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Executives

 

Martin L. Orlowsky - Chairman, President and Chief Executive Officer

David H. Taylor - Chief Financial Officer

Mark McCaul - FB

Analysts

 

Judy Hong - Goldman Sachs

Filippe Goossens - Credit Suisse

Niki Modi - UBS

Ann Gurkin - Davenport & Co.

Erik Bloomquist - J.P. Morgan

Christine Farkas - Merrill Lynch

Caroline Lintz - Pioneer

David Adelman - Morgan Stanley

Adam Shulman - Citigroup

Presentation

 

Lorillard, Inc. (LO) Q2 2008 Earnings Call July 28, 2008 9:00 AM ET

Operator

 

Welcome to Lorillard’s second quarter 2008 earnings conference call. (Operator Instructions) I would now like to turn the call over to Mark McCaul from FB.

Mark McCaul

By now you should have received a copy of the company’s second quarter 2008 earnings release. If you have not please call our offices at 212-850-5600 and we will you send a copy. Speakers we have on today’s call are Marty Orlowsky, Chairman, President and Chief Executive Officer; and David Taylor, Chief Financial Officer of Lorillard.

Before we begin I would like to remind you that some of the comments made on today’s call and some of the responses to your questions may contain forward-looking statements. Statements are subject to the risks and the uncertainties as described in the company’s earnings release and other filings with the SEC. I would now like to turn the call over to Marty Orlowsky. Go head.

Marty Orlowsky

 

Thank you. Good morning everyone. We are pleased to have this opportunity to report Lorillard’s Inc, first quarter results as an independent publicly trading company. We look forward to a continuation of our core strategy of balancing profitability and Newport share growth. Our leading position in the Menthol segment and our focus on operational excellence will support our ongoing commitments of long-term success and achieving enhanced shareholder value.

Our recent announcement of a $400 million share repurchase authorization is a demonstration of our interest in furthering shareholder value as part of our overall strategy. On an overall basis I believed our financial and market performance results for the second quarter of 2008 are consistent with our core strategy of balancing Newport share growth and profitability as well as there’s one of the key factors that is valuing our decision making all the time and that is periodically adjusting promotion spending for the Newport based on the competitive environment and the brands own trend.

This approach has and will continue to reappoint Lorillard for a potential long-term profitable share growth. While the total industry wholesale unit shipments for the second quarter of ’08 were down 3.2% versus the second quarter of 2007, Lorillard’s total wholesale shipments were down slightly by two tenths of a percent and Lorillard’s domestic shipments were down slightly by one-tenth of 1% comparing to the same period.

Domestic Lorillard shipment share for the second quarter of ’08 was 10.55%, an increase of 0.33 of a share point over the second quarter of 2007. Newport's domestic shipment volumes reflected a 1.5% decline in the second quarter of ’08 versus the second quarter ’07. This difference can largely be attributed to a substantial quantity of promotional units shipped during the second quarter of 2007 with no corresponding activity in the second quarter of ’08.

Newport's shipments share for the second quarter of ’08 was 9.57%, an increase of 0.17 of the share point over the second quarter of 2007. On a sequential quarterly basis Newport improved its second quarter 2008 wholesale domestic shipments as compared with the first quarter of this year by 12.2%. Based on Lorillard proprietary retail database Newport achieved a 9.93% share with a second - of the total industry for the second quarter of ’08, an increase of 0.43 of the share point versus the second quarter of 2007.

The total industry Menthol segment accounted for 28.71% of industry retail shipments in the second quarter of ’08, which was an increase of 0.44, almost half of a share point versus the same quarter a year ago. Newport's share of the retail menthol segment was 34.59%, up almost a full segment share point of 0.99 over the second quarter of 2007, and now I am going to turn the discussion over to David Taylor, our CFO who will review the financial results for the second quarter of 2008.

David Taylor

Thanks Marty. Net sales for the second quarter of 2008 were $1.07 billion compared to $1.056 billion in the second quarter of 2007. This increase of $14 million is a result of an increase in net or revenue producing units sold and the impact of higher net average selling prices.

To company increased its wholesale prices to customers on substantially all of its brands by $0.10 per pack in May, which contributed to this increase in average prices. These factors were partially offset by the effect of a slightly different product mix, with Maverick units making up a larger portion of the total than in last year’s mix.

In addition, sale promotion costs accounted for as a reduction in net sales were higher in the second quarter of 2008 than in the second quarter of 2007. Gross profit was essentially unchanged from the prior year, as the increase in net sales was offset by increases in amounts due under the states Settlement Agreement.

Selling, general and administrative costs increased by approximately $8 million to $91 million in the second quarter ’08 from $83 million in the second quarter of ’07. This increase is the result of costs related to the separation transaction of approximately $5 million and legal fees which were approximately $4 million higher in the second quarter of ’08 than in the prior period. This increase in legal fees is primarily a result of higher defense costs for the Engle project cases.

Net investment income was $5 million in the second quarter of 2008, compared to $22 million in the second quarter of 2007. This $17 million decline in investment income is the result of lower average yields in 2008 as compared to 2007, lower average cash balances invested in 2008 than in 2007 and the lack of significant income from limited partnerships in ’08 as compared to 2007.

As we previously described, Lorillard substantially reduced its investments in these implemented partnerships in the first quarter of 2008. We expect that investment income will continue to be lower than that reported in 2007 as a result of these factors.

Our effective income tax rate for the second quarter of 2008 was 39.2% as compared to 37.3% in the second quarter of 2007. This increase is primarily due to the inability of Lorillard to use the full manufacturer’s deduction for the pre-separation period and the non-deductibility of certain separation risk expenses.

The company will file two tax returns for the two tax periods, one for the pre-separation period and one for the post-separation period and as a result of the timing of our taxable income and the required allocation of certain items between these two tax periods, our manufacturer’s deduction was limited. We expected our effective tax rate for the full-year will approximate 38.1%.

Net income for the second quarter of 2008 was $217 million or $1.25 per share, as compared to $239 million or $1.37 per share in the second quarter of ’07. For the first half of ’08, net sales increased $22 million or 1% to $1.991 billion from $1.969 billion in the 2007 period.

Operating income declined to $619 million in the first half of ’08 from $646 million in the 2007 period. Separation related expenses for the first half of ’08 totaled $18 million. Net income for the first half of 2008 was $391 million or $2.25 per share as compared to $441 million or $2.53 per share in the first half of ’07. We have indicated in previous presentations that we expected to experience revenue growth of 3% to 4% and maintain operating margins in the 32% to 33% range for 2008 and at this point we see no reason to change that view.

As previously announced the board has authorized a $400 million share repurchase program. This action was taken in recognition that not only does the company have debt capacity; it also had high cash balances and liquidity. Management and the Board concluded that this element of the balance sheet should be used to fund share repurchases, even though we have not yet completed any debt finances. This announcement does not in anyway change our previously announcing intent to enter the debt markets.

With regard to our announced intent to borrow approximately $750 million to $1billion, we continue to expect to accomplish this debt issuance and we are making progress too in that regard. I should caution all who are listening that we do not intent to announce our expected timeline for a targeted closing date during settlement to create unwarranted concern and consternation should there be any sort of delay.

While we fully expect to accomplish this borrowing I should also note that the timing structure and amount of that indebtedness will depend on a number of factors including the credit and interest rate environment in the future. In addition I know that many of you expect a dividend announcement in the near future. The board will take up the matter of a quarterly dividend in the next few weeks and you should expect an announcement shortly thereafter.

With that we’d like to open the line for questions; Operator.

Question-and-Answer Session

Operator

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

Judy HongGoldman Sachs

I wanted to get your perspective on the promotional environment in the second quarter. I know your revenue per unit wasn’t up as much as sort of your long-term target. I’m wondering what was the environment like in the second quarter particularly versus the first quarter and then what gives you confidence in the back half of the year that trends will improve when you kind of get back to that 3% to 4% revenue growth for the full year.

Martin Orlowsky

 

Well, for one thing overall the environment in the second quarter wasn’t in general terms the major competitor; wasn’t too specifically different than the first quarter and in our case we did spend a bit more, it was about flat in the first quarter versus the first quarter of ’07, but it was a little higher than we had traditionally presented at.

The second quarter was simply a continuation of that same sort of level of spending that we had in the first quarter, so there really wasn’t any significant deviation in the second quarter for us, but we were spending at a higher level and on a comparative basis with the first and second quarter’s of 2007, we would expect as we move through the third and fourth quarter’s of ’08 the comparison between ‘07 and ‘08 will become a little more favorably disposed towards ’08 versus ’07.

Judy HongGoldman Sachs

Okay and then Marty, just in-terms of the industry, the shipments were down 3.2% in the second quarter. It looks like it was a moderation from the first quarter; I’m wondering if you can talk about why you think the decline moderator in the second quarter versus the first quarter from an industry perspective and secondly obviously given the economic pressure we’re seeing some signs of trading down in some of the other tobacco categories; I am wondering if you can talk about what you’re seeing in the cigarette category vis-à-vis trading down or like thereof to the discount segment?

Martin Orlowsky

 

Well, first let me point out that the second quarter industry shipment volume was essentially the same as the first quarter; I think the first quarter was 3.2% or 3.3% decline and the second quarter of ’08 was actually an improvement of one tenth of a percent, so I don’t think the overall industry pattern per se has changed, but I necessarily view that on an overall basis as something impacting the industry with respect to any kind of price pressure.

However, obviously on an individual basis there were changes. I will not speak to, necessarily towards the other companies, but other two major companies what their results were at. They’re going to be reporting their own towards the end of the week, but I think the same general pattern continued in the second quarter for all companies as they were in the first. So I don’t see any major trend difference as a result of second quarter performance on the volume basis and I can’t remember the second part of your question.

Judy HongGoldman Sachs

 

Trading down to the discount segments?

Martin Orlowsky

 

Obviously, we’ve seen a somewhat slight degree of growth on a year-over-year or quarter-over-quarter basis in a discount segment and I should say the deep discount segment, not necessarily the middle tier discounted brands. So there is a degree of that occurring, however we at Lorillard have not necessarily seen any particular erosion of business due to down trading.

I think Newport’s market share even though it was down slightly in volume, the second quarter of this year versus second quarter of ’07; as I explained it was a huge difference in promotional units that we shipped in the second quarter of ’07. If you took that out, we we’re probably even on a positive basis. So we had not witnessed any material deterioration of our business due to account rate.

Judy Hong – Goldman Sachs

Okay, and then David some of the one-item items or some of the items that you called out in the second quarter, the $5 million expenses related to the spend-off, some of the tax items; how should we think about those items; are they just really the second quarter one-item impact or some of them staying for the balance of the year?

David Taylor

Well Judy, I think we’ve said before that the separation related expenses are one thing and then the incremental costs associated with operating and public company are something else. We think we’ve accounted for all the separation related expenses, the transaction related expenses during the second quarter. We don’t see any significant items yet to hit the P&L. Now going forward we will continue to bear the costs of operating as an independent public company. I think we’ve estimated those would be about $9 million of year.

The tax rate in the second quarter is due to some, second quarter discrete kind of items, but I think I’ve said during my comments that we expect the tax rate for the full-year to be in this 38.1% neighborhood.

Judy Hong – Goldman Sachs

Okay, and that’s sort of an ongoing rate beyond 2008, 38% number?

David Taylor

No, beyond 2008 it would likely fall below that, but I have not prepared to give you an estimate of what that rate would be.

Operator

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

Filippe Goossens - Credit Suisse

A couple of housekeeping questions first if I may; David can you give us the number of promotional units that were shipped in the second quarter of ’07 that Marty referred to earlier?

David Taylor

The number of units consists of brand product were about $200 million.

Filippe Goossens - Credit Suisse

Then secondly David, can you tell us what the cash number on the balance sheet would be if we subtract from that the accrual for the MSA payments?

David Taylor

I’ll get back you on that Filippe.

Filippe Goossens - Credit Suisse

Then my kind of more relevant question; Marty, have you seen any meaningful impact from the New Your state that’s increased during the second quarter?

Marty Orlowsky

We have not. As you well know that tax was implemented effect, I believe June the 6th and we have not seen any effect of that on our average shipping volumes on a weekly basis for the month of June. There’s only a portion of the second quarter that would be effective.

David Taylor

Filippe, let me get back to you about the balance sheet; it’s included in the press release, the cash and cash equivalents number is $1.158 million and the accrued settlement costs is $604 million.

Filippe Goossens - Credit Suisse

So Marty you have not seen then basically any kind of like trade loading occur in the state of New York ahead of the tax increase, correct?

Martin Orlowsky

No, I didn’t say that. There was a degree of loading that took place. What I said was based on our pattern of shipments in the state, as we looked at our retail database, there was trade loading at both levels, both the wholesale and the retail level; however, even with that trade loading we did not see any major disruption to our average weekly; the pattern if you will, the take away by consumers that’s measured by our retail database.

Filippe Goossens - Credit Suisse

Then a more kind of strategic question Marty; if you look at year-to-date shipment volumes for the smaller brands Kent, True, Max, it becomes a smaller and smaller portion of your overall business. Is there a reason why to stick with these kind of like sale brands if you want to call them like that; is there a reason from an overhead absorption prospective why you’re sticking with these brands and perhaps not channel all that support to let’s say Maverick, which continues to do very well in the current environment?

Martin Orlowsky

Well Filippe we don’t spend a penny on those brands, but there is nothing to re-channel, number one; and why do we stick with them, because they’re profitable and they through up a huge amount of cash even though they represent relatively smaller fractional market shares. So there really isn’t any reason to consider doing anything other than what we’ve been doing and this has been a long-term part of our strategy, which was essentially to harvest the profit on these brands. It costs us nothing to market, there is an absorption factor obviously; there is nothing to move to any other brands.

Filippe Goossens - Credit Suisse

Okay, then coming back to the dividend question because obviously on everybody’s minds here; can you give us an update perhaps on the individual Engle cases and whether the Engle cases on their own could have any impact on the boards decisions whether to move directly towards the full increase and the dividend or whether you might still be a little bit cautious early on?

Martin Orlowsky

 

Filippe, the board will consider everything both earnings patterns and expected demands on liquidity in determining the declared dividend. I think the board will consider all matters whether real or contingent liabilities in that consideration and it will be way pretty mature for us to comment on the board’s deliberations.

David Taylor

Besides that nothing really has changed materially from the past in terms of litigation outcomes. So, if there is something that we have to account for, we will, just as we have in the past. I don’t see that as being any unique issue, but the boards considered anything else we’ve just dealt with.

Filippe Goossens - Credit Suisse

Okay and then my final question Marty; again a more strategic question as we feel very strongly that the chances of menthol being banned over the near-to-medium term is next to zero; that being said the stock has been somewhat volatile. If FDA regulation were not to be passed this year and that headline risk kind of stays with us for us for a while, does that at all change the way you think about the business? In other words any though about perhaps looking at opportunities to diversify the portfolio and therefore to diminish the headline risk

Martin Orlowsky

 

We are not dealing with headline risk, maybe some investors that dealt with headline risk over the past few weeks. Clearly looking at the share price movement one can include that we don’t make strategic decisions based on headline risk, we make strategic decisions based on business fundamentals and so one way or the other, if it makes sense for us to acquire something under any circumstances we’ll consider that; if it doesn’t, we won’t. It has nothing to do with the full headline risk.

Operator

 

And your next question comes from the line of Nik Modi of UBS. Please proceed.

Nik Modi - UBS

Just a real quick question; the settlement cost, we should maybe be expecting a slight step up just given the inflation factor, correct?

David Taylor

The inflation factor does cause the settlement cost to continue to step up, yes.

Nik Modi - UBS

Okay, no I just wanted to clarify that. That was actually it; all my other questions were asked. Thanks.

David Taylor

Alright, this is a point of information; we’re constantly adjusting the accrual rate based on anticipated inflation factor, so it’s still into our sort of process.

Operator

 

And your question comes from the line of Ann Gurkin of Davenport; please proceed

Ann Gurkin – Davenport & Co.

 

I was wondering if you could talk about performance of the business in the different months in the quarter and then how is the business doing in July, cigarette sales?

Martin Orlowsky

We don’t speak to current; we’re not going to speak to the current month. We’re just reporting on the second quarter. Sorry.

Ann Gurkin - Davenport & Co.

Alright, what do you say that you see a change in difference as you move through the quarter, in terms of volumes?

Martin Orlowsky

I don’t think I want to comment on the current quarter, frankly.

Ann Gurkin - Davenport & Co.

The second quarter you won’t comment on?

Martin Orlowsky

I am sorry, I misunderstood your question. Could you repeat that?

Ann Gurkin - Davenport & Co.

Can you comment on the cigarette sales during the quarter by month? Do you see a change in the sales volumes?

Martin Orlowsky

Yes, in our case we saw improvement as we moved through each of the months for the second quarter and so that was the pattern. I really don’t remember what the industry sort of pattern was on a monthly basis for the quarter, but certainly in Lorillard’s instance it was gradual improvement as we went through them. In fact June was probably, not probably, June was our strongest month.

Ann Gurkin - Davenport & Co.

We’ve heard July has been extremely strong; I mean can you comment on that at all for the industry in general?

Martin Orlowsky

Well I don’t know about the industry. In fact we don’t even have final results for the July. Frankly, we still have a couple of days left and we don’t have complete results. I really can’t comment on the industry pattern and I'll just say this in general; there has only been a very slight seasonality factor affecting our shipments positively in the third quarter, so that obviously hopefully we have some favorable impact, but clearly that seasonality factor also applied to the last third quarter of ’07. So, but there is a slight degree of seasonality involved, so hopefully we should have a strong third quarter.

Ann Gurkin - Davenport & Co.

Great and then if I can just get an update on your relationship with Swedish Match and your venture on the other tobacco products, any updates there?

Martin Orlowsky

There’s really not much to update on the joint venture with Swedish Match. I think as your aware probably we expanded into the State of Georgia; we’ve been trying to use marketing tests, so we are now in two states; Ohio and Georgia. We’ve seen positive results there, but we’re not making any announcements about any future decision regarding that proposition.

Operator

And your next question comes from the line of Erik Bloomquist of J.P. Morgan; please proceed.

Erik Bloomquist - J.P. Morgan

Just a question on the buyback and in terms of the timing; is it fair to think that we could have the $400 million buyback begin post to next board meeting and then secondly could you just give us the date before that board meeting when we might then post that meeting expected divided announcement?

Martin Orlowsky

The board meeting to consider the dividend will likely occur in the next several weeks as I said before and the announcement will likely follow the approximate pattern of announcement and record date for CG share, that’s the likely pattern. Okay, so if you go look back at the old CG pattern for dividend declaration and payment, I would expect it to follow that same approximate pattern and the $400 million share buyback as you know you can’t really -- that’s the open market purchases and we’ll adopt that plan to enter the market during an open window.

Erik Bloomquist - J.P. Morgan

Okay, but we could expect that to begin sometimes this year?

Martin Orlowsky

Yes.

Operator

And your next question comes from the line of Christine Farkas of Merrill Lynch; please proceed.

Christine Farkas - Merrill Lynch

First, Marty if you could talk about the net pricing for the quarter, you indicated net pricing was up, but this is offset by mix; can you give us an indication what that level looked like in terms of percentage increase or pennies per pack?

Martin Orlowsky

I think it was up. The net pricing, I don’t know off hand, we’re looking.

David Taylor

I don’t have the net price…

Martin Orlowsky

We don’t have that.

Christine Farkas - Merrill Lynch

Or gross pricing. I mean either?

David Taylor

Maybe there’s several factors that work here Christine; first, the pricing which we enjoy the benefit of the price increases that I talked about before. We had more revenue producing unit in the second quarter of ’08 than we had revenue producing units in the second quarter of ’07. Remember Marty talked about the $200 million units of granite units in ’07; so you got an increase in net volume, you’ve got an increase in net price and that is offset partially by this mix issue and offset by increased consumer spending compared to ’07.

Martin Orlowsky

Where there is a reduction on sale relative to promotion, plus we have a price increase in middle of May or early next year, I can’t remember exactly when, but that had some impact as well. It’s a complex number of factors that are involved here.

David Taylor

And we have to really talk about the quantifying each individual component, because we’re clear of announcing the consumer spending amount.

Christine Farkas - Merrill Lynch

No, that’s fair. I appreciate that; I’m trying to understand if your pricing and your promotional levels along with the adjusted volumes if that would have been up if we ignored the mix impact?

Martin Orlowsky

Yes.

David Taylor

Yes.

Christine Farkas - Merrill Lynch

Okay, great and then a second question just with respect to the separation costs; you have indicated $18 million in separation costs had occurred in the first half and you’re now completed with that and you’ve also shown the target on your road show of $25 million of total separation or transition expenses in the first year; is that $25 million still on target and still intact?

David Taylor

 

Yes, the $25 million was the transaction related separation costs and the estimate of that amount of $9 million that we would expect to incur during 2008 since we’ve…

Christine Farkas - Merrill Lynch

Right; so a portion of a full-year of that $9 million?

David Taylor

 

Yes.

Christine Farkas - Merrill Lynch

Okay great, and then with respect to the legal fees which were higher this quarter again, can you give us an indication of what that level could look like per quarter or in the second half or what a good run rate would be?

David Taylor

 

I’, afraid we can’t and the reason for that is that the legal costs are being affected by activity related to the Engle Progeny cases and it’s very difficult to project the amount of activity that will be taking place this quarter and the next quarter. So, there is no fixed ratio or factor that one can apply and obviously we’ve estimated our legal expense for the full-year which I’m not going to get into here, but it’s going to be more than last year, which I know it’s not very helpful to you but really trying to predict that is not very viability at this point.

Christine Farkas - Merrill Lynch

Okay, on growers payment was it about the same as the first quarter, near $27 million?

David Taylor

 

It might have been a little higher because we had higher share.

Martin McCaul

The growers buy out was personally unchanged.

Christine Farkas - Merrill Lynch

Okay final question then. I know you’ve been asked this about the FDA bill and potentially moving through that house, but can you maybe give us an update as to what maybe new; there’s talk about a potential this week. Is there anything from your perspective that has changed or grown in momentum?

Martin Orlowsky

 

Well, there is nothing fundamentally new that we are aware of with respect to the FDA legislation and as it sits in the House of Representatives. We are not aware of any changes in language as it’s been for the past month or two or anything like that. So, as far as we know the bill continues to be in the same form as it has been; number one.

Number two, I guess the news is that there is a possibility that that bill can be voted on this week or next -- this week actually because I believe this is the last week of the session before they go off on their recess, so there is a possibility and they get voted on as it is as far as we know. It was placed on what they call a suspension calendar which means so amendments can be made to that legislation at this point, so it may be voted on this week, we don’t know for sure whether that will happen.

Operator

 

And your next question comes from the line of David Adelman of Morgan Stanley; please proceed.

David Adelman - Morgan Stanley

 

Marty, I wanted to ask you a few things; first, can you reconcile your characterization that there wasn’t much of a change in the promotional environment in the U.S. cigarette industry from Q1 to Q2 with the fact that you had a fairly material manufactures price increase by both you and the market leader, during the quarter.

Martin Orlowsky

Well, I’m not sure I understand your question with the relationship of the price increase.

David Adelman - Morgan Stanley

Well if you take pricing, normally one would think that on a net basis prices are going up therefore in effect there is less promotion -- on a net basis less promotional activity per pack of revenues going up.

Martin Orlowsky

Yes. Well that’s a change obviously, that’s a arithmetic change, yes. I’m not sure I understand.

David Adelman - Morgan Stanley

I just would have thought that one would characterize the industry therefore as being somewhat less promotional in Q2 than Q1, simply by the fact that there was a price increase, so are you saying that it was largely spent back in the market place?

Martin Orlowsky

No, I’m not saying that, I don’t know that, from what the other company did or did not do. What I was attempting to characterize was that the nature of the activity itself buy downs, free goods promotion, did not change radically in the second quarter versus the first quarter of this year. I’m not speaking to spending.

David Adelman - Morgan Stanley

Okay. You’re talking more about the types of activity in the market.

Martin Orlowsky

Types and the level of activity itself; in other words it was still strong use on the part of some of our competitors, strong use of free goods promotion that was clearly a continuation of discounting at retail otherwise know affectionately as a buy down and so that did not change materially in the second quarter. What the spending relationships where to revenues or as a percentage of sales, I can't really addressed that, I don’t have that information.

David Adelman - Morgan Stanley

Okay; am I correct that subsequence of the announcement of the share repurchase authorization, the company did not buyback any stock during July?

Martin Orlowsky

That’s correct.

David Taylor

Sorry David we wouldn’t enter the share repurchase program except during open window, so the window wasn’t opened during that period.

David Adelman - Morgan Stanley

Okay and then the comment Marty you made earlier about recalibrating MSA accruals based on inflation, is that would happened during the year-to-date because of the Q1 per pack accrual rate; looks like it was a bit higher than the Q1 rates for Lorillard.

Martin Orlowsky

No, we did not change our inflation. We didn’t change our adverse inflation between the second and first quarter.

David Taylor

But the MSA accrual did significantly increase over ‘07 primarily as a result of higher inflation.

David Adelman - Morgan Stanley

 

Okay and then on this issue of both FDA and Menthol, can you speak to us Marty about sort of the effort that you’ve underweighted to get your points across at Congress; how much traction you think you’re getting on those issues and how do you asses the risk irrespective of what may have happen with Menthol language, the presents or absence of it in the FDA language that the Menthol category in the future has somewhat a higher or heightened degree of whether it’s a legislature of a public health scrutiny?

Martin Orlowsky

Obviously we’ve not been supporting the FDA legislation over the past years and as has continued we have attempted to vigorously provide information regarding the Menthol issue to try to cast it in a more objective light relative to the nature of the science which is essentially inconclusive dealing with the Menthol issue. We try to reinforce that and we’ve spoken with many peoples in the Congress about it. We’ve issued a press release not too long ago after the Harvard study on Menthol was issued.

So obviously we are active in attempting to put some objectivity into the equation here in terms of what does this issue actually represents and so we’re very active in that sense. I am not going to speculate on whether or not what the future maybe or not be regarding menthol.

As far as I know menthol is not an issue per se from a science standpoint and is no different to a menthol cigarette as far as we’ve concerned and as far as I know is no different than a non-menthol cigarette. So, unless anything changes there I’m not going to speculate on how anyone’s going to view this thing; all I know is the language today in that bill has not changed essentially.

Operator

And your next question comes from the line of Caroline Lintz of Pioneer. Please proceed.

Caroline Lintz – Pioneer

 

It looks to me like Newport’s out performing that carbonated soft drink industry? Alright, I saw that on your balance sheet the inventory numbers are up a little bit and I’m wondering if you could talk to that and also is there any new product activity in Newport?

Martin Orlowsky

We are still testing a product called M Blend in the State of Pennsylvania that’s been in test for a fair amount of time and we’re still evaluating what the potential for that is. Other than that we’re not dealing with any other new mine extension or version of Newport.Caroline Lintz – Pioneer

And what’s M Blend please?Martin Orlowsky

M Blend, is a unique blend of menthol; it’s different than the other current Newport and we believe that the blend has the feel to competitive menthol smokers and we have an end market; it has the different taste signature than a regular Newport product and we’re evaluating whether or not we can obviously improve our business by generating incremental business through converting competitive menthol smokers to the Newport brand name.Caroline Lintz – Pioneer

Just two other numbers; could you give us the capital spending for that quarter or what your estimates might be for the year and also could you call out what the interest income number was?Martin Orlowsky

Mr. Taylor is looking for it right now.David TaylorWell, alright there’s several number of questions that you had there Carol. First, you asked about inventories; they may have increased from December and that’s primarily as a result of increase within leap inventory, raw materials inventory and it just has to do the timing of our receipts there.

I talked to you about net interest or net investment income for the quarter being $5 million as compared to $22 million last year and we talked about investment income or interest income, that’s all due to the same, except that in the prior year we had significant amount invested in these limited partnerships that threw out a good bit of income in the prior year that we did not have in this year. With respect to the quarters CapEx, it’s really rather minor. I think the quarters CapEx was about $18 million.OperatorYour next question comes from the line of Judy Hong of Goldman Sachs; please proceed.Judy Hong - Goldman SachsMarty, I have a follow-up question on your comment about the FDA bill begin placed on the suspension calendar; does that basically mean that there could be no amendment that could even be proposed and debated on and does the current FDA version really will get voted on by the house and either that passes or it doesn’t pass?

Martin Orlowsky

As far as I know, my understanding is that no amendments can be introduced at this point.

Judy Hong - Goldman Sachs

Okay, and then just Marty, just kind of going back to this promotional question again and I know there is a lot of sort of people looking at your trend in the second quarter and this is a second quarter where you’re operating profit really didn’t show improvement, so I guess we’re just trying to understand -- I understand your strategy of trying to balance share and profit, but it seems like again this is another quarter where you’re probably looking at volume a little bit more, share a little bit in terms versus profitability; so I’m just wondering why you’re really focusing at this point more share versus profitability?

Martin Orlowsky

We’re not focusing on share versus profitability. I think, I’ve tried over many years now to articulate the fact that we don’t manage the business quarter-to-quarter, and so our decision making with respect to supporting Newport in the promotional context is not predicated on share per se in terms of managing it on a quarterly basis.

It is again -- just hopefully not to sound boring, but it is gain due to the fact that we’re looking at the longer-term strength of the brand and we looked at the environment, the brand strength and we make decisions as to how much we’ll spend in promotion and we may adjust that. That’s what we’ve done, that’s what happened in the second quarter and the first quarter.

How that sort of reflects through the rest of the year we’ll determine as we go along in terms of what we think of your profit levels of spending are. We’re looking at beating last quarter’s operating income numbers; we’re looking at building a strong business over the long haul.

Judy Hong - Goldman Sachs

Okay, are there any then sort of changes to the external environment that might upset your ability to balance your share of Newport at a greater cost than it has been historically?

Martin Orlowsky

I’m sorry, could you repeat that?

Judy Hong – Goldman Sachs

If you look at how much your spending on Newport today versus lets say two or three years ago in order to get certain share points, is there any changes to how much you need to spend more today versus say two years ago or a year ago?

Martin Orlowsky

Being honest with you, I’m not sure I can even answer that question. We don’t measure how much of cost per share point difference; I don’t know if I can answer that Judy. There are so many other factors involved, it just depends on other competitive factors at a given point in time; it’s hard for me to answer that.

Judy Hong – Goldman Sachs

Okay, and just a clarification on share buyback, the $400 million that you’ve authorized at this point, that could start now immediately, is that correct?

Martin Orlowsky

Shortly.

Judy Hong – Goldman Sachs

 

Okay, and it doesn’t have anything to do with the board meeting or anything from the timing standpoint?

Martin Orlowsky

No, it’s not tied to our board meeting.

Operator

 

And your next question comes from the line of Adam Shulman of Citigroup; please proceed.

Adam Shulman - Citigroup

I would like to follow up, a couple of questions we’ve had before. You said mostly to David Edelman’s question that the -- from as you reiterated the promotional levels are similar in Q2 versus Q1; I was just wondering, as you went through the month, as you went through April, May, June, is it also true to say that it was similar. In other words I’m asking, did promotion get rather less or more as you went through the quarter.

Martin Orlowsky

No, it’s correct to assume that they were pretty flat through each of the months.

Adam Shulman - Citigroup

And so coming back, to turning that into another question; you said in the second half you had expected to see an acceleration in revenue growth, presumably then that’s only because, the comps get easier. There’s nothing you’re seeing sort of current trading that is making you think life is getting any easier, it’s just the second half of 2007 was a pretty tough period.

Martin Orlowsky

No, I wouldn’t necessary conclude that we are looking for improvement, because the comps will get easier. I think that we will see some strengthening in terms of where our spending patterns are through the balance of the year and what our results might be, so it has nothing to do with sort of viewing easy comparisons.

Adam Shulman - Citigroup

 

But at the moment in June unless at July there wouldn’t be any signs, though I could see on the ground that actually happening there, it’s to do with your plans.

Martin Orlowsky

I’m sorry; I couldn’t understand what you said.

Analyst

 

Well, I guess I mean intrigue; this is how the environment’s -- say for at least up to the end of June as I’m getting into early July hasn’t goes any easier, but nonetheless your bullish about the second half of the year.

Martin Orlowsky

A; I didn’t say that the environment hasn’t got easier or it’s harder or easier or more difficult than it has been. There are some changes that will taking place by some of our competition in terms of their promotional activity that may or may not have some positive or affect or otherwise on what we are doing, number one; number two, what I’m saying is that based on our outlook for the second half of the year we believe that we will have stronger results on a comparative basis and relative to our prior quarter performance.

Operator

 

And your next question comes from the line of Filippe Goossens of Credit Suisse; please proceed.

Filippe Goossens - Credit Suisse

Just a follow up question; with regard to supply and demand for the tobacco leaves Marty, can you just gives us an update one, in terms of how far out you guys typically buy and then secondly, kind of more your take on the current market because our sources seems to indicate there is a little bit of tightness in that market, thanks.

Martin McCaul

Yes, that’s true. It is a tighter market, it has been a tighter market for the last year or so and we are out at least two years because of the aging issue that we put the tobacco through. So we’re a couple of years out and well there will be and we do expect there to be increases in the cost of leaves in the near future; we don’t think they will be materially impactful on our cost structure, but it will have some impact.

Filippe Goossens - Credit Suisse

In other words given that everybody talks about price inflation is there anything within your cost architecture Marty that would be subject to higher raw material price increases, shipping, packaging costs, anything that you can…

Martin Orlowsky

Just as in any industry the cost of raw materials are increasing, however, I don’t accept that the nature of those increases will have some form of disproportionate negative impact on our overall cost structure. It will affect it clearly, but we’re not operating on the same kind of margins as some other industries do, so it doesn’t have as much of a direct impact as it might for someone in other industry.

Operator

And your next question comes from the line of Christine Farkas of Merrill Lynch. Please proceed.

Christine Farkas - Merrill Lynch

Thanks so much for taking the follow-up. David, just as a housekeeping you’ve mentioned that grower’s payments in the second quarter were about unchanged; did you mean unchanged for the second quarter of ’07 or the first quarter of ’08?

David Taylor

No, I mean it was the second quarter of ’07.

Operator

And there are no further questions. At this time I’d like to turn the call back over to Mr. Martin McCaul, for closing remarks.

Martin McCaul

Thank you operator and thank you for joining us today; this concludes our call for today and we look forward to speaking with you next quarter.

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Source: Lorillard, Inc. Q2 2008 Earnings Call Transcript
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