Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Lorillard (NYSE:LO)

Q3 2010 Earnings Call

October 25, 2010 10:00 am ET

Executives

David Taylor - Chief Financial Officer, Executive Vice President of Finance & Planning and Director

Murray Kessler - Chief Executive Officer, President and Director

Robert Bannon - Director of Investor Relations

Analysts

Judy Hong - Goldman Sachs Group Inc.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Ann Gurkin - Davenport & Company, LLC

Christine Farkas - BofA Merrill Lynch

David Adelman - Morgan Stanley

Andrew Kieley - Deutsche Bank AG

Nik Modi - UBS Investment Bank

Operator

Good day, ladies and gentlemen, and welcome to the Lorillard, Inc. Third Quarter 2010 Earnings Conference Call. My name is Sarah, and I will be your operator for today's call. [Operator Instructions] At this time, I would like to turn the conference over to your host for today's call, Mr. Bob Bannon. You may begin, sir.

Robert Bannon

Thank you, Sarah, and good morning, everyone. I'm Bob Bannon, Lorillard's Director of Investor Relations, and joining me on today's call is Murray Kessler, Lorillard President and Chief Executive Officer; and David Taylor, its Chief Financial Officer. By now you should have received a copy of our third quarter 2010 earnings release. It can be found on the company's website, lorillard.com, under News Releases.

But before we begin, I'd like to remind you that 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'd now like to turn the call over to Murray Kessler.

Murray Kessler

Thank you, Bob, and good morning, everyone. What a pleasure it is to be back at the helm of a great company like Lorillard. Most of you know me extremely well from my many years at UST. For those of you don't know me, I look forward to getting to know you as quickly as possible. But for now, know this, as has always been the case in the past, you can expect my management team and me to be accessible, transparent and relentlessly focused on building shareholder value.

Some initial observations after my first six weeks in the job. I'd always admired Lorillard as an outsider, and as a result, had high expectations walking in the door. Those expectations have been dramatically exceeded, as I have gotten to know the business and the talented people that work at the company. It's a tribute to my predecessor, Marty Orlowsky. He has much to be proud of.

Having the unique perspective of having worked at several top consumer packaged goods companies in general and tobacco specifically, I can tell you that there is something very different about Lorillard that, in my opinion, makes it a standout performer. First and foremost, the underlying volume trend on our lead brand, Newport, is organic and long term. There is no chase for volume, scrambling to launch new products or quarter-end promotions. Newport sells today almost the same number of sticks it did 10 years ago, while during the same time, the industry has declined 27%. And as you saw in our release, Newport volume this year is growing, up 2.6% through nine months.

It is my opinion that this growth stems from a superior product, consistent message and a carefully crafted regional promotional strategy that ensures Newport remains priced competitively. With a backdrop of a solid organic growth trend and the absence of quarterly fire drills, the organization is focused on doing what's right for the long term. I would say this perspective is also the result of the company's policy not to provide guidance above the original stated goals to deliver double-digit shareholder returns on a consistent and sustainable basis.

And there are, of course, other drivers of high performance, like tight cost control, a commitment to returning cash to shareholders and, as I previously stated, a talented and committed workforce. For perspective, Lorillard has returned $3.2 billion to shareholders in the form of share repurchases and dividends since separating from Loews in June 2008. All of this has resulted in high quality EPS growth and a track record of exceeding other tobacco companies on almost every measure from net sales growth to operating profit per stick.

EPS has grown at a compound annual growth rate of 7 1/2% over the last three years, which not only exceeds the combined growth rate of the other top tobacco companies in the U.S. and abroad, but it also exceeds many of the top-tier consumer packaged goods companies in the U.S. Some have argued this strong performance has not been reflected in the company's multiple as Lorillard continues to trade at a discount right along with the other U.S. tobacco companies. Notwithstanding the uncertainty related to the FDA regulatory review of menthol, Lorillard, in our opinion, is undervalued.

While there is clearly no need for course direction on the business at Lorillard, I'm also encouraged to say for all the great things I see in the company, I do think there are further opportunities for growth. It's premature to discuss those at this point, but just as you would expect for a new CEO joining the company, the management team and our board are currently engaged in a strategic review process. This review will take place over the next several months with the objective to ensure that the high performance you have come to expect from us in the past is sustained over the long term.

I will share the results of that process early next year, which in any case, will build upon our already strong current strategy. An example would be Smokeless. The company had previously indicated it would be entering the smokeless tobacco category later this year. That launch now will depend on the results from this strategic planning process.

Let me emphasize two things in regard to strategy. First -- and I'm repeating myself here. Lorillard is not in need of a course correction. Any evolution of the current strategy will start with the basic premise of focusing on the core. And second, good strategies evolve when the external environment changes, and our external environment is clearly in a state of change.

I'll now turn to a brief overview of the third quarter and nine-month results. Our Chief Financial Officer, David Taylor, will provide a more in-depth financial overview in just a few moments.

Starting with volume. Total Lorillard volume shipped to its domestic customers increased 5.8% for the quarter and 5.2% for the nine months. This strong quarterly performance was driven by Newport, which increased 2.9%, and our discount brand, Maverick, which increased 30.9% for the quarter. There was some deloading of trade inventory in the third quarter of last year, making the comparison somewhat easier.

When looking at our retail data, Lorillard continued to gain share during the quarter, up one full share point from last year's third quarter. On a nine-month basis, Lorillard’s share reached a record 12.8%, up 1.1 points versus a year ago, and Newport share was 10.9%, up 60 basis points.

The quarter did not include any volume associated with the introduction of Newport Non-Menthol. That product, which has received positive feedback from our customers, began shipping the last week in October.

This volume growth combined with price increases resulted in a robust 10.4% increase in net sales for the quarter. EPS was up 26% versus a year ago for the quarter, tracing the volume growth and price increases leading to a double-digit increase in operating profit, which was further enhanced by accretion associated with our share repurchase program. While we don't expect that level of growth every quarter, it is a reflection of the solid fundamentals I previously discussed.

Finally, a word on the TPSAC [Tobacco Products Scientific Advisory Committee] review and upcoming recommendations regarding menthol. I've read a number of your reviews and for the most part, I think many of you have it right. That is, first and foremost, Lorillard believes that based on the overwhelming body of scientific evidence, menthol cigarettes are not more harmful than non-menthol cigarettes. A cigarette is a cigarette. All cigarettes are dangerous. A recommendation to ban menthol cannot be justified based on sound science.

Second, Lorillard believes that a ban of menthol would not have the intended consequence of improving public health. In contrast, the unintended consequences of a ban, including the almost certain and huge contraband market in menthol products, could more likely result in an adverse impact on public health. Further, there is little research regarding the intended and unintended consequences of a menthol ban, and thus far TPSAC has neither studied the issue nor, to our knowledge, commissioned such research.

All advisory committees to the FDA have been charged by Commissioner Hamburg to follow the science. Time will tell if the TPSAC committee will indeed be driven by science or by personal agendas and politics. At times, it's been hard to tell. Encouragingly, the most recent TPSAC meeting on October 7 at least acknowledged that more research may be needed.

Importantly, I'd like to take a minute to make sure our investors are clear on the process. As we understand it, the TPSAC is charged to provide a nonbinding recommendation to the FDA by March 2011. There was some discussion of a delay at the last TPSAC meeting, but there is no indication at this point that an extension will be sought by the committee or granted, if sought.

Once TPSAC’s recommendation is made, the FDA is not obligated to implement the recommendation. However, we do believe FDA will conduct its own review of menthol with consideration given to the TPSAC recommendation and other relevant information, including information provided by Lorillard and others in the industry.

After its evaluation, the FDA may publish a proposed rule if it feels such action is warranted. The FDA is under no time constraint to publish a proposed rule and can choose not to do so at all, particularly if it feels that sound science does not support any action.

If the FDA decides to take action by issuing a new tobacco standard, the FDA must follow prescribed rule-making procedures. This includes publishing a proposed rule and allowing at least 60 days for public comments. Any member of the public, including the tobacco industry, can submit comments to the FDA during this period. At that point, the FDA can make modifications to its proposed rule or withdraw the proposal entirely. If the FDA publishes a final rule, it is unlikely that it would take effect before one year after its publication. The FDA has the discretion to take longer on any of these steps if it feels it is necessary. All the while, if Lorillard believes sound science did not guide the process in the decision, then the company would vigorously defend its freedom to operate through the administrative and legal system. We certainly hope it won't come to that, and for now, have no reason to believe that it will.

I want to reinforce that while we acknowledge that there will be some headlines along the way in this process that could create some volatility in our stock, down or up, we do not believe that menthol will ultimately be banned. The science simply doesn't justify it.

So once again, it's great to be back in the saddle. The company is having an outstanding year and as always, we will stay focused on growing our business profitably while at the same time, navigating the many external issues that face our industry.

And with that, I'll turn the call over to David Taylor, our Chief Financial Officer. David?

David Taylor

Thanks Murray, and good morning, everyone. After I briefly go through the financial results, we'll open the line for questions.

Net sales for the third quarter of 2010 increased 10.4% to $1.567 billion compared to the third quarter of 2009, driven by the increase in units shipped, higher net average selling prices and lower sales promotion costs, which are accounted for as a reduction in sales.

The 5.8% increase in units shipped when compared to last year's third quarter is driven by two factors: First and foremost, the fundamental strength of the Newport franchise and the continued growth of Maverick, but also by some changes in wholesale inventory patterns in both this year's third quarter and last year's third quarter.

Total wholesale inventories increased modestly during the quarter this year, while they declined during the third quarter last year. This impacts the comparison of our shipment volume between quarters, and we estimate that effect to be about two percentage points of the 5.8% increase. Continuing the trend we saw during the first six months of 2010, the increase in volume in the third quarter combined with the higher average net selling prices drives the increasing net sales before excise taxes of over 12 1/2% for the third quarter and over 10% for the year-to-date period.

Gross profit in the third quarter of 2010 increased by $78 million to $566 million when compared to the third quarter of last year. Cost of goods sold in the third quarter of 2010 reflects increases for certain raw material costs, such as tobacco and wrapping costs and FDA fees when we compare it to last year's third quarter, similar to what we have experienced all year.

Amounts due under the State Settlement Agreement increased $30 million compared to last year's third quarter as a result in the inflation factors in those agreements, combined with the relevant volume and market share adjustments.

Selling, general and administrative costs increased $5 million from last year's third quarter, mainly from legal fees and expenses associated with the increased activity surrounding the Engle progeny cases.

Third quarter operating income increased 18.6% to $465 million or 29.7% of sales from $392 million or 27.6% of sales in last year's third quarter. Operating income per unit shipped for the year-to-date 2010 period has increased approximately 7 1/2% compared with 2009.

Our effective income tax rate for the third quarter of 2010 was 37.3% as compared to 37.7% in last year's third quarter. We currently estimate that the effective tax rate for the year will approximate this 37.3%.

Fully diluted earnings per share for the third quarter increased 25.7% and reflects the strong performance we've already discussed, but also the effect of a lower average share count this year. The lower share count increased reported EPS of $0.14 per share or about 10 percentage points of the 25.7% increase.

The modest increase in wholesale inventories during the third quarter that I referred to a moment ago is temporary, just as they always are. And we don't know when that might turn around. But when it does, it may have some impact on our quarterly volume comparisons.

So for the quarter, we saw unit volumes increase, market share increase, net sales increase, gross margins increase, operating margins increase, operating income per unit increase and along with fewer shares outstanding during the quarter, all of which combined for the dramatic increase in EPS. Obviously, a very impressive follow up to the strong first half of 2010.

We announced a 12 1/2% increase in our dividend during the third quarter, and we announced a share repurchase authorization of $1 billion. So we are continuing to deliver value to shareholders on many levels. Through September 30, we had repurchased approximately 1.1 million shares at an average price of $81.10 per share.

I won't comment on the future pace of share repurchases during this call, nor will I be able to comment about the potential timing of any future capital structure activities, such as further debt issuances and so forth. We have not changed our longer-term leverage target of approximately 1 1/2x EBITDA nor our long-term target of paying dividends approximately 70% to 75% of earnings.

Once again, we're very pleased with the company's performance this quarter on virtually every measure. And with that, we'd like to open the line for questions. Sarah?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Judy Hong with Goldman Sachs.

Judy Hong - Goldman Sachs Group Inc.

Murray, I know you're going through the strategic review of Lorillard over the next several months. But just as you think about having, one, a Smokeless Tobacco business and being involved in the sale of UST to Altria, and looking at both Reynolds and Altria being more of a total tobacco company, do you think that Lorillard can actually succeed as a sort of more focused cigarette company rather than being more of a total tobacco company going forward?

Murray Kessler

I think it's a great question. I mean, if I can repeat the question and the way I understand it is, do we need to be a total tobacco or is there a pure-play cigarette strategy option? And I think the answer is yes. We don't concede growth. If you look at -- and I'm not saying that's the answer today. We'll evaluate total tobacco, and we'll look at which option creates the most value. But clearly, given sort of the focus of the company on a relative size compared to the larger companies in the category and the performance and track record of the company, there's still a lot of value to be created in this company growing our cigarette volume.

Judy Hong - Goldman Sachs Group Inc.

And then you've talked about sort of potential opportunities maybe in growing Newport or some of your core cigarette brands. Can you elaborate a little bit in terms of what the opportunities may be as you think about, Newport's obviously a great brand, but just continuing that growth trajectory going forward?

Murray Kessler

Well look, I made a point in the call of saying that during a time when the industry has declined 27%, Newport’s basically selling the same amount of sticks it was 10 years ago and has also benefited from what's happened in the category relative to pricing. So if you start from a basic premise that we’re 10 or 12 share and there's hundreds of billions of sticks out there that are being sold in segments where we haven't penetrated, then I think you would have to look at what that opportunity could be. And is that continuing to grow in menthol? I mean for even our size in menthol, we're only 36% of the menthol market. There's a whole lot of volume opportunity out there within menthol. You'd seen the company is in the process of launching a non-menthol cigarette. So we’ll go through the exercise and the discipline to make sure that anything we do creates value. But I see a lot of opportunity for the company. I'm pretty excited about it, Judy.

Judy Hong - Goldman Sachs Group Inc.

Finally, in terms of the share buyback, if I look at over the last three or four quarters, the pace of buyback actually has been slowing down. You've announced the $1 billion buyback program, but it just feels like the last few quarters, it's been coming in at a slower pace. So I'm just wondering, is there a reason why the pace has been slowing in terms of the share buyback program?

David Taylor

Judy, there's no underlying reason as to why the pace might be slowing from the first program that we executed. And if you're thinking about the one that's underway now, that was authorized in late August. We entered the market a couple of weeks after that. So it really wasn't active for the entire quarter. And really, I can't give you much guidance about how fast or slow we might buy shares going forward. I can't do that.

Operator

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

David Adelman - Morgan Stanley

First of all, whether it's this quarter Murray, the last five years, the last 10 years, Lorillard's grown its operating income about twice the rate of its peers. And I'm curious in a general broad sense, absent something hugely disruptive with respect to menthol regulation, do you see any reason why that wouldn't be sustainable or feasible, that level of relative outperformance for the foreseeable future?

Murray Kessler

No, I mean, look, the reason it does is it’s, pretty simply, a very tight cost control. But above and beyond that, with a stronger volume base and pricing, you get that expansion. So I start with the premise that I believe the volume trend is long term and organic. And it's truly remarkable, David. There are not sort of this chasing and level of fire drills that exist at most companies in this company. This is a real long-term trend. And those are the benefits you get alongside of it. And frankly, when I mentioned that I see some strategic opportunities, and there are opportunities that I think we can even be a little stronger, they're not sizable investments to change, at least the way I see it today, the operating structure and the cost structure of this company.

David Adelman - Morgan Stanley

And as it relates to those general opportunities, Murray, how do you think about with a brand like Newport, the particular benefits, but also the risks if you were to start line extending that brand in terms of the consumer familiarity in particular with principally a single SKU?

Murray Kessler

Well, I think that's what you have to study, right? I mean, there are lots of portions of geography where billions and billions of cigarettes are sold where Newport is a much, much smaller brand. So I mean, you have to craft your way through that. But you probably have the opportunity to do things geographically where it would have very little impact on the existing franchise. And I’ve said that we're going national right now with Newport Non-Menthol. But those are all the things we need to work through. Look, job one is not to mess up Newport, period.

David Adelman - Morgan Stanley

And as it relates to Newport Non-Menthol, can you speak to your sort of preliminary aspirations or objectives in terms of both distribution relative to the conventional menthol Newport and also your sort of aspirations? You'd consider it a success a year from now if it has what share?

Murray Kessler

I can't answer the what-share question. Here's how I would evaluate it because this is a great opportunity for learning for me. The product was launched before I -- conceived and launched before I got here. But a success a year from now regardless of the share is that, once it has been established and once trial has been gotten that we saw that it was incremental to the company and there were good repeat purchase levels and a base to build on. Tobacco launches take very long in my opinion. My experience at UST when I launched is, it's not like a traditional consumer packaged goods where you're trying to get out there and see if you have a success in six months. So the key is, will there be a repeatable base there that we can build from going forward and make money for our shareholders?

David Adelman - Morgan Stanley

And then lastly, Murray, from the perspective of someone that knows an awful lot about the U.S. moist smokeless tobacco category, what's your sort of coming in general -- not about the relative attraction of pursuing moist smokeless tobacco versus any other potential opportunity, but just in a sort of an objective sense, do you think there is a real opportunity conceptually for a new entrant in the U.S. moist smokeless market?

Murray Kessler

Premature for me to talk about it, but you know I'm bullish on the smokeless market in the U.S. I believe those trends are real. And hopefully, the FDA will get back to the business of what the regulation was put into place for. And one of those was seeing and evaluating relative risk and opportunities to improve public health, not just by regulation and by controls being put into place, but by aligning the interests of manufacturers with those of the public health community. It's certainly an attractive segment. You know I believe and I said this for years leading it, that it's difficult to organically enter into that category. But it can be done, and it's been shown. But there are different ways. The ultimate one for me is, is that a way for us to create value relative to a pure cigarette play? And we'll go through the process, and we'll share that with you next year.

Operator

Your next question comes from the line of Nik Modi with UBS.

Nik Modi - UBS Investment Bank

Murray, when I spent time in the trade, it's clear that Lorillard is, I would say, underspaced relative to some of the other bigger brands given its turns and its profitability. So just curious, just coming in from the outside, your thoughts on that as you spent a couple of weeks now at the company? And then the second question is, with Newport Non-Menthol coming out and the buydown being pretty steep, I'm just trying to figure out, how should we be thinking about how the net pricing will look in the fourth quarter? Will it be suppressed because of all the pipeline with the buydown? Or can you just help me think about that a little bit better?

Murray Kessler

I mean, I'll turn it over to David in a second on the net pricing. But as you would expect on a new product launch, we're going to invest in that to get trial, and that's going to have some effect on average pricing. I mean, there's no way that it won't. But at this level of discounting as I've gone out into the marketplace to get trial, is what we have learned by studying the industry and what it takes to launch a successful new product in the absence of sort of the old traditional tool of television, advertising, et cetera. So this is not something remarkably unique by Lorillard. I think you'll find that most of the new product launches have a similar discount or average pack price, or introductory pack price, I should say. I have worked retail. I went out and I am not witnessing what you're saying, Nik, relative to shelf space. I went out there. I haven't gone to a lot of markets yet, but I’ve been to a few and especially depending on where we're stronger, where we're not strong, Newport has a great presence. I don't see levels of out-of-stocks. Our contracts, like everybody else's, sort of dictate that we get our share of the market or we request that, and for the most part I believe that, that's achieved. I think we also benefit from the fact that unlike our competitors, we have a very narrow product line. So I mean, I think you want to make sure the product is visible and that you don't run out of stock and I don't see any challenge to that.

Nik Modi - UBS Investment Bank

And so, just from a pure velocity/true-cost, true-profit basis at retail, you don't think that Lorillard is, at least, under indexed to where it should be?

Murray Kessler

Well it's done on market share, right? I mean, that's the way the industry is done. We're not going to change that. We're the number three player, there's a lot of money that's given out there by the number one and number two manufacturer. I think that's a way we increase share over time is the way we've been increasing share space over time and that's to increase our market share. And every retailer I met with, Max was very firm that as our market share increases, we earn our way to more space. So it starts with good performance. I want David to come back and address your pricing question.

David Taylor

I think, Murray, you said it very well. And that is, as we introduce Newport Non-Menthol with the introductory pricing to generate trial, that's going to be a lower average net selling price than our Newport Menthol products. So if you just do the arithmetic, it may drive down net pricing. But importantly here, the pricing that we put on Newport Non-Menthol doesn't impact Newport Menthol because we don't believe that we're going to generate trial out of menthol smokers. We think that this will not cannibalize our existing franchise. And so it's going to be incremental as Murray said. And we don't think it's going to impact net profitability. In terms of the arithmetic on net pricing, we don't really care about that.

Operator

Your next question comes from the line of Christine Farkas with Bank of America.

Christine Farkas - BofA Merrill Lynch

Murray, you talked about looking at smokeless, reviewing smokeless and delaying the official entry, I guess if you would. I'm just curious when you look at Non-Menthol Newport, why that wasn't reviewed or put off? Or how that fits into your strategy in the near term?

Murray Kessler

It was launched before I got here. So it's out in the marketplace, but I think it's a less controversial launch. We'll see whether it's successful or not, is a different question, but it's a major strategic shift to make the decision to go into total tobacco. And that's one I want to think through quite carefully. Newport Non-Menthol, if you could do it well, it's incremental, it’s in our core; it's an easier one to see your way cleared to building upon the company's already great success without huge distraction. Smokeless is a whole another category. If not done right, it could be a distraction.

Christine Farkas - BofA Merrill Lynch

So I guess your view then really, there's little risk with respect to extending the brand into Non-Menthol with your comments about not messing up Newport. This is like you said, a small test or relatively little risk.

Murray Kessler

I think it's a very incremental. Any new product launch you have to -- and whether it succeeds or fails has an impact on the brand. And we're going to have to make sure we're committed to this launch and do it right. I think that if you look at it versus the prior history, the management team here has convinced me that they've learned a lot from the past, not the least of which is that it is a superior product that's sent [ph] (40:16) to our last drive. The brand comes as it's launched from a much greater position of strength. Our share is almost 50% higher than it was at the time of the last launch. And while it has some negatives that you pointed out relative to sort of an introductory price, it's that support level that we didn't have the last time that we also think contributed to the lack of trial, and it's consistent with what's in the industry. So I take these very seriously, but having said that, it's a big opportunity for the company. It's 2/3 of the marketplace.

Christine Farkas - BofA Merrill Lynch

Diving into your volume performance, I think it was pretty clear with respect to the inventory lift. I just want to get some feedback on New York. We saw taxes and prices go up. I think it was earlier in the quarter so I wonder if inventory build was ahead of that or had anything to do with that? Or if you can talk about the performance broadly speaking the impact from tax like we saw in New York.

Murray Kessler

I don't give specific numbers, but New York was soft relative to the rest of the country. It declined when the rest of the country grew, and we felt the impact of the tax in the quarter.

Christine Farkas - BofA Merrill Lynch

David, could you let us know what the D&A was for the quarter?

David Taylor

Yes, I will during this call. Let me just look at it and I'll pipe up in a moment.

Christine Farkas - BofA Merrill Lynch

I know it's a small brand for you, but we've seen Old Gold now strong for the last couple of quarters. I'm wondering if that's driven by some value brands or private labels shutting down. Or what's driving the growth in that small brand now?

Murray Kessler

It's a reflection of us putting some support behind Old Gold that it’s responded extremely well to.

Christine Farkas - BofA Merrill Lynch

Just the D&A answer then?

David Taylor

Correct. Just don't hang up. I'll pipe up in a moment.

Christine Farkas - BofA Merrill Lynch

Or we can certainly get that offline, no problem.

Operator

Your next question comes from the line of Andrew Kieley with Deutsche Bank.

Andrew Kieley - Deutsche Bank AG

So I wanted to just quickly go back to Newport Non-Menthol. Since that launched before you were there and as we try to gauge how aggressive the objectives there are, do you view that as a very sizable market share opportunity? Or should we also view that as sort of a contingency product if there is, in fact, some kind of regulatory action on menthol a few, a year out from now, say?

Murray Kessler

I guess we'll get some learning from a contingency standpoint. But that's not -- if we were in a real mode of having to deal with much a stricter menthol environment, this isn't how I'd do it. I'm not saying there won't be some learning, but I think you should view this as the company sees that there's 70% of the category or 65% of the category that we currently don't compete in, and that we see a very strong Newport brand, and we're trying to penetrate that market and establish a foothold with our great brand. And I think you've seen examples of that in all throughout the tobacco industry in reverse.

Andrew Kieley - Deutsche Bank AG

Is there any early signs of the reception that's getting with the distributors and retailers? I know it's very early in the process, but any measure, maybe percentage of the Newport outlets that you're getting placements with for that product?

Murray Kessler

Yes, and I want to temper this comment; it's been received extremely well. We are getting distribution easily, and there is a lot of enthusiasm. It was quite the buzz at the NAC show [ph] (44:08) from both wholesalers and from retailers, but we have a fabulous sales force and I would expect nothing less, but we will get very good distribution and placement right out of the shoe.

Andrew Kieley - Deutsche Bank AG

And again I know it's early in the strategic review, but are you happy with Maverick's role in the portfolio? And I guess how much of a priority is it for you to grow that brand versus the opportunity to monetize it to a greater degree at some point?

Murray Kessler

Well, I think the answer is both. Am I happy with an incremental piece of business that's growing and absorbing overheads and becoming more profitable? Absolutely. And I think I had my own personal experience as any other industry that if you can do that profitably and incrementally grow it, it's to your company's advantage. Maverick's a strong brand, but we also don't mistake the fact that Newport is the one that generates and pays the bills. That's our top priority and we make sure we don't take our eye off that ball. I wouldn't expect Murray Kessler to do anything to back off of Maverick. It's not going to happen.

Andrew Kieley - Deutsche Bank AG

And then just finally, on the TPSAC issue, I just wanted to understand as you went through the process and decided to take the CEO job, how did you gain comfort with the risk of that process? And do you think the company's done an effective job handling the process so far? Where do you think there might be opportunity to make changes in the approach in working with the committee?

Murray Kessler

Well, I think the company has very much done an effective job, and I think we can even do more. Remember that sort of the key industry representative is Dr. Heck who works for this company. By all standards, I believe everyone recognizes him as the leading expert in the world on menthol. So that's a starting point. We're involved. Dr. True has testified at, I think, at every or almost every TPSAC meeting and continues to be engaged and we will continue to engage at a higher level. But the company has been active. As it relates to me, I think it's a great question. And as I went through an exercise of looking to join this company, I had to go through the same exercise an investor would go through. And I read through the epidemiology, I read through sort of the logic relative to the intended and unintended consequences. And no matter how I cut it, if this FDA is to go through a true scientific review, there is no difference on causation. There is not a case to be made for banning menthol. No matter how you cut this thing, there is not a case to be made for it. Now some of the TPSAC -- I looked at it and said, "Boy, this TPSAC group has got some members of the committee that at the very least are conflicted.” And how do I feel about whether they'll truly follow science? We'll see. I'm optimistic, I'm hopeful. But I really believe that once it get into the hands of the FDA though, they'll do the right thing and follow the science.

Operator

Your next question comes from the line of Chris Growe with Stifel, Nicolaus.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

I have two questions for you on Newport Red. The first one I want to ask you just, there are parts of the country where menthol is not a large component of the sales or really present at all. Are there expenses or costs for you to try and get into those markets, be it people or just expenses to launch the product there? And my other question related to Red was, what can you do to minimize any kind of shelf space allocation or basically take it away from current Newport Menthol? I mean the retailers are going to make an incremental space for you.

Murray Kessler

That's not the way the cigarette space works, in general. The way the cigarette category is allocated, you have 12%, 13% of the space that roughly goes to Newport. It depends on sort of where you are in the country. And if you look at us with our narrow product line, you've many, many, many facings of Newport more than you might need to stay in sight. It's not a difficult challenge for us to be able to slot this item in within our space. If you compare that to the number of SKUs that the number one and number two players have trying to get into their space, and they constantly bring out new products, you'll see we’ll fare quite well. As it relates to expense, we're not adding people in different parts of the country and it would be my greatest joy that it sells so well in different parts of the country that I do have to add people in those parts of the country. But there will be some disproportional investment in markets where it's weak, but we'll see. We'll learn a lot from this launch and we'll learn it early on, how it performs where Newport's strong versus where Newport's not strong, and we'll measure all of those.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Just curious within menthol, if you've seen price gaps narrow of late. I mean, just in relation to a lot of competitive activity. Has that changed at all for you the last quarter or so, quarter or two?

Murray Kessler

I don't think so. I think if anything, from my observation, you saw it in our earnings release, if we don't get it, we're not very specific with it. But we talk about consumer promotion spending being reduced in the third quarter this year. And I think that was talked about it by others as well. So we don't see price gaps as a way to grow our business. We see price gaps keeping us competitive. We tend to be the most expensive products on the market, but again, we view the product and the brand and long-term trend and that, that promotion just makes sure we don't get out of line.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

This may be perhaps a question for David. In the fourth quarter, are there any inventory variances perhaps levels as you enter the quarter or year-over-year comparison factors for your volume in the upcoming fourth quarter?

David Taylor

Well, we don't know how the fourth quarter's going to finish, but I did say that we saw a little bit of a build in wholesale inventory in the third quarter. And so therefore, if and when that build turns back around, that might be a drag in fourth quarter, if it happens in fourth quarter.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

So that was not related to the prior year That was an incremental build. Is that right?

David Taylor

Yes, that's correct. The two dynamics, what happened in the third quarter last year and what happened in the third quarter this year combined to impact that comparison roughly 2%. While I've got the floor here, Christine, depreciation, amortization in our business really was pretty low. It's was like $8,500,000 in the third quarter.

Operator

Your next question comes from the line of Ann Gurkin with Davenport.

Ann Gurkin - Davenport & Company, LLC

You made the comment that you're going to review the business and maybe share some of your thoughts. I was wondering the timeline of that? Will we hear some of those strategies, thoughts before the final TPSAC ruling? Or do you think you might wait until after that timeline? Can you share that?

Murray Kessler

I'm being more driven by the process itself. So it'll take a few months to go to through the process with the board as you'd expect. So sometime early next year, first quarter next year, I would say. And I'll wait for whatever presents itself as the right opportunity. I'm not sure, sitting here right now, whether that will be in a conference or at our own Investor Day. We'll figure that out. I just want to re-emphasize, I don't want to set expectations too far. The end of this strategy process might be that the best thing for this company to do is do exactly what it's doing, where it might be some of these expanded opportunities and it may be building out some of what is already strengthened, but strengthening even further some of our processing capabilities. But as always, you can expect me to be very transparent to show where I think the future lies.

Operator

If there are no further questions, I would like to turn the call back over to Mr. Kessler for any concluding remarks.

Murray Kessler

Well once again, I'm delighted to be back in the saddle here at Lorillard. Walking in the door has, by far, exceeded my expectations and that is driven by what I believe is a real and long-term organic volume growth trend. We believe that Lorillard, because of that, remains and is a compelling investment. And we thank you for your interest in the company.

Operator

This concludes the Lorillard, Inc. Third Quarter 2010 Earnings Conference Call. For a replay of this call, please Dial 1 (800) 642-1687 and enter the conference ID 15224371. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Lorillard CEO Discusses Q3 2010 Results - Earnings Call Transcript
This Transcript
All Transcripts