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Q3 2007 Earning Call

October 25, 2007 9:00 am ET


Mark Rozelle – Vice President, Investor Relations

Daniel Butler – President, U.S. Smokeless Tobacco Subsidiary

Raymond Silcock – Senior Vice President and Chief Financial Officer

Murray Kessler - President and Chief Executive Officer


Judy Hong - Goldman Sachs

Bonnie Herzog - Citigroup

Nik Modi - UBS

Filippe Goossens - Credit Suisse

Ann Gurkin - Davenport

Christine Farkas - Merrill Lynch

Karen Lamark - Federated Investors

David Adelman - Morgan Stanley

Thomas Russo - Gardner Russo



Good day, ladies and gentlemen, and welcome to the third quarter 2007 UST earnings conference call. (Operator Instructions).

I would now like to turn the presentation over to your host for today's conference, Mr. Mark Rozelle, Investor Relations.

Mark Rozelle

Thank you for joining us this morning as we discuss our third quarter 2007 results. For those who have not seen the release, it is available on our website under the Investor Relations section.

This presentation is being webcast live and is available in playback mode. The audio will also be available on our website in an MP3 format which can be downloaded to a player such as an iPod.

Hosting the call will be Murray Kessler, President and CEO of UST. Also joining us with remarks today will be Daniel Butler, President of our U.S Smokeless Tobacco subsidiary, and Raymond Silcock, our CFO. At the end of our prepared remarks, Murray and the team will take your questions.

In order to help you understand the company and its results, we will be made some forward-looking statements. Accordingly, it is possible that our actual results may differ from the predictions we make today. Additional information regarding factors that could make such a difference appear in our Safe Harbor statement included in our public filings.

We will also be discussing non-GAAP financial measures in this presentation. A complete reconciliation of GAAP to non-GAAP financial measures can be found in the press release we issued this morning.

I will now turn the call over to Murray.

Murray Kessler

Good morning and thank you for participating in UST's third-quarter earnings call. We're doing this call from Stamford, Connecticut, as we completed our company headquarters relocation as scheduled in mid-September. So let's get started.

During the third quarter, UST achieved broad-based financial success tracing to strong volume growth in both our Smokeless Tobacco and Wine divisions and Project Momentum cost savings, which were used to both enhance margins and fuel volume growth. Financial results also benefited from the company's share repurchase program and a lower effective tax rate.

As a result, consolidated third-quarter net sales increased 4.6% versus a year ago. Diluted EPS increased 15.1% versus a year ago to $0.84. And as shown in the reconciliation table in this morning's release, underlying diluted EPS increased 13% to $0.87.

I will share some brief highlights from the quarter. Then Daniel Butler, President of U.S Smokeless Tobacco Company, will review USSTC results in more detail, and Raymond Silcock, our Chief Financial Officer, will provide more detail on financial results. We will answer your questions at the end of our prepared comments.

Let's start with volume growth. Noteworthy is the strong growth achieved by U.S Smokeless Tobacco Company during the quarter. Total USSTC third-quarter volume was up 4.6% versus a year ago, and premium volume was up 2.7%, our strongest quarterly growth in over 10 years.

As you have heard us say in the past, accelerating profitable volume growth is a top priority for USSTC. Specifically, our goal is to grow more in line with the category through brand building, product innovation, premium loyalty, and competing effectively in all category segments.

As you see from the results in the quarter, we are making great progress on that goal and it is for this reason that USSTC's share has been relatively stable sequentially for the last three reported 26-week periods.

Equally noteworthy is the continued volume growth of Ste. Michelle Wine Estates, which increased 12.6% in the quarter through a combination of robust core brand growth, particularly the Chateau Ste. Michelle brand, and the continued incremental contribution from Erath and new products.

In addition, Ste. Michelle Wine Estates' results for the quarter were positively impacted from the Stag's Leap Wine Cellars acquisition, which closed on September 11. We expect Stag's Leap to have an even more meaningful impact on fourth-quarter Ste. Michelle results.

Of note, Ste. Michelle Wine Estates remained the fastest-growing top 10 winery in the U.S during the third quarter, and Chateau Ste. Michelle was the fastest-growing top 25 brand.

Second, a brief comment on category growth. Growth remains brisk in each of the categories we compete in. The moist smokeless tobacco category was up 6.7% for the 26 weeks ending September 8, 2007, slightly above the high end of our forecast. The super-premium and ultra-premium wine segments combined, where we primarily compete, were up 11% for the most recent quarter.

Third, Project Momentum had a significant impact on our cost structure and, as a result, positively impacted earnings and operating margins for the quarter. The consolidated UST adjusted operating margin increased 140 basis points versus a year ago to 47.1%, despite the negative mix impact from wine. This is exactly how Project Momentum is intended to work, facilitating investment to accelerate profitable volume growth while protecting or even growing operating margins.

And fourth, a comment on share repurchases. Based on the lower share price we experienced in the third quarter, which was obviously unrelated to business fundamentals, the company decided to accelerate the discretionary portion of its share repurchase program, buying back $130 million of its own shares during the quarter.

So, if you look at the $0.10 of underlying diluted EPS growth for the quarter and break it into its components, you'll see that $0.04 came from increased sales driven by strong volume growth in moist smokeless tobacco and wine; $0.03 came from cost reductions attributable to Project Momentum; $0.02 came from the effect of the company's share repurchase program, and the remaining $0.01 came from a lower effective tax rate.

This is a good demonstration of how UST is utilizing the various tools available to it, as need be, to deliver its stated goal of an average 10% total shareholder return, which is a combination of EPS growth and our strong dividend yield, while at the same time investing in its brands to accelerate profitable volume growth.

We like to describe this as our expanded toolbox, which we view as essential to delivering that 10% total shareholder return goal on a consistent and sustainable basis over the long term.

Based on the continued strong fundamentals in the third quarter and our positive outlook for the fourth quarter, we are raising earnings guidance for the third time this year. We now forecast underlying diluted EPS for the full-year 2007 of $3.42 per share, which is slightly above the high-end of our previous range and $0.07 above our previous estimate.

We are also raising our annual guidance range to $3.40 to $3.44. Essentially, we have passed all of the third-quarter favorability through to the year, and our fourth-quarter estimate remains unchanged.

Separately, you may have noticed during the quarter that the company has publicly taken the position that it would support FDA regulation of tobacco if several issues of fairness and issues related to the distinct differences between smokeless tobacco and cigarettes can be addressed. We believe that they can be, and are hopeful that the bill can evolve to a point that we would support it.

So in conclusion, we are obviously pleased with the third-quarter financial results, but are even more pleased with the fundamentals of the business. I will now turn the call over to Daniel Butler, who will provide more detail on the robust USSTC results for the quarter.

Daniel Butler

Thank you, Murray. Good morning, everyone. The Smokeless Tobacco segment had a strong quarter, reporting underlying operating profit growth of plus 7.5% versus year-ago, driven by increased revenue and reduced costs. Solid volume growth in both premium and price value brands translated into net sales growth of plus 1.8%.

Favorable costs related to Project Momentum helped drive a 300 basis point improvement in adjusted operating margin versus year-ago to 56.4%. The highlight of the quarter once again was solid net can volume growth for our smokeless products.

Total net can volume was up 4.6% versus year-ago, marking seven consecutive quarters of overall growth. USSTC premium volume was up a strong 2.7%.

As mentioned in our second quarter conference call, Q2 volume results were a bit lower and expected Q3 results a bit higher than the underlying trend due to timing differences primarily related to the 4th of July holiday. This was the case, and therefore we believe year-to-date volume trends are more indicative of true underlying performance, since they eliminate that timing difference.

On a year-to-date basis, USSTC premium shipments are up 1.9% versus year-ago, nearly double our originally stated goal of 1% premium volume growth for the year and modestly favorable to our upwardly revised goal of 1.5% underlying growth on the year.

Now let me provide a little more color on Q3 volume results. First, premium volume increased for the fifth consecutive quarter and was in line with our expectations. This growth is particularly encouraging as we are now posting growth on top of the plus 0.7% growth reported in the third quarter of last year.

Second, the Copenhagen brand was the primary driver of premium performance, with growth fueled roughly equally by core item growth and the pipeline volume associated with the strong trade acceptance of new Cope, which began shipping on September 17th.

You may recall that new Cope is a sub-line of the original Copenhagen brand consisting of two new items, Cope Smooth Hickory and Cope Whiskey Blend, as well as a re-branded Copenhagen Long Cut Straight. The new Cope SKUs are natural style products that have a smoother profile than the original Copenhagen in the easier-to-use long cut style. These more approachable products will enable the Copenhagen brand to reach out to new-to-category adults, primarily smokers, so that the brand can more fully participate in category growth.

Third, the Skoal brand also posted positive results, primarily driven by Skoal Citrus Blend, which was introduced in Q1 in both long cut and pouch format. Skoal Citrus Blend was selected this month by the respected C-store industry publication, CST Magazine, as the best new product in the Other Tobacco Products category in 2007.

Notably, this marks the second consecutive quarter that both of our leading brands, Copenhagen and Skoal, were up versus year-ago, and we are pleased to see both brands growing.

Fourth, we again posted strong double-digit growth on Copenhagen and Skoal pouches versus year-ago. The total portion pack business, including both Cope, Skoal pouches plus Skoal Bandit, showed mid-single digit growth as we lapped the reintroduction of Skoal Bandit in Q3 of last year and the associated pipeline volume. As an easier-to-use, more discreet smokeless tobacco option, portion packs continue to appeal to smokers who switch to MST.

Fifth, on the price value side, USSTC growth accelerated to plus 16.3%. Husky contributed the majority of the growth with a strong double-digit increase powered by a focus on expanding distribution. Red Seal turned in high single digit growth, its strongest since early 2004, benefiting from focused promotional investment.

It’s important to note that USSTC's accelerated growth in PV came concurrent with strong premium volume and is consistent with a balanced portfolio approach designed to profitably accelerate volume.

Sixth and finally, we continue to see an increasingly strong volume contribution from new products that have been introduced in the last three years. These products include several new Skoal long cut and pouch SKUs, new and improved Bandit, the Cope sub-line, and the Husky PV line. In total, they contributed 14% of total can volume during the quarter.

Now let me turn to RAD-SVT data, which is our measure of consumer takeaway. I will be reporting on the RAD-SVT results for the full 26-week period ended September 8, 2007. Please note that these results do not include the launch of new Cope, which began shipping just after this reporting period.

Starting with the category, total MST category volume growth continued at a strong pace of plus 6.7% versus year-ago, in line with the growth we reported in Q2 and slightly higher than our full-year projection of plus 5% to 6%. Given the consistent robust growth year-to-date, we now believe that full-year category growth will be at least 6%.

For USSTC, total RAD volume grew plus 3.5% versus year-ago and we continue to see encouraging trends in share. Total USSTC volume share for the period was 61.0%, down 1.9 points versus year-ago, but essentially flat to the 61.2% share we reported last quarter.

The rate of year-over-year share decline continues to moderate as our sequential share is stabilizing, another clear sign that our plans are working. From a revenue standpoint, total USSTC revenue share continues to be very strong at 73%, driven by our leadership of the premium segment.

Now turning to volume performance by segment, the overall premium segment grew plus 1.3% versus year-ago, representing 56.1% of total category volume. USSTC premium volume increased plus 2.1%, and our share of the premium segment increased plus 0.7 percentage points to 91.1%.

The strength of our premium brands continues to be broad-based, with 36 states that represent 77% of our premium volume growing. As we saw in our shipments, both Copenhagen and Skoal brands grew strongly during the period. In the price value segment, volume grew 14.5% versus year-ago and represented 43.8% of category volume.

Total USSTC PV volume growth accelerated to plus 11.3% versus year-ago for the 26-week period. Our Husky brand continued to outpace the overall segment, while Red Seal delivered mid-single digit growth. USSTC's share of the total PV segment was 22.7%, down 0.6 percentage points versus year-ago, but essentially flat to the 22.6% share of segment we reported last quarter.

So to summarize our key takeaways from the shipment and RAD results; first, with three-quarters of the year behind us, category growth continues to be robust with moist smokeless tobacco a leading growth category within consumer-packaged goods. Our company's continued commitment to attract adult smokers to the category and our premium brand-building efforts are fueling this growth.

Second, both of our leading premium brands continued growth this quarter behind the investment in the premium loyalty plan, strong brand building, and the contribution of portion packs. This performance is especially notable, as we have now reported five consecutive quarters of premium volume growth, a clear indication that our plans are driving sustainable results.

Third, the price value segment continues to grow, though at a much lower rate than in previous years, as USSTC's premium brand loyalty is improving. USSTC price value brand performance is improving behind the distribution build on Husky and a focused promotional plan on Red Seal, without negatively impacting USSTC premium volume trends.

Fourth and finally, new products are making a significant contribution to our sales, fueled by the recent successful launches of Skoal Citrus Blend in long cut and pouches and the Cope sub-line. These kinds of new products differentiate our premium brand from competition and provide more approachable forms and flavors for adult smokers who continue to switch to smokeless tobacco.

So, given our strong fundamentals, the remainder of the year looks bright. Specifically, we expect the category to be up at least 6% for the full-year 2007. With continued category growth and improved share performance, we expect to see continued volume growth on all of our key brands. Specifically, we now believe that full-year underlying premium volume growth will be close to 2%.

Now let me give you a bit of guidance on how the fourth quarter will be affected by the extra delivery day in December and the increased spending behind brand building.

First, for USSTC an extra delivery day is like an extra full week of shipments, since we deliver the bulk of our volume once a week on Mondays and December 31st is a Monday this year. Having said that, the end of December is a seasonally soft period for the business, and it is an un-promoted week. So the impact will be significantly less than the roughly 12 million weekly cans that we deliver on average and that you might estimate by dividing our annual volume by 52. The impact of this extra delivery day has been built into our plans from the beginning.

On the spending side, the fourth quarter includes additional investments in brand building to further strengthen our brands and sustain volume growth going forward. The heavier fourth-quarter spending will be focused on the Copenhagen and Skoal brands, primarily in the areas of brand communication through print advertising, one-on-one, and adult consumer based loyalty programs.

Let me provide a few examples. First, Copenhagen. The brand recently launched a national loyalty program whereby adult consumers can collect points over a period of time and redeem those points for merchandise by entering promotional codes on our website. We have been developing and testing that program over the last two years and are now rolling it out nationally. The website can be found at

For Skoal, the brand has just launched a new advertising campaign called Welcome to the Brotherhood. The advertising has tested extremely well, and we are making additional investments in the new brand website, The website launched just last week and it strongly reinforces the brand positioning while providing interactive components to fully engage our adult consumers in the brand experience.

We are also making changes to our event sponsorships. As we said in the past, U.S. Smokeless Tobacco Company's corporate and brand name event sponsorship are an important part of our ongoing effort to communicate with adult consumers. Our sponsorships reinforce company and brand positioning and give us unique platforms from which to interact with adult consumers through close associations with pastimes they enjoy.

Consistent with the provisions of the Smokeless Tobacco Master Settlement Agreement, or STMSA, we are permitted to have one brand name sponsorship in a given 12 month period. For a number of years that sponsorship has resided with the NHRA, the National Hot Rod Association, through our sponsorship of the NHRA and the Skoal Racing Funny Car Team owned and managed by drag racing Hall of Famer Don Prudhomme.

With two powerful premium brands and only one branded sponsorship available to us, we have decided to move the brand name sponsorship in 2008 to Copenhagen, which will become a branded sponsor of Professional Bull Riding, or PBR. Bull riding has become one of America's hottest and fastest growing sports. And the grit, courage, and determination of the cowboys who ride these animals are a perfect fit for the Copenhagen brand and its long association with the cowboy lifestyle and Western imagery.

We look forward to seeing our Copenhagen Bull Riding Team compete in the 2008 PBR season, and we will continue our strong participation in the NHRA through a U.S. Smokeless Tobacco Company sponsorship of the Prudhomme team and the NHRA.

The powerful new communication platform for Copenhagen and Skoal will require significant investment in the fourth quarter to ensure that all of the collateral materials we use at our one-on-one events are aligned with the new brand messaging and deliver consistent integrated communication to our adult consumers at all points of contact.

Those investments include the onetime costs of changing our sponsorship, including refitting our mobile marketing units, changing signage, changing uniforms, changing race cars, and the production costs associated with new websites and advertising.

In summary, we are pleased with the sustained growth in our premium brand, the acceleration of our price value brand, and the significant progress we are making in stabilizing our category share. For the remainder of the year our plans are strong, both in brand building and effective loyalty programs, and we look forward to delivering record can sales for U.S. Smokeless Tobacco Company on both a reported and an underlying basis.

With that, I will turn the call over to our CFO, Ray Silcock.

Raymond Silcock

Thank you, Dan, and good morning once again to everyone on the call. This is my first earnings call as Chief Financial Officer of UST Inc., and I am very happy to be part of the team. I'm especially happy today, though, to be in a position to report outstanding financial results across all our business segments for the past quarter.

As Murray pointed out earlier, we continue to use more of the tools from our toolbox to maintain and improve our financial results in order to deliver on our goal of 10% average annual shareholder return.

As an example, this quarter we used our strong financial position both to buy an 85% stake in Stag's Leap Wine Cellars and to make incremental share repurchases. I will discuss both of these items in more detail later in this presentation.

But first, our third quarter financials. In the quarter ended September 30, 2007 we reported net sales of $479.6 million, 4.6% ahead of the same period last year. Our cost of products sold for the quarter amounted to $126.5 million, 9.2% more than in last year's third quarter and gross margin of 73.6% was 110 basis points lower than for the same period last year primarily, as a result of the shift in the mix between Wine and Smokeless Tobacco, a consequence of the rapid growth in our Wine business. Margins on wine are significantly lower than those on smokeless tobacco.

To a lesser extent, the reduction in gross margin also reflects an increase in price-based support for our smokeless tobacco products as we make them more competitive. It is worth noting, too, that we have not taken a price increase in our Smokeless Tobacco segment for two years now.

When we turn to adjusted operating income for the quarter, however, the third quarter of 2007 was up 7.9% as compared to the third quarter last year. Total adjusted operating income was $226.1 million and our adjusted operating margin was 47.1% for the third quarter this year, as compared to 45.7% for the same quarter last year.

This 140 basis point improvement in operating margin was driven not only by the strong volume growth we achieved in all of our businesses in the third quarter, but also by the ongoing impact of Project Momentum in reducing selling and administrative costs for both USSTC and UST corporate.

In fact, Project Momentum continues to provide cost savings ahead of our expectations. Its implementation has not only helped drive our business through increased spending on brand building marketing programs, but has also empowered a focus on efficiency and productivity throughout the entire company which will, we believe, help us consistently deliver our shareholder return objectives in the future.

Adjusted net earnings for the third quarter amounted to $138.5 million, up 10.6% from last year's third quarter, while adjusted diluted earnings per share of $0.87 were up 13% from the same period last year.

This year's third quarter adjusted net earnings exclude a $0.03 impact from a combination of restructuring charges related to Project Momentum, the effect of imputed rent associated with the sale of our prior headquarter building in Greenwich, and legal charges recorded this quarter arising from a previously resolved antitrust action.

While last year our adjusted diluted EPS was $0.77 and excluded a net $0.04 adjustment comprising $0.06 of Project Momentum restructuring costs and $0.02 of income from discontinued operations. This $0.10 per share improvement in adjusted EPS versus prior year came primarily from the impact of net sales growth, but also from lower sales and administrative expenses.

A lower effective tax rate, reduced interest expense, and the impact of share repurchases over the past 12 months also contributed to the improvement versus last year's third quarter.

Moving on to the individual business segments, Dan has already explained Smokeless Tobacco's strong third quarter driven by solid volume and net sales increases and by tight cost controls. With respect to operating income, the Smokeless Tobacco segment's adjusted operating profit increased 7.5% to $216.6 million for the past quarter.

Higher net sales and lower administrative expenses primarily due to Project Momentum drove this increase. The continued focus on cost management, which resulted in a 10% decline in administrative expenses in Q3, has allowed the company to reallocate resources in order to grow can volume while simultaneously increasing operating profit margins. Smokeless Tobacco adjusted operating profit margin is up 300 basis points versus year-ago to 56.4% for the third quarter.

The Wine segment is also thriving, with net sales up 18.3% in the quarter on a 12.6% increase in case volume. Excluding our recent acquisition of Stag's Leap Wine Cellars, net sales growth in the Wine segment was 14.5%, mainly due to strong performance by our core brands.

Wine segment operating profit increased 34.1% to $12.7 million for the third quarter. The impact of the Wine Segment's strong top-line growth was somewhat offset by higher promotional spending behind the Antinori brands, and also by an increase in headcount as a consequence of expanded distribution.

Despite these offsets, the winery’s 15.4% operating margin in the third quarter was 180 basis points higher than as compared to the same period last year. We did not present adjusted winery results for the third quarter, as the difference between GAAP and adjusted results is quite small in their case.

The final remaining significant component impacting net earnings in the third quarter were income taxes. Third-quarter results reflect an effective tax rate of 36.1%, versus 37.3% in Q3 2006. This lower rate is primarily due to the scheduled 2007 increase in the federal tax deduction for qualified domestic production activity.

Moving on to our share repurchase program, the company already indicated earlier this year that it would increase share repurchases by an incremental $100 million in the second-half of the year, bringing total share repurchases for 2007 to a planned $300 million. $20 million of these incremental share repurchases had already been accelerated into the second quarter. The remaining $80 million worth were repurchased this quarter, bringing total third-quarter share repurchases to $130 million, 2.6 million shares.

Total share repurchases for the nine months ended September 30, 2007, amounted to $250 million. The share repurchase program is expected to continue to be accretive to EPS growth not only because unexercised stock options now represent less than 2.5% of common shares outstanding, but also because the company now primarily provides long-term equity compensation in the form of less dilutive restrictive share grants.

Turning to the balance sheet, net debt increased sharply in the quarter, rising to $704.3 million. Cash on hand including short-term investments at the end of the third quarter amounted to $135.7 million, a decline of $208.9 million from the end of the second quarter. This decline was due to the impact of the Stag's Leap Wine Cellars acquisition and also to increased levels of share repurchases.

The company anticipates that cash balances at year-end will be lower and net debt correspondingly higher, as a result of scheduled payments to be made in Q4 in connection with antitrust settlements resolved in the first quarter of this year. The company plans on continuing to utilize its strong financial position both to strengthen its businesses and to return cash to shareholders.

Looking forward to the balance of the year, we have raised our 2007 adjusted diluted EPS target and range. Full-year adjusted diluted EPS is now targeted at $3.42 a share, with a range of $3.40 to $3.44. The increase in guidance for the year is a reflection of growing Smokeless Tobacco premium volume, stronger than anticipated Wine results, and the acceleration of Project Momentum cost savings, somewhat offset by our planned fourth-quarter Smokeless Tobacco brand-building projects. With that, I would like to turn the call back to our Chief Executive Officer, Murray Kessler.

Murray Kessler

Thanks, Ray. Once again, it was a strong quarter in which we continued to build momentum on each of our businesses and deliver on our commitments. And while I am pleased with our results, I still believe we can do better in a smokeless tobacco category that is growing faster than we are.

We will be discussing how we further build momentum in 2008 at our upcoming investor conference on December 19 in New York City. Invitations will be going out shortly. If you would like to attend and did not receive an invitation, please contact Mark Rozelle, our Vice President of Investor Relations.

On a side note, over the next several days you may notice the company will be filing Forms 4 in connection with shares that will be disposed of in order to cover tax withholding obligations for certain executive officers. These dispositions will be made pursuant to our 2004 restricted share awards, which are currently vesting. And to be clear, these are not discretionary dispositions but rather a pre-established mechanism designed to handle the tax withholding.

Now, Dan, Ray, and I would be happy to answer any questions on the quarter.

Question-and-Answer Session


(Operator Instructions) And your first question comes from the line of Judy Hong of Goldman Sachs.

Judy Hong - Goldman Sachs

First, I just wanted to ask you about the category growth. I mean I think it’s been several quarters now where the category has been growing kind of in the high-single digit rate. Obviously, you feel more comfortable this year with category up at least 6% or 7%.

But looking out over the next few years, do you think we're at a point where you feel that category growth can be sustained for in that 6% or 7% range? Are there any reasons why the category growth would start to slow?

Daniel Butler

Yes, we have been very pleased with category growth. You said it's been several quarters in the mid-single digit range. In fact, it has been several years in the mid- to high-single digit range. So we are very pleased with the category growth.

I believe the category can continue to grow at a significant rate for a long, long time to come, because the fuel that drives that to a large extent is smokers converting to smokeless tobacco. There's about 45 million smokers in the U.S. and there are still 6 million adult consumers of moist smokeless tobacco. So, we believe that is fuel that can drive the category for a long, long time to come. Whether that is 5% or 7% remains to be seen. I am not sure I’d go for 7% for the long term. But I think there is very healthy category growth for a long time to come.

Murray Kessler

Yes, and as always, Judy, at the December investor conference we will give you our projection for the category for 2008 and how we get there. But just to support what Dan said, it’s an incidence-based strategy and you are still dealing with 6 million smokeless tobacco consumers versus 45 million non-smokers.

The bulk of what we do every day is, and the bulk of our spending, is still focused on converting adult smokers to the smokeless tobacco category and I don't see anything changing in terms of the dynamics that make that work. There is increasing smoking restrictions. All the issues that make our products appealing on their convenience and discreetness still present themselves going forward.

Judy Hong - Goldman Sachs

Okay. And then secondly, just in terms of your decision to increase brand support behind Skoal and Cope in the fourth quarter, is that tied in any way to looking at competitive landscape and with new products coming into the marketplace? Whether it is Red Man or a Marlboro moist smokeless, is that decision being driven partly by those new products in any way?

Daniel Butler

No, and I want to be clear, too. What we were trying to explain is, with the extra week you might have done some math and said you ought to come out to a little bit of a higher number in the fourth quarter.

These are not dramatic changes. We had a lot of these plans in place and that level of spending in the quarter for I am not sure we had it all in the beginning of the year, but most of it in the beginning of the year. So there is not a radical change. I'm just trying to help, and we are trying to help provide you some guidance when you are building to our estimate.

The spending that is in there, I didt say at the end of the second quarter, at the end of the first quarter that we retain some competitive flexibility. The reality is the competitive entries we have seen are very small in scale. So, the amount of spending that is going towards that area is very small, and it did give us some opportunity to do some what we think are spectacular long-term things for the brands. But they are kind of the opposite of spending on a tactical basis in the market there.

Going to a Copenhagen branded sponsorship and new advertising and all that, those are not short-term moves. Those are brand building moves, which we think is important and is what this company is based on, strong and resilient and highly loyal consumers and great brands and we are using the opportunity to reinforce that.

Judy Hong - Goldman Sachs

Okay. Just following on the fourth quarter, the extra shipping day impact. I mean, you said the volume impact would be less than the $12 million. So, should we say it half that? Or can you give us a little bit better help on quantifying that number?

And then from an EPS perspective, if these are un-promoted volume, though, I guess the profit per unit on this extra volume would be higher than your normal volume? So, the EPS impact could be a little bit higher than the volume impact?

Murray Kessler

I think, the guidance we gave you on EPS is what we believe in. So, there is only one quarter left so you can solve for that number. But on the relative basis, it is a little bit hard to tell. December 31st it depends, does it snow? Doesn't it snow?

Does the SCHIP bill revive itself? And if the SCHIP bill revives itself, there is a floor stock component to it, does that temper it a little bit? It is an un-promoted week. We will give you clarity. We are trying to report our numbers on an underlying basis.

And I think what Dan said to you was you're basically up 2% on nine months, and we expect to be up 2% on premium volume for the year; so fourth quarter is about the same. That is the number that should drive you. We will tell you how much it is when we see it actually play out.

Judy Hong - Goldman Sachs

Okay. So up 2% without the extra volume, though, right?

Murray Kessler

Correct. Yes, we will report that number at the end of the fourth quarter. We have tried not to be very specific with it. Because it is a strange time of the year and then it will all just be all incremental. We will point that out and we will let you know what the underlying numbers are, so you are clean on the real trends.


Our next question comes from the line of Bonnie Herzog of Citigroup.

Bonnie Herzog - Citigroup

I just have a few questions. I was curious, if you could just talk about the overall trends that you are seeing. For instance, certainly your volume continues to grow, but your market share has been declining.

So, first, you lost overall market share. And then you also lost, if I am not mistaken, market share in both your premium segment as well as your price value segment or category. Can you talk to that and how comfortable you are with that?

Murray Kessler

Well, I think the share is going through a tremendous stabilization. Frankly, ahead of what we might have even hoped for, based on the acceleration of volume and Dan raising his volume targets for the year a few times. You are right, compared to year-ago, we continue to lose market share, but at a much lower rate than we had been a couple years ago, and it has been slowing sequentially every time we report.

But we now basically have lost maybe a tenth or a couple tenths over the last three 26-week reporting periods. Or said another way, our market shares today are the same as they were last November. So, you sequentially have seen a dramatic change and it makes sense, right?

If the category is continuing to grow, something had to change in order for our volume to accelerate. And, we just reported the strongest volume in over 10 years and it is more like a dozen years for the brands. And even within share, that is the share in the total because you have a mix issue, but we are gaining share in every segment.

Our sub-price value brand, Husky, gained share within the sub-price value segment. Red Seal gained share within the price value segment and premium gained share within the premium segment. So, I am pleased with the way share is heading.

Is it good enough? No, it is not good enough. I would like to see us growing as fast as the category. That is why I continue to state that our goal is a 10% total shareholder return and that we are continuing to invest to accelerate profitable volume, and because the goal is to grow in line with the category. But that is not going to happen in an instant, and so we are making great progress on it.

Bonnie Herzog - Citigroup

Okay. And then secondly, can you talk about your current inventory levels or what they were at the end of the quarter, and how that compares to the year-ago period? I'm just tried to get a sense of was there some loading or de-loading? Where were you at at the end of the third quarter?

Daniel Butler

Are you talking about trade inventories, Bonnie?

Bonnie Herzog - Citigroup

Yes, I'm sorry. Yes, correct.

Daniel Butler

I don't have those numbers handy. But I don't think you have seen any change in those. I wouldn't tell you that our shipment numbers are at all reflective of any shifts in trade inventories other than the fact that we started shipping on the new Cope sub-line on September 17.

So there was a pipeline fill even towards the end of the quarter, but a lot of that would have moved through retail in the first couple of weeks.

Murray Kessler

And it is comparable to the Bandit launch.

Daniel Butler

Right, you had a Bandit’s launch in the year-ago period. So I really don't think inventory would account for any swings. The only thing that I mention in my comments is that the timing of shipments around the 4th of July had a little bit of an impact on this quarter and last quarter. That is why I encourage you to look at the year-to-date trends.

Murray Kessler

Yes. Just adding to that, we didn't adjust at the end of the second quarter; I think premium volume was up one four, we said, 4th of July timing, and one five, 4th of July timing was a little later this year. But we didn't try to come up with an estimate that said second quarter would have been higher but for 4th of July.

The only inventory shift was at the beginning of the quarter, not the end of the quarter. There was no special push. There is no reason to believe inventories are different one way or another. And if you look at the six months, it washes out 4th of July everything else was equal. And premium volume has grown about 2%.

Bonnie Herzog - Citigroup

Okay. That helps. And then, Murray, as you mentioned and it was in your press release, you talked about the increase in the share repurchase program, specifically this third quarter. What are your goals for your program in the future?

And I'd also be curious to hear from you what programs, if any, may have lost support, given more money being allocated to your share repurchases. Or was it, as I look through your financials for the quarter, was it because of the sale of your building in Greenwich, for instance?

Murray Kessler

Well, it was because of the share. We basically said we sold the building, we got almost a $100 million of cash and that’s what supported the incremental share repurchase. So, that’s an accurate statement. We also sit on lots of cash and beyond that we have tons of balance sheet capability and we are not particularly leveraged.

So, we are investing in our brands. And even when you see our S&A numbers going down, it is in nonworking dollars. It is not in things that drive the business. We are investing in the things that move cans and we’re cutting back in the non-product or becoming more productive in areas. And that’s what is generating the dollars.

So, I will let, I will turn it to Ray, to comment on sort of how we think about share repurchases and we obviously won't talk about that now. We talk about those things at our December conference. But, Ray?

Raymond Silcock

No, I think we are in an enviable position with respect to our balance sheet. As you said, as Murray said, we’re certainly not skimping on advertising or other kinds of marketing support in order to make the share repurchase program.

We saw a small increase in our overall indebtedness in the course of the quarter; but that was principally from buying Stag's Leap Wine Cellars. And I think, as we go forward we will be in a position to evaluate better, what our position should be in the future.

Murray Kessler

Yes. It is sort of what we’ve been saying all along, right? We have this toolbox. What we have tried to do is evolve our business model over the past two years to say there was sort of this one way of getting to the numbers.

And now with a toolbox that includes share repurchases, some acquisitions, faster growth from the winery, more accelerated volume growth, cost reduction, etc., we are constantly evaluating all of those tools--pricing flexibility that still remains, all of those things--to deliver our results and still try to accelerate profitable volume growth.

So, it is an ongoing process. That is what you pay us for, to be looking at each of those and which are the right levers to pull at the time in order to deliver the returns. And we will do that.

Bonnie Herzog - Citigroup

Final question. Speaking of your toolbox, what are your thoughts on the “snus” category? Do you believe it can be a viable category in the future?

Murray Kessler

Well, I will redefine it as that spit-free small pouch category, which is being called “snus” by some brands, called Skoal Dry by us. We called it Revel before.

That whole segment, we have invested a lot of money in it and have been working on it for five or six years. So, I ultimately believe in it. I think it presents an opportunity. We struggled getting it done ourselves. So, I kind of welcome the competition. It is still none of them are setting the world on fire. Dan, it's kind of like a line extension of…?

Daniel Butler

Yes. I think if you look at it within those test markets, Bonnie, you see fair retail movement. They perform about like one of our sort of respectable line extensions. But that is not what you want or need out of something that is a significant new platform.

So, I think all of us are trying to figure out the best way to go to market and optimize the products and I think we all recognize that since that product is not sourcing volume from moist smokeless tobacco consumers, it is really designed for smokers. It takes some time and education to get smokers to adopt a fundamentally different behavior and that kind of product.

Murray Kessler

And we don't report on how competitors are doing in their test markets. The only thing I will tell you is in every single test market, where snus and Skoal Dry and Revel and all those products are, Copenhagen and Skoal are growing as fast or faster than in the balance of the U.S.

Bonnie Herzog - Citigroup

No, I think you hit upon a really very important point and it is education. I think the consumer especially in the U.S. doesn't really understand this relatively new category. Although you have been there. But how to use it and to your point earlier, Murray, by having others enter it, that might potentially help you?

Murray Kessler

Yes, it is an education, that is the right word, too. It is education. The dippers that are out there today, it has no appeal to. So, it’s getting smokers and helping them understand what it is and how you use it. It is work, but long-term, I think it presents an opportunity for the whole category.

Bonnie Herzog - Citigroup

That’s part of your toolbox in the future. Thank you so much.


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

Nik Modi - UBS

Just a couple quick questions, on the cost side, I know you rose your targets last quarter. But are there other projects that you're evaluating right now in your pipeline? And then the second question is, on the discount versus premium side, it seems like obviously we’ve seen 40% market share grab over the past 15 years or so.

When you see these new lower-end products coming into the market or lower-priced brands coming to the market, are they just taking shelf space from other discount brands? Or are retailers still willing to take away premium space given the trade off on the price per can?

Daniel Butler

I will take the last question first and then I will let Murray take the first one. Regarding all the activity on the lower-end of the market, one thing I will say is that this MST category for a long time has had a very long tail of a lot of very small SKUs.

In that respect a lot of these things aren't anything any different and there is a number of them, I think, that have gotten a disproportionate amount of attention, but the reality is that that share grab that you talked about came from big brands from big companies and that’s where the growth in the category has come from.

So yes, these smaller brands coming in are really fighting within the PV segment. I think what is important, you look at the trends we showed, that price value growth overall despite the introduction of a number of brands at very low price points, the overall rate of segment growth is declining on both an absolute and a percentage basis.

And in that category, our premium growth is accelerating. The category growth remains robust. We are increasing our rate of growth within the price value segment. So, long story short, it is not something that really concerns me or I think represents anything new.

Murray Kessler

On the Project Momentum side, the answer is yes.

Nik Modi - UBS

Okay. Fair enough. Last quick question. The original test market where you were looking at closing gaps in certain concern territories, I know it's been about a year and some change now. Can you provide some perspective on how that market in particular is progressing? Just kind of give us a view on how sustainable the strategy is.

Murray Kessler

Nik, I think you are going way back when we first started the premium loyalty plan. And we said we are going into a handful of markets where we sort of tested that program, probably about six months before we really rolled it out nationally and for the most parts, those areas that we did that are doing quite well. We don't share a lot of these details, but within our national share numbers, there are actually individual markets where we are growing share not only sequentially but also year-over-year.

The third quarter is a bit of a milestone for us, because it’s the first quarter where we posted premium growth of top of growth from the prior year period. I expect you're going to see that again in the fourth quarter. So short answer, I think we do have a sustainable growth strategy here.


Your next question comes from line of Filippe Goossens of Credit Suisse.

Filippe Goossens - Credit Suisse

A few questions here on my side as well. Murray, obviously, I mean trying to predict what is going to happen in Washington. I mean, I'm trying to give up on that.

Murray Kessler

Me too. Go ahead.

Filippe Goossens - Credit Suisse

But anyhow, if one assumes that FDA legislation is not going to pass this year based on the number of legislative dates left out there, can you just kind of give us a better feel in terms of when you may actually roll out a potential game changer?

You have mentioned in the past that, I forgot the actual count, but a significant amount of patents that you have applied for or have received, and that you are kind of waiting to get a better feel for the timing of the FDA before you might roll out one of these game-changers. Any additional kind of color there, Murray?

Murray Kessler

I really don't, except to say that at the last year's December investor conference we said by the end of this year or the beginning of next year we thought we would have a more innovative product that would be ready for test market. We said we would hope to bring it to test market.

We are still on track for that. We’ve made tremendous advancements. We still proceed down the path of getting ready for launch. We have tested with consumers, gotten terrific scores, and everything is sort of marching along.

But we will continue to assess what’s going on with the external environment to determine when is the right point to launch that product, and we will see. I wish I could give you a better answer right now, but I don't have one.

Filippe Goossens - Credit Suisse

Okay. Then moving on to one of the new competitive rollouts. If I understand it correctly and unfortunately, I don't have the same historic knowledge as all of you do, but maybe Dan can help us out here. The Red Man product of Swedish Match, that is a re-launch, Dan? How does it differ from what they’ve tried in the past, today? And which product will it compete the most with on your side?

Daniel Butler

Yes, Filippe, Red Man equity is based in traditional loose-leaf chewing tobacco, which is a much smaller category than moist smokeless tobacco. They launched that product some years ago and it was not successful in market. It was before my time. And they are re-launching it today.

It is priced like a sub-price value brand. I guess, a couple things, I would tell you about that. Surprisingly, the number of MST consumers who also use chewing tobacco is relatively low, significantly lower than it is for cross-usage with cigarettes. So I am not sure they are going to find a large potential audience there.

It is a very strong brand within its segment. But, it remains to be seen how that will translate into moist smokeless tobacco. It didn’t do well before. But with that being said, we will wait and see. But, it is another brand at a price point that exists in the category and I expect it is going to compete at that level within the category. I don't see that as a significant change in the marketplace, but we will watch it carefully.

Murray Kessler

Yes, I mean, specifically to answer your question. Last time, it was launched at a premium price up against Copenhagen and Skoal. Last time they launched it as a premium product; this time they have launched it as a price value product.

Filippe Goossens - Credit Suisse

Okay. And then perhaps, a couple of questions for Ray, if I may. Can you give us an update in terms of program-to-date savings under Project Momentum, please?

Raymond Silcock

Yes, hi, Filippe. Yes, to date, I think on a year-to-date basis we are a little over $56 million of savings year-to-date.

Murray Kessler

Remember at the investor conference, Filippe, we said $45 million was built into the plan, and we thought there was upside of another $20 million. Looks like, we will get both what is built into the budget. We were $0.12 ahead of our original guidance, so in what we are projecting. But we expect to get all of that.

Filippe Goossens - Credit Suisse

Okay, perfect. Then the second question, Ray, if I understood correctly, what you were saying is that, as it relates to any potential review in terms of the financial policies and the capital structure and stuff like that, might we hear something already in December? Or not necessarily?

Raymond Silcock

I think not necessarily, Filippe. I think it is one of those tools in the toolbox that Murray talks about that is clearly there. I think that, as we go forward towards the end of the year, we are certainly going to evaluate it. It is possible that in December, we will have reached some sort of conclusion and decision. But I am not going to commit to that.

But as I say, clearly we have an under-leveraged balance sheet. I don't think anyone would dispute that. It is just a question of deciding where we should focus that tool, if you like.

Filippe Goossens - Credit Suisse

Okay. Then in terms of Wine, Ray, you gave us the year-over-year sales growth ex-Stag's Leap. If, I understood again correctly with regard to operating profit, it was only a de minimis contribution in the most recent quarter for Stag's Leap?

Raymond Silcock

That would probably be accurate. I mean the fact of the matter is, although we said Stag's Leap is an accretive acquisition and we expect it to be very slightly accretive this year. The contribution margin from the sales, obviously, that we talked about is partially to almost completely offset by the reduction in interest that we were earning on the cash we used to pay for it.

Murray Kessler

It will show itself in the little more operating profit growth. Because, we don't charge the cost of capital down to the segment. It is within our numbers. It is modestly accretive, exactly as we have positioned it.

Filippe Goossens - Credit Suisse

Okay. Then finally, Murray or Dan perhaps, the increase in your value segment shipments are up 11.3% from the 9.6% in the prior quarter. Can you just give us a little bit more color in terms of how you go about in terms of improving or getting closer to category growth there? Is it driven by price positioning? Is it driven by more distribution? A little bit more color would be very helpful here.

Daniel Butler

The one thing I will say about it, first, I am pleased that we're doing well on both of the brands. Red Seal had been a bit of a disappointment last year. I would say in the case of Red Seal, it is a matter of paying very close attention to the brand and managing it at a granular level. It has not been a huge investment, it is just executing thoughtfully on a market-by-market basis and calibrating and getting it right. It hasn't been a huge amount of money, but it has worked.

On the Husky side, it is more about on that brand it is not about deep price promotion. It is about building out to full distribution. The brand went national a couple years ago, but there is still a lot of distribution voids out there.and we think it is a strong viable national brand. So we are filling out voids where we don't have distribution and we are building out the line in stores where we do have distribution. So the strategy on Husky is really about building its full national presence.

Murray Kessler

Husky is fully integrated, too. It was a new and improved product, so it was new packaging, fabulous graphics; in building that distribution, we went to our customers with a fully-integrated marketing approach to it.

The numbers you quoted were the RAD numbers. I think they are even stronger on a shipment number. I think we went from around 8% growth in the second quarter to about 16% growth in the third quarter.

Dan foreshadowed that on the last call, saying that we would be more aggressive in those areas as part of that overall competing effectively in all segment strategy. So we are quite pleased with the way it is progressing.


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

Ann Gurkin - Davenport

Good morning. I wanted to spend some time talking about your presence at the retail level. Are the retailers giving any more space to the smokeless segment, kind of any update there?

Daniel Butler

We have an ongoing program with retailers. We engage on a strategic level with all of our key accounts. I wouldn't say it is anything new, but we have a sustained high level of investment. Putting showcase shelving systems into retail that make a better presentation of our product enable us to get more facings at retail and better presentation of the product to consumers.

I believe that one of the drivers of category growth over these last years, on a consumer side it’s about incidence and more smokers converting to smokeless tobacco. But that goes hand-in-hand with significantly enhancing the presentation of the moist smokeless tobacco category at retail, through those investments we have been making in high-quality showcase shelving systems. But also working strategically with accounts and telling the category growth story and talking about category profitability. This is one of the most profitable and productive faces within the C-store, period.

If you talk about retail velocity and profitability per cubic foot in the store, moist smokeless tobacco is a very tough story to beat. For that reason, retailers have been working with us to improve presentation, visibility, and improve shelf space.

Murray Kessler

Yeah, I think we placed an additional 6,000 showcase shelving units this year, which is probably like a 7% or 8% increase in the total number of retail stores out there that have that. They significantly expand the footprint of the smokeless tobacco category.

We have reported the number. We will do it again in December, I am sure. But I just don't have the number at my fingertips right now. But I would venture to say USSTC category facings are probably up in the neighborhood similar to the kind of numbers you are seeing in category growth.

Ann Gurkin - Davenport

Great. Then, you now look for the domestic smokeless category to be up at least 6%, I think you stated, why not 7%? And what’s keeping you from moving that range to like 6% to 7% or closer or to 7% for the year? Are you going to promote less in the fourth quarter or increase pricing, can you help me understand that?

Daniel Butler

It is not that we are really expecting the growth to slowdown or there is anything fundamentally differently happening. We are up less than 7% I think or in that neighborhood year-to-date. It was 6.7% for the latest 26-week period. So I don't expect it to accelerate for the balance of the year. I wouldn't be surprised if it slowed down a little bit. But having said all that, it’s comfortably above 6% year-to-date. So, we think yes, on a full-year it is going to be at least 6%, we will see.

Murray Kessler

Yes, when you model out incidence you come out to a 5% to 6% category growth gain. The things that are being done to drive incidence.

Last year we got above that. But we believed after a couple years ago with spiking gasoline prices, etcetera, that you had some drop-off and some just general cutback in Copenhagen and Skoal consumers, who were highly loyal but didn't just quite buy as much.

You saw some of that in the category growth last year. We thought that would go away. We don't get those sort of diagnostics till the end of the year. But having said that, the category has grown above the 5% to 6%. So we are anxious to see those diagnostics as well, to see if that incidence accelerates a little bit more? Or what is driving that above what we would have typically modeled?

Ann Gurkin - Davenport

Okay, and then if you look across your business can you comment on the number of states or the percentage of the business where you still need to work on managing the gap, the price gap? Or maybe where the premium growth is not meeting expectations? Can you give me kind of a number?

Daniel Butler

36 states that represent about roughly 77% of our volume are growing, and we have been pretty consistently at that level for the last several quarters. Frankly, if you look at any business, you are always going to have some portion of states that are issues.

I think this is a very healthy profile. And we look at those numbers every single month. And part of what has made us successful, I think, is managing that at a very detailed level. So we are always focused. There is always going to be some areas where we have got issues. But frankly, there's also states that are growing 5, 6, 7%. So it is a mix, and we manage that very proactively.

Murray Kessler

Yes, it is not just price gap. There could have been a state tax increase that affects a state. There's a number of things that will drive how we continue to make modifications going forward. But you know, fundamentals are good. We are delighted to be sitting here where we are seeing now, quarter after quarter, where the fundamentals are strong.


Your next question comes from a line of Christine Farkas of Merrill Lynch.

Christine Farkas - Merrill Lynch

Thank you very much and thanks for taking the question. Just quickly, your margins expanded 300 basis points in tobacco. Murray or Dan, could you maybe quantify how much of that came from Project Momentum? You must know how much you have saved in that segment, versus the volume and mix improvement.

Murray Kessler

Well, the gross margin in tobacco was down about 30 basis, 40 basis points, so Project Momentum had a gigantic impact on the quarter.

Christine Farkas - Merrill Lynch

Okay, great. Then with respect to the balance sheet, Ray, I know you may not be giving targets this early, but the shareholder equity turned negative this quarter. Can you comment a little bit about targets there or what we should see going forward?

Raymond Silcock

It's an interesting question. You are right that we went slightly negative on our shareholder equity. Because that’s really a legacy to some extent of the antitrust payments made over the last few years, and we don't consider that to be a major issue for the company.

Christine Farkas - Merrill Lynch

Okay, great. Then just finally, Murray, with respect to your overall loyalty program spending, the run rate, how is that looking now? Has that basically stabilized? Are you still adding to that now? How would you put the spend on Copenhagen and Skoal in the fourth quarter in that bucket, or would that be separate?

Murray Kessler

Yes, I think what you saw us do last year, as we were learning about it, was we went out with an initial estimate and then we kept some funds flexible. We did that on purpose, so we could make adjustments. We ended up spending a little bit more. We got it kind of figured out by the mid-half of last year. Then when you carry through that to this year, that was the increase in spending that we had announced in December that was associated with the trade plan for this year.

This year has been completely different. We have just been executing to plan. We haven't thrown any more dollars that way. It has just executed exactly as we thought. Dan and his team do a remarkable job. We have this spectacular trade marketing team that make these adjustments and work with the field to do that.

So it may move from state to state and tweak programs, etcetera. But it really hasn't taken us throwing a lot of fuel to that fire. That’s why I think you see us continually beating estimates. Because otherwise, what I basically said is we keep spending and we would hold to the 10%, but we keep raising guidance because it is translating into higher volume.


Our next question comes from the line of Karen Lamark of Federated Investors.

Karen Lamark - Federated Investors

I understand there is some pipeline fill for new and re-launched products. But, I wanted to ask you a couple questions about receivables. It looks like they're up nearly 40% year-over-year, just looking at your historical filings. Can you give us a little bit more color?

How much of the increase is the Wine acquisitions? Then maybe adjusted for that, separate the increase into Wine and Smokeless and maybe if you could, just tell us a little bit more about how much of the increase might be sell-in versus sell-through? Thanks.

Raymond Silcock

Well, the increase in receivables is principally driven by the growth of our Wine business. There is a different profile in a number of days outstanding between Wine and Smokeless Tobacco. So it is the growth of our Wine business has driven our receivables up. Could you restate the second part of the question? I am not sure I got that.

Karen Lamark - Federated Investors

Well, I was basically trying to understand how much of the increase in inventory, particularly on the Smokeless side, might be driven by inventory, sales. Your sales growth was driven more by pipeline fill as supposed to or deals with your retailers, say.

Murray Kessler

Just to be clear, we don't believe we had any inventory increase in this quarter relative to last quarter. There was a pipeline associated with the new Cope launch. But it's about equal to the pipeline that was in the prior year associated with the Bandit’s re-launch.

On Smokeless Tobacco, our terms are zero days. So we don't extend credit. We direct debit on the day we ship. I mean, it is all the Wine business. And it is not the Wine business doing some kind of special terms; it is adding Stag's Leap and it is them growing like gangbusters.

Karen Lamark - Federated Investors

Are you giving any kind of guidance, what we should expect year-over-year then, by the end of the year? Because, it is quite a big jump. And I understand the Wine growth was quite high. But I'm just curious what you expect at the end of the year?

Raymond Silcock

We are not giving specific guidance at that level of detail on the balance sheet. But the Wine business does continue to grow and you could expect to see a modest increase over the course of the fourth quarter.

Murray Kessler

Yes, now you have a full quarter of Stag's Leap. It will be a big fourth quarter for Wine.


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

David Adelman - Morgan Stanley

I wanted to ask you a question about the gap between your RAD data on discount volume versus the shipment numbers that were released today by each of the major manufacturers. And I know that there is some timing distortion between the two.

But the RAD data for price value up was up, I think, 14% or 15%. Your shipments were up over 16%. Reynolds was up 18%. Swedish Match was up 34% for the third quarter. So I am just curious, how do you reconcile those two things? What do you think is happening?

Murray Kessler

Well, I think, what is happening is it is accelerating, right? As you're talking about our specific brands, we're reporting a 26-week number, and the programs that we launched to build distribution and all that happened in the middle of that 26-week period. So, you're seeing a higher level of shipments from us than you're seeing RAD, because it is a six-month RAD period versus a three-month shipment period.

David Adelman - Morgan Stanley

So, do you think you're going to see some reacceleration in the discount segment's growth given those manufacturer shipment trends this quarter?

Murray Kessler

Yes, I'm not going to give you exact numbers, but we get more recent periods and we are not seeing anything.

Daniel Butler

I will tell you, we see the data, obviously, in more detail than you do. We present the six-month data, but within a month you will see a spike. There are promotional spikes that happen. But fundamentally you're talking about, we're reporting on a six-month period ended September 8, and the other companies are reporting on their shipment volume for the third quarter. So that accounts for a lot of the difference.


And your next question comes from the line of Thomas Russo of Gardner Russo.

Thomas Russo - Gardner Russo

You had said that Ray was going to bring a whole set of new skills with him to UST. But little did you suggest that he would bring a halt-trading opening on the first conference call he did for quarterly results. So, I congratulate you on your selection. Congratulations.

Murray Kessler

Thanks, Tom.

Thomas Russo - Gardner Russo

Yes, congratulations on your numbers. Murray, could you just spend a second talking about state excise taxes and how progress is underway there? And also the federal excise tax threats that you might see.

Murray Kessler

Well, federal excise tax, I think everyone is aware that the President vetoed the SCHIP bill and that the House sustained the veto. I think as late as last night there was debate, and a goal by the Democrats to resubmit a SCHIP bill within the next couple of weeks, and they have stated that. And I don't think they came to an agreement; but they are trying to negotiate and redo it. So, it’s very much active.

Whether that is enough to be able to convince the administration that they believe it’s addressed their concerns and that is yet to be seen and there is still negotiation underway, but if the SCHIP bill did not just die; it is very much active.

On the state excise tax equity initiative, we view that as a top lobbying priority and over the long term, we have had five states in the last 12 months, two states earlier this year, a couple close calls earlier this year, and we are active and engaged in a number of states.

There are not that many states left in legislative session right now on a state level, but there are a number, and we are actively engaged in discussions in each of those areas. Plus hard at work at educating for the beginning of next year when the sessions come back.

Thomas Russo - Gardner Russo

Great, thank you. Dan, you’d mentioned the constant effort to recruit from smokers and just spend a second, if you could on the conversion process. What’s your learning--now that you have been at it for a long time--about the products where the smokers are most likely to convert into your category; and then products that they end up using as they renew as smokeless consumers?

What have you learned about where you are pulling them in through, what offers, and then how do they stay in the category, premium versus sub-premium?

Daniel Butler

In terms of how they enter the category, first of all, the majority of people who enter the category are smokers. And the majority of those, about two-thirds of new adult consumers who enter the category enter through the premium brand.

Then if you cut that down a little bit further, the conversion is primarily in the more approachable long cut format, where we've had a lot of innovation, particularly on the Skoal brand and most recently on the Copenhagen brand through new Cope.

And very disproportionately, while pouches are about 5.6% of category volume, they’ve a much higher share among new-to-category consumers. So, the portion pack format as an approachable, discreet, easier-to-use product is working very well at converting new-to-category consumers.

Thomas Russo - Gardner Russo

And, if they come in with the pouch because of the ease of sort of access, do they stay pouch consumers? And, if they want to stay pouch consumers, but they would be inclined to drop into sub-premium, do you have sort of products for them? What is your experience?

Daniel Butler

Our experience would be that I think when people come into pouches they tend to stay there. To this point USSTC premium pouches are about 93% of portion pack volume. There is very small price value activity and I think you can expect, given the growth in the segment that you may see more there. But we’ll be ready to compete wherever we feel we need to compete. Right now, I think we have a very compelling value proposition in our premium portion packs. They are growing strong double digits, and I think that will continue.

Murray Kessler

Yes, if you remember back, Tom, it has got to be three years ago now, sort of preemptively we went out and we tested Red Seal pouches, and we tested it in sort of high price value markets and they didn't get much traction.

You’re already starting with a premium consumer and it is a very high appeal to a smoker and in general it is highly differentiated. So, for whatever reason, we have seen even higher loyalty levels among pouches and less from our own test market experience, less willingness for trading down.

But to answer the question, if we needed to, we already did it. We already have the packaging. We already have the label. Whether you did it on Husky or Red Seal, it’s easy for us to do. But we would have to see that there is really a justification.

And remember, price value brands, there's a lot of them. In general, on any individual SKU they tend to move at a fraction of the volume of a premium brand. When you are starting with a whole category segment that is only 6% or 7% of the category and do a fraction of that, it is questionable whether there is sufficient velocity to hold that at retail.

Thomas Russo - Gardner Russo

Yes. Thank you. And then last question for Dan. The shift in your sponsorship for to PBR, how do you square the clear target and sort of likely consumer overlay there to the ability for your sponsorship dollars to grow the category to new users?

I can imagine that you overlay quite closely to the PBR audience. How does the PBR audience then relate to the rest of the country and the possibility of speaking to other nonusers possibly interested in coming into the category?

Daniel Butler

Well, I think, we are active in the PBR today. We are successful within those events at bringing adult smokers into our adults-only facilities and sampling them with the product. So, I think it is a rapidly growing sport; it is beautifully aligned with the Copenhagen brand.

But importantly, it does not mean we’re going away from the other venues. We will continue to have a very strong presence in the NHRA as we have for over 20 years. We will continue to work with Don the Snake Prudhomme and we will have a race team out there and we will continue to interact with that consumer group.

It is really just a matter of shifting the branded portion of the sponsorship over to another property. The fact of the matter is we have two powerful brands and a branded sponsorship has resided with Skoal for a long time. And we think it is appropriate to kind of share the wealth a little bit, if you will.

Murray Kessler

It is time for a rotation. And we are reaching in our one-on-one events more smokers this year than we did last year. We, in our plans, preliminary plans and again we will share that in December, we will reach more smokers next year in our plans than we do this year in those events.

This is about brand imagery and reinforcing the authenticity of the Copenhagen brand. It’s a perfect match for the brand because this is still an image category. When a smoker converts, he's going to want to associate the image. In our category, the rugged authentic American original is Copenhagen.


You have no questions at this time. I would now like to turn the call back over to Murray Kessler, CEO, for closing remarks.

Murray Kessler

Once again, we are pleased to report strong financial results. We are pleased to report that we're delivering on our commitments. We look forward to seeing everybody at our investor conference, where we share plans for next year. Thank you for your continued interest in UST.

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Source: UST, Inc. Q3 2007 Earnings Call Transcript
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