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Executives

David Taylor - EVP, Finance & Planning and CFO

Marty Orlowsky - Chairman, President and CEO

Analysts

Judy Hong - Goldman Sachs

Thilo Wrede - Credit Suisse

Adam Spielman - Citigroup

David Adelman - Morgan Stanley

Andrew Kieley - Deutsche Bank Securities

Chris Growe - Stifel Nicolaus & Company

Steve Farell [ph] - Carmen Asset Management [ph]

Lorillard, Inc. (LO) Q4 2009 Earnings Call Transcript February 8, 2009 10:00 AM ET

Operator

Good morning, ladies and gentlemen and welcome to the Lorillard fourth quarter and full year 2009 earnings conference call. My name is Carissa and I will be your coordinator for today.

At this time all participants are in listen-only mode. We’ll be facilitating a question-and-answer session towards the end of today’s conference. (Operator instructions) I would now like to turn the call over to David Taylor from Lorillard. Please go ahead.

David Taylor

Thank you operator and good morning everyone. I am David Taylor, Lorillard‘s Chief Financial Officer and joining me on today’s call is Marty Orlowsky, Chairman, President and Chief Executive Officer. By now you should have received a copy of our fourth quarter 2009 earnings release. It can be found on the company’s Web site, www.lorillard.com under News Releases.

Before we begin, I would like to remind you some of the comments on today’s call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and uncertainties as described in the company’s earnings release and in other filings with the SEC.

I would now like to turn the call over to Marty Orlowsky. Please go ahead.

Marty Orlowsky

Thanks David. Good morning everyone. Lorillard’s financial and marketplace results achieved in 2009 were very positive in our opinion given the unprecedented increase in the federal excise tax on cigarettes that occurred in April of 2009. As a result of this increase, as well as the state excise tax increases, we believe that consumption patterns were disrupted and that a degree of down trading occurred affecting the premium price brand segment.

On an overall basis, this is evident in the decline of the industry’s domestic wholesale shipments during 2009 versus 2008 of 8.6% as well as a shift of approximately just over 200 basis points of these shipments from premium brands to price-discounted brands. Despite the challenges that faced the industry and our company, Lorillard’s operating income gain of 8.9% in 2009 over 2008 reflects the strength of the company’s brand portfolio (inaudible) Newport’s leading menthol brand retail share position and average profitable unit volume gains in the discount segment.

Newport achieved a 10.28% retail share of the domestic market; a gain of 0.36 points in 2009 versus 2008 and Maverick gained almost 0.5 share point resulting in a 1.14% share of the retail market for 2009. These results reflect a consistency of Lorillard’s longstanding strategic objective of balancing profitability and Newport’s market share growth. We will continue to follow this path as we move into 2010, and we will also continue to monitor our performance variable, and the industry and brand trends to ensure we are in a position to make adjustments to our promotional plans as may be appropriate. Although industry wholesale shipments were off 8.6% and there was one last shipping day in 2009 versus 2008 on an adjusted basis that was 8.2% versus 2008. Lorillard outperformed its major competitors with a decline of 3.9% unadjusted or 3.5% at the wholesale level adjusted for the same period.

Newport’s wholesale shipments were down 6.6% on an adjusted basis and 6.9% unadjusted in 2009 versus 2008. According to our proprietary retail database, Newport achieved a 35% share of the menthol segment, which reflected an increase of 0.5 segment share point in 2009 versus 2008. This performance was due solely to organic growth of the brand i.e. without line extensions or steps of promotional support. I would also like to announce today that Lorillard will be entering into the moist smokeless tobacco market in the not-too-distant future. And we look forward to further extending our participation in that growing segment of the tobacco category.

Lastly, I would like to briefly comment on an issue that is on the minds of many investors these days and that is the FDA’s regulatory authority and its upcoming review of the use of menthol in cigarettes. As you know, the FDA will empower a Scientific Advisory Committee to review the signs relating to the health effects of menthol as a flavoring in cigarettes. The panel is likely to be named shortly and we expect that its first meeting may be somewhere in the March timeframe of this year. As we said before, we believe that the weight of the scientific evidence does not support a conclusion that menthol cigarettes confer greater health risks than non-menthol cigarettes. We also believe that the Scientific Advisory Committee will indeed form its conclusion and recommendations based on scientific evidence before it. We therefore continue to believe that the Scientific Advisory Committee will not make a recommendation to the FDA that it banned menthol.

Furthermore under the Family Smoking Prevention and Tobacco Control Act, the FDA must take into account other information in connection with its decision on whether or how to regulate all cigarettes, regular or menthol, including specifically weather event or other limitations would lead to, and I quote “the creation of a significant demand for contraband or other tobacco products that do not meet the standard set by the FDA for tobacco products. We believe that a ban on menthol would indeed lead to a massive black market for contraband mentholated cigarettes and encourage the entry of totally unregulated products into the marketplace that would not meet even the basic standards for product integrity and quality.

There has been much speculation in the hypothesis offered for who may comprise the membership of the committee, or on how the committee process will unfold, or on what evidence they will reach a conclusion, or what that conclusion might be, and what the FDA will eventually do in response to the committee’s recommendation whatever that might be. Of course all of this speculation is based almost entirely on conjecture. So we must avoid jumping to conclusions and use speculation with an appropriate attitude. We expect that the process will proceed with the appropriate respect for the science and an appropriate assessment of all other public policies issues involved. Nothing we have seen or heard has changed or believed that a ban on menthol products is highly unlikely.

And now I am going to turn the proceedings back to David Taylor.

David Taylor

Thanks Marty and good morning again. I will spend a few minutes reviewing the numbers and then we will open the line for questions.

Net sales for the fourth quarter of 2009 were $1.378 billion compared to $1.088 billion in fourth quarter of 2008. Excluding excise taxes, net sales increased $20 million or 2.2% from $912 million to $932 million. There are a number of factors that play impacting net sales for the quarter. Higher net average selling prices were positive but were largely offset by total unit volume and a less favorable product mix along with the impact of higher sales promotional cost, which are accounted for as a reduction in net sales.

The impact of Maverick's significant growth combined with Newport’s unit volume decline has resulted in a less favorable and profitable mix in 2009 than in 2008. This growth in the price/value brand as a percentage of our total will tend to dampen the net revenues per pack if one were to calculate that in simple arithmetic. Maverick units accounted for over 10% of our total unit volume compared to roughly 7.25% last year. For all of 2009, net sales were $5.233 billion compared to $4.204 billion for 2008. Excluding excise taxes the net increase in sales in 2009 amounted to $194 million or 5.6%.

Gross profit in the fourth quarter 2009 declined by $12 million to $481 million or 51.6% of sales excluding excise taxes from $493 million or 54.1% of sales excluding excise taxes in the fourth quarter of 2008. While the 51.6% gross margin is lower than our 2008 fourth quarter, it is in line with and approximate our 2009 annual gross margin rates of 51.7%. Gross profit per unit shipped in the fourth quarter of 2009 is up 1.7% from last year’s fourth quarter as the impact of price increases was largely offset by the impact in the mix shift I mentioned a minute ago, the higher promotional spending, and the increases in our manufacturing and settlement costs.

As we reported in prior quarters, cost of goods sold in 2009 has been impacted by higher raw material costs, higher pension costs, the new added DAVs [ph] and the impact of the excise tax on our LIFO inventory valuations. Our wrapping costs were also up in 2009 as we moved more production towards cigarettes that comply with the lower ignition propensity standards. And now 100% of our production is compliant with these standards. Amounts due under the State Settlement Agreements increased $17 million compared to last year’s fourth quarter as a result of the inflation factors in those agreements and the increase in our market share. The impact of the lower industry unit volume did not fully offset these things.

I should point out that although wholesale inventory fluctuations did not play a significant role in comparing our fourth quarter volumes, the significant disruption we saw in the first two quarters of 2009 as a result of last April’s federal excise taxes increases will impact our quarterly volume comparisons in the first half of 2010.

Selling, general and administrative costs increased $4 million to $83 million in fourth quarter of 2009 compared to the fourth quarter of 2008. This increase is primarily the result of higher legal and pension costs in 2009 compared to 2008. As in prior quarters, we continued to incur higher defense costs for the Engle progeny cases underway in Florida among other things.

Operating income declined 3.9% to $398 million from 42.7% of sales excluding taxes in the fourth quarter of 2009 from $414 million or 45.4% of net sales excluding excise taxes in the fourth quarter of last year. Operating income per unit shipped remained roughly flat with last year’s fourth quarter. Interest expense fell $9 million in fourth quarter of 2009 and reflects the interest expense on our $750 million senior notes issued net of the effect of the interest rate swap we entered into in the third quarter. Our effective income tax rate in the fourth quarter of 2009 was 37.9%, the same as in 2008, but up slightly from the third quarter and the annual effective rate due to certain state tax expenses.

Net income for the fourth quarter of 2009 was $242 million or $1.52 per share compared to $258 million or $1.53 per share in the fourth quarter of 2008. Now, for the year ended December of 2009, net sales excluding excise taxes increased 5.6% from roughly $3.7 billion in 2009 from roughly $3.5 billion in 2008. Operating income increased 8.9% to $1.541 billion from $1.415 billion last year. Earnings per share were up 11.8% in 2009 to $5.76 a share compared to $5.15 last year. The $0.61 per share improvement in EPS in 2009 includes positive impact of the lower average share count and the impact of lower average share count is $0.25 a share.

The $750 million share repurchase program that the company announced last summer has now been completed. Under that program as of January 19, the company repurchased an aggregate of 9.8 million shares at an average purchase price of $76.80 per share for the total of $750 million. So cumulatively from the data separation, the separation from Lowe’s, we have repurchased 19.3 million shares for approximately 11.1% of the additional issue.

With that, I would like to open the line for questions. Operator, you can help us.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Your first question comes from the line of Judy Hong of Goldman Sachs. Please proceed.

Judy Hong - Goldman Sachs

Thanks, good morning everyone.

David Taylor

Hi Judy.

Judy Hong - Goldman Sachs

Marty, just your comment about your decision to enter the MST category in the near term, can you just elaborate on that comment? Will you be looking at using the Newport trademark, is it sort of an extension of your JV that you have with Swedish Match, and is this any indication that maybe you think gaining share in cigarettes is just getting tougher and that you need to enter into this category?

Marty Orlowsky

First of all, I am not going to make any specific comments about our plans with respect to the marketing of moist smokeless tobacco products at this point. So I am going to defer on that one. Secondly, it is not a statement of any kind other than an opportunistic perspective that we have applied to the world at large and we have decided that we believe there is an opportunity to enter moist smokeless and add to our portfolio, and add to our profitability over time. It is not any sort of stated or unstated statement or implicit to what we are saying here. It is not a statement of lack of confidence in cigarette business or a renewed view of the cigarette business. We still believe very strongly the cigarette business regardless of its declining state has long ways to go especially as it relates to Lorillard of generating profitability immunity and the longer term objectives that we have. So it is not any sort of hidden statement (inaudible) not involve Swedish Match thought at all and so it will not be part of that venture and in fact our joint venture with Swedish Match was mutually agreed to be terminated at the end of 2009 in the Snus business.

Judy Hong - Goldman Sachs

Okay. And then Marty, just as you look at the cigarette industry and clearly in 2009, you saw the consumer down trading to the discount segment, I am just hoping to get your perspective on how much of that down trading is really the economy and the price list [ph] location versus sort of a secular maybe a change in how the consumers are behaving in the cigarette industry at this point. In other words, if you assume that the economy normalizes and all of the price list locations from the FET driven price increases are lapped, do you think that the premium segment will grow again or at least stabilize going forward?

Marty Orlowsky

I clearly think that obviously the result during the last six months of 2009 for the industry as well as for ourselves was clearly driven by what I call the (inaudible) as I said earlier an unprecedented increase in the federal excise taxes on cigarettes as well as state excise taxes. And so obviously it is a combination of that rather substantial price increase that occurred as a byproduct of the taxes as well as the general nature of the economy. It was through a double landing, if you will, in a relatively short period of time. I do believe longer term, I hope actually and believe, that there should be a degree of stabilization that might occur. So I think a lot of the down trading is a byproduct of the combination of economic factors as well as pricing shift. Even though we all recognize that the gap between high and low price brands actually narrowed on a percentage basis, I think that clearly we are now looking and have witnessed a degree of the so called flicker shot [ph] factor. I hope so that even though the GAAP is not – the GAAP was pretty important for many years, it still is important, I would not minimize it but I think that your (inaudible) that occurred earlier last year.

Judy Hong - Goldman Sachs

Okay. And then David, just a couple of quick questions, first, in terms of your 4% decline in the shipment numbers in the fourth quarter, was there any factors that impacted that number, I think that inventory de-stocking really was not a factor, so any timing in terms of the promotional units shipped that may have affected that number? And then secondly, on your MSA payment per unit, there seems like it was up a lot more than what people had anticipated, so I am just wondering if we can get some clarity on why that was up so much.

David Taylor

Yes. In terms of our shipments in the fourth quarter, inventory levels would not entertain more averages or change in any inventory levels anymore at the end of the fourth quarter. It does not really affect the comparisons. We did ship a number of promotional or buy some, get some free units in the fourth quarter of 2008 but that may have contributed to some of that decline but it is very hard to quantify exactly how much buy some and get some impacts real quantity comparisons on an apples-to-apples basis. When you talk about MSA per unit, again there is a number of things going on there. Remember the higher our market share and the higher our profitability, the higher our MSA per unit. And in addition, remember if you just compare an MSA per unit in the fourth quarter of last year, you may recall that the first three quarters of 2008, we were accruing at a higher assumed inflation rate than what we really had. So the impacts of that reversal hit the fourth quarter of 2008.

Judy Hong - Goldman Sachs

So it is sort of a catch-up in terms of your market share position and then just what happened last year where your MSA per unit was actually down last year.

David Taylor

Yes.

Judy Hong - Goldman Sachs

Alright, thank you.

Operator

Your next question comes from the line of Thilo Wrede of Credit Suisse. Please proceed.

Thilo Wrede - Credit Suisse

Good morning Marty and David.

David Taylor

Good morning.

Marty Orlowsky - Good morning

Thilo Wrede - Credit Suisse

Can you give us a little bit more detail why the joint venture with Swedish Match was terminated?

David Taylor

I am sorry, could you just repeat that?

Thilo Wrede - Credit Suisse

Could you give us a little more detail why the joint venture with Swedish Match and Snus was terminated?

David Taylor

But keep in mind that the joint venture solely consisted of our joint effort in the Snus business. We did not see in the test markets any sort of outside force that hit the Triumph Snus product that we were test marketing. We looked at other companies’ entries although some of them have gone national where they have certainly been more aggressive, and after careful analysis of the status of the category really I think it transcended our own experience but our own experience was one and the same as the category as it evolved. We jointly and mutually agreed that Snus will not – that this was not the right time for Snus and there is the lingering question as to whether or not there will be a right time for Snus. But obviously I am not going to take over liberty but clearly in the short run, it would appear to us as well as the Switch Match that it was not necessarily from a joint venture standpoint. So, we mutually agreed to end the relationship. And we as I said as an extension sort of that experience for us in Snus, we decided that we felt it was a greater near term opportunity getting to the moist smokeless market and a more conventional product.

Thilo Wrede - Credit Suisse

And then Marty, giving the comment you just made about the moist smokeless market to be it sounds like it will be an organic market entried, can you imagine at some point in the future to work with Swedish Match again in that area?

Marty Orlowsky

I do not rule out anything Thilo.

Thilo Wrede - Credit Suisse

Okay. Then your question about your comments on the FDA and the pending mental study there, you said that the scientific evidence does not support any conclusions for – makes any difference in terms of the risk. Do you see the risk that the FDA might actually commission its own study until the effects of menthol be it for risk or be it for the impact initiation or any other impact menthol could have?

Marty Orlowsky

Well Thilo, I am going to refer back to my comments, I think in there I said pretty clearly – it is really no faces for further conjecture about what the FDA may or may not do. I think it is slippery slope to be on and it can only lead to potentially misleading conclusions. So I am not going to comment any further other than what I have said. I think it is pretty clear. I do not think -- we could all speculate from now until doom’s day, whenever that is, hopefully not in my lunch time, and they come up with any number of sort of hypothesis and I really do not think it is very productive. We fully understand and appreciate that investors have concerns about the issue, so do we, but we can only make or reach conclusions based on what we think we know, what we believe we know, and our take on what the legislation implies. So, if you take all of that into consideration, that is our position.

Thilo Wrede - Credit Suisse

Okay then one last question on your leverage target and share repurchases, you have obviously exhausted the $750 million authorization, can you give us an idea for timeline, if and when you might add additional leverage and if you will use that for mare share repurchases?

Marty Orlowsky

Thilo, I am not going to give you an idea about timeline, again even when we entered the market last time, we were very clear of trying to give guidance about when we might enter the debt market. The long-term leverage target that we lay out is roughly 1.5 times remains the long-term leverage target. We do not see any reason to get back away from that or change it at this point in time but I cannot tell you when we might take that next step and what the use of those proceeds may be. It could be used for share repurchases or as you know any other good corporate purpose. As soon as we know Thilo, you will know.

Thilo Wrede - Credit Suisse

Alright, thank you Marty and David.

Marty Orlowsky

Okay.

Operator

Your next question comes from the line of Adam Spielman of Citigroup. Please proceed.

Adam Spielman – Citigroup

Hello, I have got a couple of questions. First of all you said you entered the MST market basically opportunistically. Can you explain what the opportunity is now when margins in that industry have just come down so sharply?

David Taylor

Adam, do you know something, we have nothing to lose. We are not going to have lower margins; it is all incremental for us. If we are successful, it adds towards our life. So frankly, we have less risk on the margins side than the existing company. It is going to be profitable for us if we are successful.

Adam Spielman – Citigroup

Fair enough, okay.

David Taylor

Whatever the margins they may be, they may be.

Adam Spielman – Citigroup

You obviously have not thought or have not that conclusion in the past, or had not come to this announcement in the past.

David Taylor

That is correct, we have not. In the past, we decided that our first entry will be in the Snus segment of the business and that is what we did. And now that we have done that, evaluated the proposition as it was, we will move on to moisten up in the more conventional product segments.

Adam Spielman – Citigroup

Thanks, that is very clear, thank you very much. Can you ask you another question turning to cigarettes which is obviously the core, as you have said it has obviously been a highly eventful year with the double Wiami [ph] maybe even triple Wiami if you included Blend 54, but as you take a big step back, do you think the intensity of competition is menthol has actually changed in 2009 versus previous years?

David Taylor

Well let me just correct you. Blend 54 does not qualify as a Wiami. It was a non-Wiami or non-event for (inaudible) supplies that. From the competitive standpoint, we should (inaudible) from one of our competitors and it was just the loud blip of a noise for a brief period of time. I think clearly some of our competitors continue to, in my terms, rather oddly disproportionately focused on menthol as some sort of major, major opportunity. In some instances there are other businesses that seem to suffer as a consequence, which is something that sounds a little illogical to me, but nonetheless, nothing has radically changed. There has been obviously a few other entries between Camel Menthol, Menthol and 54 and whatever else if somebody can conjure us but other than the line extension coming into being heavy promotional support, none of those events or entries have been game changer or in any real sense competitive factors with any consequence.

Adam Spielman – Citigroup

I suppose what I am trying to drive at is do you think that you should have taken the big picture the level of promotions. I mean you just said heavy promotions, do you think that is really different from how it was in previous years or do you think it was just as heavy as in previous years?

David Taylor

Pretty much relative to what it was in previous years.

Adam Spielman – Citigroup

And as I think about 2009, there is a whole, I mean, is there any differences you went through the quarters, I suppose I am trying to say, was fourth quarter any different from third quarter in this respect?

David Taylor

Do you mean in competitive terms?

Adam Spielman – Citigroup

Yes, was it more, less, same compared to--?

David Taylor

Pretty much the same. I do not think we saw anything of any great significance either way.

Adam Spielman – Citigroup

Excellent, thank you very much.

Operator

Your next question comes from the line of David Adelman of Morgan Stanley. Please proceed.

David Adelman - Morgan Stanley

Hi, good morning Marty and David.

Marty Orlowsky

Hi.

David Adelman - Morgan Stanley

Marty, I can understand the hesitancy talking about moist smokeless tobacco and your efforts, but can you give us a little more information, when do you think you will be in the marketplace, I presume you are going to go into the price value segment. Is that correct?

Marty Orlowsky

David, we are not yet going to divulge any other information on any specific level about what we may or may not do with moist, not until we get there. I am sorry, but as you can well understand, some of it could be considered proprietary information at this stage of the meeting.

David Adelman - Morgan Stanley

Any frame at all of what you have considered being successful two, three, four years from now in that category?

Marty Orlowsky

Yes couple of bucks and just bottom line. No, I cannot characterize it today. Obviously, I think the key factor for us or anyone that might be entering or is in it, is share growth is position, I think the major strategic question for us really comes down to what kind of position can we achieve relative to share and then can we sustain some acceptable margin as that would offer us some tangible profit contribution. So it is a matter of relative position and obviously the profit margin that is attendant to that and that would really see the basics of how we look at it. (inaudible) how we look at Snus and it just never materialized. And if you have a look at those upside potentials, we will obviously look at our slide potential once we move through with the moist smokeless profit.

David Adelman - Morgan Stanley

Are you outsourcing or you intend to outsource the manufacturing?

Marty Orlowsky

Yes we do.

David Adelman - Morgan Stanley

Okay. And then secondly Marty on the FDA situation, the consideration of the FDA under the statute has to provide to concerns about economics, and smuggling and black markets and so on, is that a responsibility of both the FDA itself and the Scientific Advisory Board or just the FDA or is that unclear?

Marty Orlowsky

No, I think it is fairly clear it is the FDA’s responsibility itself. But keep in mind, the Scientific Advisory Committee is just that, they are the Scientific Advisory Committee. They are going to review the issue from the standpoint of the science aspect as it relates to (inaudible). It can comment upon the FDA itself to examine that as well. Keep in mind the Scientific Advisory Panel in drugs and other areas have made recommendations and the FDA has not followed those recommendations. So clearly the FDA has the accountability in our mind to exact [ph] this issue as per the law really, the statute does not exist and it’s their accountability.

David Adelman - Morgan Stanley

Okay and then two last financial questions, on cost of goods sold excluding the MSA and related expenses and excluding the federal excise tax, those costs on a run rate basis were higher in the fourth quarter than earlier in the year and I was just curious, is there any one or two things that stand out for driving that dynamic?

Marty Orlowsky

Well they have increased in the fourth quarter from the third quarter, some of those things that you just mentioned such as FDA drive that up but in addition, we see they continue to impact our wrapping cost. Remember, I said that 100% of our production is now lower ignition propensity for standard LIP and that paper, that wrapping paper that we use for LIP is more defective than the non-LIP paper. For instance, in the third quarter, I think we were only two-thirds of the way and in the fourth quarter now we are now 100% of the way, so that is riding costs up some. And again, if you are just trying to calculate margin per unit, you get the mix shift impact again. Again at the end you have got the impact of the increased cost and our LIPO adjustment.

David Taylor

Again the FDA in the fourth quarter ended up fair amounts to the cost of goods.

David Adelman - Morgan Stanley

Okay and then one last thing, with respect to the buy back, announcing a new authorization or starting to execute on that authorization, that is not contingent on a new debt offering. You could do it in the absence of that if you elected to.

David Taylor

If we wanted to spend cash on the balance sheet?

David Adelman - Morgan Stanley

Yes.

David Taylor

Yes, we have done that before.

David Adelman - Morgan Stanley

Okay, sure. Thank you.

David Taylor

Sure.

Operator

Your next question comes from the line of Andrew Kieley - Deutsche Bank Securities. Please proceed.

Andrew Kieley - Deutsche Bank Securities

Good morning everyone.

David Taylor

Good morning.

Andrew Kieley - Deutsche Bank Securities

Hi, Marty or David, vis-a-vis the long-term guidance ranges that you have given in the past, when do you think visibility is high enough to I guess reiterate those, and then secondly, do you agree with the competitors that rates of category volume decline would start to normalize in 2010?

Marty Orlowsky

I would hope that they start to normalize in 2010. I certainly know – I am not going to make any predictions as to whether they will or not. I do think the there was a degree, now whether or not that is going to represent a long-term shift with a degree of moderation as (inaudible) do not overreact to what I am saying here but I think there was a degree of moderation between the third and fourth quarters with fourth and third quarter at the retail level but again, I would not run to the bank with that statement. So, yes, is it possible, yes; the fewer events that occur that will affect pricing and the improvement of the economy, and the longer people have to become somewhat accustomed to the higher pricing structure, that should lead to some degree of stability but by no means am I going to guarantee that.

And as for guidance Andrew, you know our practice in the past is not to give a Street guidance on a short-term basis.

Andrew Kieley - Deutsche Bank Securities

Okay and then secondly going back to the gross margins, I will start from the items you called out in terms of higher material cost and MSA, could you tell us if the cost of promotional units played any role in terms of the lower year-over-year gross margin or was it a non factor because I think you record some of the cost of promotional items in the cost of goods, is that accurate?

David Taylor

Yes we do and it does – it could be the other way. So it does run through cost sales, so if you calculate that by units, it would impact that number.

Marty Orlowsky

Yes. We stand somewhat more in the fourth quarter on past [ph] promotions really in the form of discounting at retail in the fourth quarter of 2009 than we did in the fourth quarter of 2008, in fact more in 2009 than 2008 in the full year. And that is reflected as a cost reduction to sales in our numbers. So, yes, that had some impact on our margins.

Andrew Kieley - Deutsche Bank Securities

Okay and then thirdly, sorry just to go back to FDA again, I know you cannot speculate about things but is there any indication from them that if you have been in communication with them and have they given you any clarity in terms of what steps the science review process would take and what kind of materials that committee would look at or not look at and things like that?

David Taylor

We have not heard anything (inaudible) that we do. Everything is posted on their Web site, so it is publicly disclosed. We have not heard anything we believe based on what they have said publicly that they are going to form a committee over the next, should be in the next week, and supposedly they are scheduled to have the first meeting of the Scientific Advisory Committee sometime in March. However we have heard nothing of any tangible value that would indicate what is going on in here. So it has been pretty soft.

Andrew Kieley - Deutsche Bank Securities

The March meeting schedule, was that based on the old – some said that they would form the committee by the end of December?

David Taylor

No, I have no idea what they committee does, it is just that it is part of the public record at some point it was listed that they were intending to hold the first committee meeting in March. Whether that was the first reiteration, it really does not make any difference. I think frankly what we have seen is what I call an evolution of development in terms of the whole FDA regulatory capability of regulating cigarettes itself. I think it is a huge issue, it was a huge undertaking and it is just taking on time. That is just the practical.

Andrew Kieley - Deutsche Bank Securities

Right, okay, thanks.

Operator

(Operator instructions) Your next question comes from the line of Chris Growe of Stifel Nicolaus & Company. Please proceed.

Chris Growe - Stifel Nicolaus & Company

Hi, good morning.

David Taylor

Good morning.

Chris Growe - Stifel Nicolaus & Company

So just a couple of quick follow-ups for you, just to be clear Dave, was there a LIFO charge in the fourth quarter then that would have come through?

David Taylor

Yes it was.

Chris Growe - Stifel Nicolaus & Company

Could you say how much that was?

David Taylor

We have not talked about how much that was but it does impact your cost of sales.

Chris Growe - Stifel Nicolaus & Company

I think you said it was around $0.025 [ph] in EPS terms in 3Q, would it have been less than that? Could you say that?

David Taylor:

Ask your question again Chris.

Chris Growe - Stifel Nicolaus & Company

In the third quarter, I think you had said it was around $0.025 into earnings if I have the number correct and I am just wondering if it was more or less than that?

David Taylor

In terms of cents per share, I do not have that right in front of me but I can tell you the LIFO charge in the fourth quarter was slightly high than it was in the third quarter.

Chris Growe - Stifel Nicolaus & Company

Okay that helps Dave, thank you. Okay and then just to be clear on your – you talked about sales promotion costs picking up, was that up in dollars or in per pack spending?

Marty Orlowsky

It is up in both.

Chris Growe - Stifel Nicolaus & Company

In both, okay. And then, I just want to ask a question regarding your entry into MST, I think you have addressed that to a large degree, I am just trying to get a sense of what that could cost and I guess it is a matter of time whether it happens this year or late in the year, I understand we cannot not predict that but what is (inaudible) are willing to commit to that effort. I also would ask along with that, all through the experience of Marlboro, which was not a great experience of entering that category, was that instructive in any way or are you going to do something different or would you study more going into this process?

Marty Orlowsky

Well first of all, we are not going to register a factory and spend hundreds and millions of dollars to produce the product. So we have a very efficient arrangement where contract manufacturing of the product – now what is our expectation of course, I will say this, we will be entering into a test market universe initially. So we are not about to roll out nationally with the product and incur rather substantial money associated with either cost of goods or markets and sales. So, we will have and I am not going to discuss what our projected sort of cost factors may or may not be for this thing.

We will manage the process, we do not envision it to have a certainly not initially any sort of substantial, material impact on our financials. We will manage it as we manage all other things. I think we were in the Snus tech market for a couple of years and it did not bankrupt us. So there should be no fear that we are going to take our eye off the ball. Our core strategy remains that it is, it is centered on cigarettes. We are entering into the moist smokeless market. It is simply what we looked at as a said earlier, an opportunistic situation for us. We think we can generate some business there and certainly we hope it would be incremental to what we have today. But we are not going to become Lorillard smokers tobacco company.

Chris Growe - Stifel Nicolaus & Company

Okay thank you, I am searching a letter here for any bankrupting that is encouraging, just one final question, just to be clear, your inventory levels I think you said was not really a factor year over year, is that correct?

Marty Orlowsky

There are levels of inventory at wholesale are not really a factor when comparing our fourth quarter volumes 2008 versus 2009.

Chris Growe - Stifel Nicolaus & Company

Okay, that is great, thanks a lot.

Marty Orlowsky

Thank you.

Operator

And your next question from the line of Adam Spielman of Citigroup. Please proceed.

Adam Spielman – Citigroup

Actually your last question or last answer answered the question I would have asked. So thank you.

Marty Orlowsky

Alright.

Operator

Your next question comes from the line of Steve Farell [ph] of Carmen Asset Management [ph]. Please proceed.

Steve Farell - Carmen Asset Management

Good morning.

Marty Orlowsky

Good morning Steve.

Steve Farell - Carmen Asset Management

What was the funding position of your pension plan was at year-end, and if you put any money in it last year and if you plan to put any in this year?

David Taylor

Steve, the first part of your question got cut off, I am going to ask you to repeat the whole thing.

Steve Farell - Carmen Asset Management

I was just wondering what the funding status of your pension plan was at year-end and what if any money you put in at last year, and also what your plans are for this year.

David Taylor

At year-end 12/31/2009 the RFA [ph] plan was fully funded and the Salary [ph] plan was roughly 81% funded. We made contributions to the plan – Steve, if I quoted a number I would be wrong, I cannot tell you.

Steve Farell - Carmen Asset Management

Is it a material number what you have put in there or not?

David Taylor

Yes it is, I think we put $15 million into the salary plan and I cannot remember what the ROI.

Steve Farell - Carmen Asset Management

Okay, thank you.

David Taylor

You are welcome.

Operator

And there are no further questions. At this time, I would like to turn the call back over to Mr. David Taylor for closing remarks.

David Taylor

Thanks everybody for joining us this morning and we look forward to talking to you soon. Bye.

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Source: Lorillard, Inc. Q4 2009 Earnings Call Transcript
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