The Carlyle Group Inc. (CG) Q2 2007 Earnings Report, Transcript and Summary

Good day and welcome to this conference call to discuss Loews Corporation 2Q 2007 results. At this time, all lines have been placed in listen-only mode. After the speakers’ remarks, there will be a question-and-answer period [Operator Instructions]. Thank you and it is now my pleasure to turn the call over to Darren Daugherty, Director of Investor Relations for Loews. Please go ahead sir.

Thank you, Melissa. Good morning everyone and welcome to Loews Corporation’s second quarter 2007 earnings conference call. A copy of the earnings releases for Loews Corporation and Carolina Group maybe found on our website www.leows.com. Also on the call this morning are Jim Tisch, the Chief Executive Officer of Loews and Peter Keegan, the Chief Financial Officer of Loews, and they will be joined by Marty Orlowsky, Chief Executive Officer of Lorillard. Before we begin, I’d like to make a few brief disclosures concerning forward-looking statements. This conference call will include the use of statements that are forward-looking in nature. Actual results achieved by the Company may differ materially from those projections made in any forward-looking statements. Forward-looking statements reflect circumstances at the time they are made and the Company expressly disclaims any obligation to update or revise any forward-looking statements made during this call. This disclaimer is only a brief summary of the company's statutory forward-looking statement's disclaimer. We urge you to read the full disclaimer which is included in the Company's 10-K and 10-Q filings with the SEC. I would also like to remind you that during this call today, we may discuss certain non-GAAP financial measures. With regard to such, please refer to our security filings for reconciliation to the most comparable GAAP measures. After Jim, Peter, and Marty have discussed our results, we will have a question-and-answer session. If you would like to ask questions and are listening via the webcast, please use the dial-in number to participate 8776922592. I will now turn the call over to Loews Chief Executive Officer, Jim Tisch.

Thank you, Darren and good morning everybody. Judging by the stock market reaction to our reported earnings, you’d think we had a miserable quarter but in fact Loews and all its subsidiaries reported excellent second quarter results with positive underlying trends from previous quarters remaining in track. Earnings per Loews common share increased to $0.95 up from $0.85 in the second quarter of last year. Strong results from Diamond Offshore and improved investment income were the primary drivers, although, each of our subsidiaries is performing well. Earnings per share of Carolina Group increased to $1.30 from $1.09 in the second quarter of last year. CNA reported another very strong quarter, reflecting the Company’s continued focus on improving operating fundamentals. Net operating income was the highest ever reported and a combined ratio for P&C operations decreased by over 100 basis points to 94.9% for the first half of ‘07 versus the first half of last year. As the insurance markets softens, CNA is well positioned to manage through the business cycle with disciplined underwriting and claims management and its well diversified portfolio of commercial property casualty products and services. Diamond Offshore achieved another quarter of record revenues and earnings. The international markets for semisubmersibles and jack-ups remains quite healthy and were characterized by strong leading edge day rates and improving duration of contract term. In contrast, the Gulf of Mexico jack-up market continues to exhibit some pricing weakness. Accordingly, Diamond has announced that another of its jack-up rigs, Ocean King has departed for the international market where day rates are stronger. Also announced was the 10,000 feet water depth capable semisubmersibles Ocean Endeavor has commenced operating under a four year contract in the Gulf of Mexico after completion of its two year upgrade in commissioning. The combination of increased average day rates and the willingness of operators to enter into longer term contracts have enabled Diamond to settle the increase its revenue backlog which currently stands at $9 billion. Carolina Group net income in the second quarter was the highest of any quarters since the issuance of Carolina Group stock in 2002. Benefiting from the sales strength of its Newport brand, Lorillard posted a 3.6% volume increase, while also increasing unit profitability versus prior year second quarter. In a few moments, Marty will discuss operating results for Lorillard in greater detail. Boardwalk Pipeline Partners reported strong results that benefited from favorable market fundamental. Earnings were driven by higher storage revenue and increased rates for transportation. Boardwalk also continues to make progress on its pipeline expansion projects, which are expected to contribute to the Company’s continued growth as they are brought online. Boardwalk has announced a cash distribution of $0.44 per unit for the second quarter, which represents a 16% increase over last year’s second quarter distribution and is the fifth consecutive quarterly increase since going public. Loews hotels had a good quarter posting a 15% increase in net income. Revenue per available room increased by 7.8%, reflecting ongoing market strength in the luxury and upper up scale of hotel segments. In June, we announced plans to buy Natural Gas Exploration & Production assets from Dominion Resources. Our newest company will be called Highmount Exploration & Production and will operate as a wholly owned subsidiary of Loews Corporation. We expect the transaction to close soon. As of June 30, our whole new company cash investments totaled $5.8 billion. During the second quarter, we have received $273 million in dividends from our subsidiary company and paid about $83 million in dividends to our shareholders. Also during the quarter, Loews repurchased over 1.4 million shares of our common stock at an aggregate cost of approximately $78 million. Now, I will hand things over to our CEO, Pete Keegan, who will provide additional detail on our financial results. Pete?

Well, thanks, Jim and good morning everyone. In the second quarter, Loews Corporation reported consolidated net income of $653.4 million versus $568.7 million in the prior year second quarter. Net income for Loews common stock was $511.7 million, a 7.7% increase over net income of $474.9 million in the second quarter of 2006. Net investment losses were $78.6 million versus losses of $55 million in the prior year second quarter. These relate primarily to CNA’s investment portfolio which I will discuss in just a moment. Net income attributable to Carolina Group stock increased to $141.7 million from $93.8 million in the second quarter of 2006. The main drivers were higher effective unit pricing, increased unit sales volumes, and the increased weighted average number of Carolina Group shares outstanding after the sale of Carolina Groups stock in May and August of last year. The change in the number of shares outstanding does not affect the quarters per share results. Lorillard contributed $97.1 million to net income for Loews common stock during the quarter versus $110.5 million in the prior year second quarter. As I just described, Lorillard’s contribution was impacted by the reduction of Loews economic interest in the Carolina Group. As of June 30, Loews Corporation owns $65.4 million share equivalents, representing a 37.6% economic interest in Carolina Group. Lorillard reported charges of $172.4 million and $144 million after taxes for the second quarter of 2007 and 2006 respectively to approve our obligations under the state settlements agreements. CNA contributed $284.9 million to Loews’ operating income in the second quarter versus $281.4 million in the prior year second quarter. Operating income benefited from disciplined underwriting and increased net investment income. Loews interest in CNA's net realized investment losses were $80.6 million versus losses of $57.9 million in the prior year second quarter. Investment losses were primarily driven by other than temporary impairment losses taken on fixed maturity securities that declined in value in response to increasing interest rates. And now I want to go off script just for a second to follow through on some comments that Craig Mense made in the CNA call about an hour ago. So, you all understand, for GAAP purposes, the majority of CNA's investment portfolio as carried is available for sale. What that means is the unrealized gains and losses that occurred in quarter grow go to unrealized gains and losses on the balance sheet and not through the income statement. And the only time actions go to the income statement is when Company buys or sells securities at a loss and then you have a realized loss in the income statement. Every quarter CNA reviews its securities that are in unrealized loss position to determine whether or not it had the intent to hold those maturities… those securities. If for any reason, it determines it does not plan to hold these securities to maturity, it impairs those securities and therefore the losses go through the income statement and become rather than just through the balance sheet. The effect on the balance sheet is the same whether those securities are realized loss or unrealized loss. The only difference is when we impair those… when CNA impairs them, they move to the income statement. And the statement to the… the intent to hold through recovery is the determination that Company makes mainly it sort of it can maintain the flexibility to trade the portfolio appropriately in the future depending on its view of market circumstances have that time. Go to our pipeline reported contribution below the second quarter net income or $16.4 million versus $16.5 million in the second quarter of 2006. The primary driver of results were higher revenue from increased demand for transportation services and a healthy demand for gas storage services, partially offsetting these factors was pretax impairment charge approximately $15 million related to Boardwalk’s Magnolia Storage Project. Affecting the comparison of results between the second quarters of 2007 and 2006, the secondary equity offerings by Boardwalk executed during the fourth quarter of 2006 and first quarter this year to helps finance it’s announced expansion projects. The increase in limited partner units has reduced Loews its total ownership interest in Boardwalk to 75% from 85% in the prior year second quarter. It is important to note that Loews maintain its 100% ownership of the general partner. Diamond Offshore’s contribution to net income rose to $117.6 million from $87.6 million in the second quarter 2006. As we stated during our first quarter earning conference call, Loews’ ownership interest in Diamond Offshore is decrease 51% from 54%, as the result of an increase in the total number of shares outstanding upon conversion of Diamond’s 1.5% debentures due 2031. Loews Hotels net income for the second quarter was $13.8 million versus $12 million in the prior year second quarter. Investment income and other rose to $84.2 million from $37.3 million in the prior year second quarter primarily due to favorable results of Loews trading portfolio. As of June 30th, 2007, total cash and investments at the Holding Company totaled $5.8 billion while Loews Corporation’s debt of $865 million remained unchanged from the previous quarter. We expect to finance the purchase of natural gas exploration and production assets by our new Highmount subsidiary with cash provided by the Holding Company of about $2.4 billion and approximately $1.6 billion in a Highmount term loan. Holding Company cash will be reduced by approximately $2.4 billion as a result of the acquisition. Lorillard end of the quarter with $1.6 billion in cash and investments while Carolina Group notional debt amounted to $978 million. And now I will turn the thing over to Marty Orlowsky at Lorillard. Marty?

Thanks Peter. Good morning everyone. As you have heard Lorillard’s operating income of $359 million, ours net income of $239 million for the second quarter of '07 as compared with the second quarter of '06 was up 13.7% and 16.9% respectively. And as you have also heard contributing to these results were higher unit pricing as a result of price increase taking in December of '06, increase wholesale unit shipment, lower promotional spending, partially offset by an increase in expenses, poor state settlement agreement. Additionally, the second quarter of '06 included the charge of $5.5 million in related to restructuring expenses. Total Lorillard wholesale unit ship were up 3.6% for the second quarter of '07 versus the second quarter of '06. Total domestic Lorillard at Newport wholesale unit ship were up 4.3% and 3.6% respectively comparing the same period. Lorillard outperformed the total domestic industry during the second quarter of ’07. Industry shipments were down 4.6% for the second quarter of ’07 as compared with the second quarter of ’06. Lorillard’s domestic shipment share was 10.22% for the second quarter of ’07 which was an increase of just over eight tenth of a percent compared with the second quarter of ’06. Newport’s domestic share of shipments for the second quarter of ’07 was 9.41% which was also an increase of eight tenth of a share point when comparing the same quarters. Lorillard’s retail share for the second quarter of ’07 was 10.33% representing an increase of just over half a share point over the second quarter of 2006. And Newport’s retail share also increased by just over half a share point to 9.50% for the same period of comparison. Newport achieved the 33.6% share of the menthol segment as of the second quarter of 2007, which was increase of nine tenth of a segment share point over the second quarter of ’06. Lorillard continued to be during the second quarter of ’07, the only major tobacco company to reflect positive unit volume and market share improvement as compared with the second quarter of ’06. Lorillard’s marketing strategy continues to attempt the balance Newport’s market share performance and overall profitability. Promotional spending in support of Newport is subject to change depending on the brand strengths and competitive factors. Thank you.

Thank you, Marty. Operator at this time we like to start the question-and-answer session. Question and Answer

Thank you. [Operator Instructions]. Your first question is coming from Bob Glasspiegel with Langen McAlenney.

Good morning and let me say I appreciate your answer. And Jimmy I share your confusion at the stock reaction today. I do sense from investor sort of nervousness about the overall investment picture and your Company’s exposure to what's happen in the third quarter. So, I was wondering if you would… you want to share with us any sort of incremental changes in the portfolio to date in the third quarter with the treasury rally were you are well positioned to benefit from… as I expect in… whether you are playing offense or defense on the margin with the significant changes that have happened in July?

I am not going to talk about what we have done in our portfolio since the end of the quarter. But I think that a lot of the reactions of Loews and CNA stock to our earnings report related to the other then temporary impairments that we took. And please explain the one but let me just add a little bit to this discussions. We managed today and for the past 30 years, we have managed CNA portfolio differently than most other insurance companies had managed their portfolio. Typically, when an insurance company manages the portfolio, they buy an asset, they put it there and they buy a bond, they put it their portfolio and they wake up five, 10 or 20 years later or whatever and the bond matures. That is typically not what happened in the CNA portfolio. When we managed the portfolio, we have a more active portfolio management start. We buy securities and we sell securities. And the reason that we do this is because we believe that we can add value by moving from one security to another, from one sector of the market another. And so, as I said that’s been our modus operandi for 30 years and I would happily stack up all performance record versus those of our peers in the insurance industry. What's happened more recently is that the accounting rule has been tweaked and changed slightly. And the result of it is that most of the portfolio that we have, we carry are available for sale. And the way the rules work today on securities that are carried available for sale, is that if at the end of the quarter that individual security is at a loss, doesn’t matter if it’s a penny, a point or 20 points. If it’s at a loss, you have to state an intention to hold that security to recovery of the loss, and if you can’t make that assertion, then you have to take an impairment law. They are what’s call other than temporary impairment law. The result of this is that we very much want to keep as much of our portfolio available for sales so that we can trade it to capitalize on changes in the market. So, therefore, we take as big a impairment charge as we can so that we can keep as much as of our portfolio open and available for sale. And so what you are seeing is an impairment charge that took place, due to the significant increase in interest rate that occurred in the second quarter, and very little of that impairment charge actually resulted from deteriorating credit in our portfolio. There is also at this time, I understand, tremendous sensitivity about CDO’s and sub prime securities, and let me just review for a minute the mortgage portfolio that we have at CNA. CNA has a mortgage portfolio of just under $11.7 billion, of that 3.8% is in CDO debt, but of that in CDO debt substantial portion in fact most of that is in commercial CDO’s and mostly we are rated A. We also have some about or just under $700 million of assets backed securities that are backed by sub prime mortgages, and that is a portfolio that we are in fact very comfortable with. Additionally, because we recognize when we bought these securities that there was some risk to them we have also entered into short in derivatives to offset some of the risk from those sub prime mortgages. So, yes, some of those sub prime mortgages are down in price but the other thing offsetting that is significant increases in the hedge that we have put on to counter balance those sub prime mortgages. That’s my answer Bob and I am sticking to it.

That’s a very good answer. I worry that having you teach me accounting probably there is a notebook for the stock but it’s definitely helpful for my knowledge of the facts. I appreciate it. What’s the size of your short portfolio, roughly?

I don’t want to go into that. I don’t want to talk about individual securities.

Okay. Good. You don’t want to talk about any of these positives that are happening, but you’re outlining all the negatives fully consistent with your historic conservatism? Thank you.

Thank you.

Thank you. Your next question is coming from Judy Hong with Goldman Sachs. Please go ahead.

Hi. Jim, just on the Loews trading portfolio part of it, I mean, I know that we’ve always said that it’s mostly in cash and government bonds, but can you clarify that none of the Loews trading portfolio really is exposed to any sub prime or CDO market?

We have very little exposure to our sub prime and CDO in the Loews portfolio.

Is it fair to say its much less than what CNA is exposed to?

Say again?

Is it fair to say that the exposure is much less than what CNA is exposed to?

Yes.

Okay. And then just some questions for you, Marty. First, in terms of just looking at your COGS per case or… sorry… COGS per unit in the second quarter excluding MSA payments and the buyout expenses. It looks like in the second quarter was up much more than what was seen recently. So, can you just talk about what drove that increase in the second quarter?

Well, in part it was increased excise debt size taxes related to the higher volumes. And secondly, we had some promotion expense was included due to the nature of the expense in the cost of sales were the cost of goods. However, overall our promotional spending if you include what does not get accounted for and cost to goods was down. So, mostly it’s due to the promotional expense.

Okay. So, the nature of the promotional expenses that hurt the COGS in the quarter, is that related to higher percentage of free goods promotions in the second quarter?

That’s correct. Yes.

Okay. And then just in relation to that, can you just talk about these… the competitive landscape in the menthol segment? I mean we’ve heard Reynolds talk about the competitive activity heating up a little bit in the second quarter, could you just talk about what you are seeing more recently as it relates to menthol competitive dynamic.

Well, I don’t, other than a couple of line extensions that have been introduced by Reynolds and Philip Morris and the associated promotional activity that goes along with that… those introductions, essentially I don’t see any major, major changes. There is still a fair amount of buy downs, or off invoice and buy down programs on the part of Philip Morris on their menthol packings and Reynolds is pretty actively supporting through promotion Camel menthol, as well as some, as I mentioned some of the line extensions for Cool. Other than that I haven’t really seen anything hugely different. It’s still very competitive in general… in a general sense.

Okay. And then just thirdly, in terms of the industry demand picture obviously the first half of the year was weaker than what we have seen in recent years. You think that the decline of the consumption would moderate in the second half of the year?

Well, I don’t know if I could attribute whatever weaknesses are reflected in the numbers for the second quarter to consumption declines. I think from a shipment perspective on the wholesale level, a lot of the… there is a lot of distortion that occurred during the second quarter in comparing the second quarter of ’07 with ’06. Not necessarily that affected us, but certainly the industry itself and then by that I mean, there were differences in promotional volumes in the part of some of the competition. It was a difference in terms of shipment patterns because of different systems changes. So, there is a lot of noise in the wholesale level, I think the… so the underlying numbers I don’t think are quite as weak for the industry as was reflected in terms of what was reported. With respect to consumption, I think, we don’t measure consumption. I don’t think anyone really has a duly good handle on consumption. So, I can’t really speak to that.

Thank you. Your next question is coming from David Adelman with Morgan Stanley. Please go ahead.

Good morning. Jim, let me ask you a follow-up question to the comments you made about the hedge positions for CNA on some of their sub prime related exposure to the extent that they make money on one of those hedge positions, is that reduce or moderated all the mark to market P&L impact that was incurred during the quarter?

Yes. Those derivatives are mark-to-market every quarter.

Okay. And then a bigger picture, Jim, do you think the hypothetical that were be significant stress in the capital market over some period of time. Would you be willing to have the Corporation borrow money, a significant amount of money to make an acquisition or to incur a credit rating downgrade?

I don’t want to talk about hypotheticals like this, like that. I just want to say that where I thought you were going was if there was a… a melt down of the financial markets, I think that the CNA portfolio is in terrific shape in order to take advantage of that, and in fact we have been doing that in a certain markets now that have seen a particular stress. We have been allocating more and more capital to those markets. So, we actually… we are actually having a pretty good time in these markets notwithstanding the stress or in fact because of the stress.

Okay. And then Keith you might have said and I missed it what was the quarter end gross cash balance of the holding company?

It’s 5.8, David.

Okay $5.8 billion. And then Marty I wanted to ask you a few questions please. One was did you have any… was there any material change from the quarter start to the quarter end in your trade inventory levels?

No.

Okay. And okay that was the principal thing I wanted to ask you. Thank you.

Thank you.

Thank you. Your next question is coming from Nik Modi with UBS. Please go ahead.

Good morning everyone. Marty, just one quick question in terms of Newport and Keith just give some perspective on that. If you have shipped that already, and if some of the promotional goods that you shipped were related to the new product launch? Thanks.

Yes. We went into test market effective the first week of July and it’s in a limited test market. Its obviously one of the rare, we are not big on line extending, but we feel that, this particular blend may have an opportunity to build some incremental competitive business for us. Gains some of the activity was very minor. Mike was promotional and shipped in the late second quarter, but it was really relatively insignificant in the scheme of things.

Okay. Thank you very much.

Okay.

Thank you. Your next question is coming from Filippe Goossens with Credit Suisse. Please go ahead.

Yes. Good morning, gentlemen and again congrats on a good quarter here on the Lorillard side. Jim or Pete, just as a follow-up on Judy’s question. The marketable securities at Carolina Group, if I recall correctly from past SEC filings, some of that is in limited partnerships. We should have be concerned that any of these marketable securities carry significant mark-to-market risk, correct?

No. Those securities are basically market to market every quarter and they have generated extra ordinary earning for Carolina Group, just as the billion plus dollar portfolio partnership investments for CNA has generated extraordinary investments for them. We don’t see anything extraordinary in the negative sense coming from those investments.

Okay. And then on the tax rate the rate was down for the year-over-year. Anything particular behind that decline and what should we assume for the second half of the year there?

Pete’s got the information on the tax rate.

I don’t have that revenue but I have got for Loews consolidated.

Only for Loews consolidated?

Talking about the Carolina Group or Loews?

It’s Carolina Group.

Carolina Group the tax rate was 39.10 and it went down to 37.34, and the principal decline was attributable to an increase in the manufacturer’s deduction. And that’s 37.34 is about our current estimate.

Okay and then Marty, we had recently Swedish Match announce that they are going to take Red Man into Snus. Can you give us an update at this juncture in terms of what the joint venture maybe working on with regard to the smoker site? Thanks.

Well, the only thing that I am going to say is that we continue to work on the project which we announced a while back. I really don’t have anything more specific to add at this point.

Okay. And then my final question is for Jim and Pete again. And I want to ask more questions on the potential dividend review, but that being said if the net worth test, if it gets listed based on my calculations if you were to pay down all the inter company debt, it looks like you may be sitting on a sizable amount of excess cash on the balance sheet. Should we kind of assume that, that’s most likely going to be returned to shareholders in the form of a special dividend or are there other uses of cash that we have not spoken about so far? Thanks.

Well, as you know the basic modus operandi of the company has been to pay down the notional debt as quickly as possible, and then once that’s done to pay dividend, pay as much as possible in the dividends while also maintaining the financial strengths and solvency of Lorillard and also keeping Carolina Group on a good financial balance. So we have no plans beyond that.

But if you are sitting on excess cash, Jim, I would assume that you will return that to shareholders, no?

Filippe you have got to be careful. Not only do we have to look at cash but we also have to look at shareholders equity, and we always want to run Lorillard so that it has a significant amount of shareholder equity, so that it can operate as a strong and solvent company.

Okay. Thanks so much, Jim.

Thank you. Your next question is coming from Christine Farkas with Merrill Lynch. Please go ahead.

Thank you very much. Good morning. Marty, I am wondering if I could follow-up a little bit on your operating expenses and perhaps you highlighted this a little bit earlier. Even if we were to pull out the charges from a year ago there is still about 300 basis points of operating leverage. How much of that improvement came through with the promotional expense that was in the COGS line versus any other timing of expenses or overall cost savings associated with your cost cut put in place last year.

When you say operating expense you are talking about SG&A.

Correct. Yes.

Yes. Most of the… I would say it was a combination… most of the positive on SG&A was derived through lower promotional spending. And then secondarily lower cost attributable to the sales restructuring that we took, the ongoing reduction in expense. I am not sure I quite understand your question.

Well, just earlier you mentioned higher cost of goods part of that had to do with the nature of your promotional expense in the quarter.

Correct.

So I guess the flip side would be if you get a benefit of that in the SG&A line because it came through above… in the COGS line.

Well, I think… well, if you add up total promotional dollars, forget the accounting rule, but just in terms of total promotional spending we were down in the second quarter of ’06 versus I am sorry ’07 versus ’06. We spent less in promotions overall. From an accounting standpoint we lowered the cost because if some expense goes into the cost of goods sold. But again I am not clear on...

And that’s helpful. Just I… and on your second point or a clarification if there were in fact some cost savings that came through in the quarter.

Okay.

And then just housekeeping items which Julio was trying to get out of you. Would you have the tobacco growers paid--?

It sounds like I never answered the question.

For which question the first one?

No, no, go ahead.

No, no. When you do owe just give it to us. I am sorry the tobacco growers payments and the depreciation expense for the quarter? Thanks.

All right. The grower expense was $27.4 million in the second quarter of ’07 and our depreciation was $10.3 million or $10.4 million.

$10.3 million.

That’s helpful. Thanks so much.

Okay.

Thank you. Your next question is coming from Ann Gurkin with Davenport. Please go ahead.

Good morning.

Good morning.

Just one thing left, I didn’t know if you had any comments on potential FDA regulation or FET tax increases. And then also, I think it was Senator Enzi has been floating a bill that would propose eliminating the entire menthol segment. I didn’t see your comments on any of that.

Well, the only comment I can make is on the FET right now, the activity on the house side was for a $0.45 increase. But the way the Congress has evolved lately one never knows where it’s going to go, but that’s where it seems to be heading. On the FDA side they are going to resume committee meetings on Wednesday. There are laundry list of amendments that Enzi and others either have already proposed or may propose, and it’s very difficult to comment on how, what the basis of the potential of any of those amendments are I think a lot of it is… remember this is all at the committee level, I do a lot of it is maneuvering and jockeying around for some kind of position on the legislation. Beyond that there really isn't much I can comment on.

All right. Thank you.

Thank you. Your next question is coming from Michael Millman with Soleil Securities. Please go ahead.

Thank you. That’s Soleil Securities. Sorry more CNA and thank you it was very helpful explanations but from reading the press release CNA seems to be saying that net operating income included the $119 million net investment gain. And in fact the improvement in net operating income was primarily due to increased net investment income. And that operating income from… in fact may have been negative. Can you just clarify those comments?

Sure. Net operating income includes investment income but does not include capital gains or loss. So, the net operating income, $318 million is what was earned in the insurance business including the investment income on the portfolio. And then additionally to that, there was a net $91 million loss on capital transaction within the CNA portfolio. So, that resulted in a net income from continuing operations of $227 million.

So, if we just look at the operations, excluding that net investment income, it might have been more like $200 million compared, down from about $305 million.

No. No. CNA eared from its insurance operation which include interest and investment income earned $318 million, which I might add is the most the CNA has ever earned in a quarter from its operating business.

Okay. But that included the investment income?

That included the investment income, yes. It always does.

Okay. And investment income--?

Investment income… by the way investment income is an integral part of the business model not only of CNA but of every insurance company. And to read Warren Buffet's annual report, he refers to it as float and how important that float is in the income for him and every other insurance company.

So, we should not be concerned that the mix this quarter was more skewed to investment income?

There was a significant increase in investment income. I leave it to you to decide whether or not you should be concerned about it, I am comfortable with it.

Okay. I just… can you give us again the Lorillard debt figure you said --?

Notional debt I can give $975 million.

$978 million.

That was the notional. What about Lorillard… sorry Loews debt?

$865 million.

Okay. And can you give us an idea of what you expect to be a long-term return on your investment and gas exploration production?

We don’t even own it yet.

Can you give us an idea on what your long-term growth returns is expected to be once you own it?

No, we don’t make forecasts.

Do you see it as being maybe relative to what you saw when you first got in to gas pipelines?

I don’t want to characterize the rate of return but we think we are going to earn. We are a Company that goes about our business. We have a sense of what the value that we brought but we don’t want to put ourselves in a position where we are making projections and estimates for investors because that can only come back to haunt the Company in one way or another.

Okay. Thank you.

Thank you. Your next question is coming from Filippe Goossens with Credit Suisse. Please ahead.

Yes Marty. Just a follow-up please if I may this morning. In the last… if my memory is certainly right, the last couple of quarters, your operating earnings benefited from lower litigation expense. Am I right to assume that that was still the case this quarter and when will you actually anniversary those lower expenses? Thank you.

Well, yes our expenses were basically flat in legal this second quarter of '07 with the same quarter of '06. So, we have about flattened out at this point. Where it's going to go in the future, I think as I had explained in the past is totally dependant on the number of trials and cases that one deals with. So, there is a degree of unpredictability associated with that. Other than in general terms clearly the legal landscape is as so to speak calmed down a bit. Certainly, major class actions are not as much of an issue as they have been in the past and therefore the expenses are going down related to that. So, right now it was about a flat comparison.

And then Marty, since I asked you, in terms of the arbitration for the disputed payments, do you have any feel for what the timeline may be to have that all resolved?

No, not at all. In fact, there has been no agreement on arbitration of any consequence. So, we… the industry has been successful with virtually every one of these issues that were brought into the trial court and in many instances at appellate level in the individual states. However, there is no way to project when anyone… any of the states are going to agree to attempt to arbitrate the issue as per the agreement itself. So, I can't give you any kind of timeline.

Okay, thanks so much you and Marty again.

Thank you.

Thank you. There appears to be no further questions. I would like to turn the call back over to management for any closing comments.

Thank you for joining us today. A replay of this call, as well as the downloadable broadcast will be available on our website loews.com in approximately two hours. That concludes today's call.

Thank you. That concludes today's teleconference. You may now disconnect.