is the greatest idea they've ever heard of, let them go try and do that. It's going to take quite awhile to respond to that. But we do try and hold the information as long as we feasibly can.

Bob Bosworth

Operator, we will take one more question.

Operator

Yes, sir. Your last question comes from Jeff Rode - Segall Bryant.

Jeff Rode - Segall Bryant

I was wondering if you could just walk us through again how Icy Hot competes with the private label type patch.

Zan Guerry

Well, you know, of course Icy Hot is in six different forms - creams, rubs, vanishing scent, sleeves, patches and now there'll be two others. One thing you always want to do is stay ahead of private label, so you like new patches and other things they don't have. You like new things. That's one strategy for innovation is staying ahead.

The whole subject of who buys private label and why they buy private label is a subject to itself, and everything is different depending on the category. As a general rule, the stronger a brand is and the more important it is to somebody, the more likely any consumer is likely to say, "I want the best." If you have arthritis, if you have a cough, if you have something which is what most OTCs - you don't want to mess around and say, "Well, maybe that generic is good. Maybe it works as good." You want the real thing.

And I think that Icy Hot has brought the finest technology, their products are trusted so the general rule, people - and that's why we continue to innovate with different types of patches - prefer that. You are going to get some consumers - we occasionally will respond to that by running some price, for the people who might switch back and forth we run - that's why you run promotions is you hopefully, if you run a promotion, you might see some of the people switch. But as a general rule, the private label shopper is kind of unto themselves is what we're finding.

And the Icy Hot patch actually, as we look at this, is one of the strongest growing pieces of our business. I think it's up 15% to 20%. So probably a lot of - all the stress out there, probably a lot of sore necks and sore backs. And they want the best thing they can, which is, in fact, the Icy Hot patch.

Bob Bosworth

And let me just put some quantification around that because it is a question that gets asked frequently. Over the last year, the private label in the topical analgesic category increased a little over 2 percentage points during that time. During that same time, Icy Hot itself has grown over 2 percentage points, which just lends credence to the comments that Zan made.

Zan Guerry

ThermaCare has had some unusually intense pressures against them, and since they get lumped in the category - and you can imagine, I mean, heat is not necessarily medicine, so to speak, and we have seen - and it's a very high-priced item, so that is - probably the biggest area of private label growth has been against that.

Operator

There are no further questions.

Bob Bosworth

Well, we thank everybody for participating on the call, and we look forward to a good balance of 2008 and a real strong 2009. Thanks.

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