Fool on Call: Chattem Looks Toward a Record '08

So you think consumer goods are boring, huh? Don't tell that to Unilever (NYSE: UN  ) (NYSE: UL  ) shareholders, who have seen their stock rocket up almost 50% this year. And don't sell that nonsense to Chattem (Nasdaq: CHTT  ) shareholders, either -- it has been on quite a ride the past five years or so. And the good news is, 2008 may be the best year yet for Chattem and its owners.

We learned some very important details about what lies ahead for Chattem, by way of its most recent quarterly earnings conference call. In this edition of "Fool on Call," we will explore what management revealed for the year ahead and what it all means for investors.

A sales boost
Back in February, my Foolish colleague Rich Duprey reported on Chattem's acquisition of five brands from Johnson & Johnson (NYSE: JNJ  ) : ACT mouthwash, Cortizone anti-itch cream, Unisom sleep aids, Kaopectate anti-diarrhea formula, and diaper-rash reliever Balmex. Three of the five, he notes, are No. 1-selling brands.

The acquisition became possible because Johnson & Johnson had to divest itself of the brands to acquire the consumer health-care business from Pfizer (NYSE: PFE  ) . And the purchase has already made its presence felt: The five additions contributed to a 31% revenue increase through the first half of fiscal 2007. In the call, CEO Zan Guerry noted that through five months of ownership, these five brands are up 10% in sales versus the comparable period a year ago and are performing ahead of expectations.

Guerry also pointed out that these five new brands, along with the company's core concepts, including Gold Bond and Icy Hot, have led to factory sales that he characterized as "outstanding" so far through the first half of the third quarter. 

The added benefit of this sales momentum, he adds, is that it becomes easier for Chattem to introduce new products from the same brands. And that's exactly what we should expect through the remainder of this fiscal year and into the next.

In fact, Guerry indicated that nine new products will roll out between early August and the company's annual sales meeting. We learned in the question-and-answer session of the call that this roster includes two new products from two of its newest acquisitions, Cortizone and Unisom, and will be scheduled for shipping in early 2008. In light of the new product lineup, Guerry is "very confident" about the remainder of this year and "very enthusiastic" about the potential for the next.

Cost savings kicking in
Beyond the obvious sales boost that will come as the acquisitions hit full stride and the new products come out, investors will want to take special note of the significant cost savings that Chattem is projecting by early 2008.

When commenting on the company's gross-margin progress, COO Bob Bosworth pointed out that for the first six months of 2007, gross margin as a percentage of revenues was 69.1%, up from 68.7% in the comparable period last year. One factor leading to the increase was the decline in sales of Icy Hot Pro-Therapy, a less profitable product.

He then added that the company's gross margin has yet to benefit from the expected cost savings that will come as it brings in-house some of the manufacturing processes from the new acquisitions. The projected consolidations are for the manufacturing of Cortizone and Balmex, as well as the packaging of Unisom. All are scheduled for completion by later this year and into early 2008, but the boost to the company's profitability will not hit until 2008, Bosworth said.

All told, Bosworth provided four major factors for why sales and earnings will see a boost in 2008. First, he said, by 2008, the company will have had the new brands in its stable for an entire year, "rather than 11 months, as is the case this year." Beyond the benefit of the additional month of revenues, he sees an added bonus coming as the company learns from the new products over the course of a full year.

Second, new product entries should "enhance organic growth in 2008," he said. The new products, along with increased advertising and, in some cases, "new packaging for many of the acquired brands," is anticipated to add up to increased growth potential. Third is the aforementioned benefit that the company expects to feel in its gross margin as it consolidates manufacturing processes. In the Q&A session, it was suggested that the cost savings here will be a "minimum" of 20% to 30% in terms of cost of goods. That is significant.

And finally, operating margins should continue to improve, just as they have over the past couple of years, as the company's sales growth continues to outpace the rise in sales, general, and administrative expenses. On this point, Bosworth sees "significant savings over 2007 levels."

What it all means
In his analysis of Chattem's second-quarter results, my colleague Brian Orelli cautioned investors from taking a nibble on its shares, warning that "it will be hard for the company to keep up the stellar growth." While it is difficult to predict precisely what its 2008 financial results will be given that management have refrained from offering any guidance for next year until the completion of the third quarter, in light of the remarks made in this conference call, I would be hesitant to write off Chattem as a potential investment.

When factoring in the impact of the new brands, new packaging in some cases, an intense advertising campaign slated for later this year and into 2008, all of the growth that will come from new product introductions, the cost savings anticipated from consolidating manufacturing processes, and the continued leveraging effect of SG&A expenses, it is not going out too far on a limb to predict both record revenues and record profits for Chattem in 2008.

As Chattem gears up for a record 2008, it behooves prospective investors to at least take a closer look.

More Foolishness on Chattem:

Unilever and Johnson & Johnson are Income Investor selections. Pfizer is an Inside Value pick. Take a free 30-day trial of the market-beating newsletter service.

Fool contributor Jeremy MacNealy has no financial interest in any company mentioned. The Motley Fool has a disclosure policy.


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