英美煙草 (BTI) 2006 Q2 法說會逐字稿

Good morning, everyone. Welcome to our interim results presentation. I'm Jan du Plessis, Chairman. And with me are Paul Adams, Chief Executive Officer, and Paul Rayner, Finance Director. After taking you through our results, there will naturally be an opportunity for people in the audience to ask questions. A warm welcome also to those of you who might be listening on the conference call or watching on our website, BAT.com.

This is a very pleasing set of results, and demonstrate the continuing improvement in the quality of our business. Certainly, each of the key drivers are running ahead of [trend], and show that the group's strategy is delivering shareholder value. Group volumes on a like-for-like basis have grown by 3%, led by the global drive brands which are up by a remarkable 20%. This has translated into strong growth in the topline with net revenue up 6% and profit from operations up 9% at constant rates of exchange. Although we do not report on cost savings at this stage of the year, I can confirm that we continue to make progress from the various initiatives that we have a place.

Our associate companies continue to do well, with particularly good results from India and the United States. Profit before tax and profit after tax in minorities rose 7%, and adjusted diluted earnings per share rose 20%. In line with our policy of declaring an interim dividend representing one-third of the prior year's total dividend, the interim dividend is 12% higher at 15.7 pence.

Now in the first quarter results announcement, we drew shareholders' attention to the benefit from exchange gains which we believe were unlikely to continue into the second half of the year. We still believe that to be the case. Exchange gains during the first six months accounted for approximately one-third of the 20% rise in adjusted per share. However, based on current exchange rates, it is more likely that for the year as a whole, the impact from exchange will be marginal.

Furthermore, when you are looking at our results for the full year, there are also other factors that you should take into consideration, such as the timing of shipments in certain major markets in the first half of this year which will reverse in the third quarter; a very strong third quarter last year; and, as you no doubt will have gathered from their press release, the fact that Reynolds America's results appear to be skewed towards the first six months.

So during the presentation, Paul Adams and Paul Rayner will discuss these factors in more detail, of course. But they will also show that the business is in good shape and very much on strategy. I hand you over to Paul.

Good morning, everyone, and thank you, Jan. The first six months have seen strong volume growth, up 8.6 billion or 3% on a like-for-like basis with global drive brands up 11.3 billion or 20%. Excluding the loading effects that Jan has just referred to, volume was nearer 2% higher on a like-for-like basis. Global drive brands now account for 20% of total volume, and international brands almost 40% of total volume.

Dunhill volumes rose 9% to 15.2 billion, helped in part by the absence of the shipment distortions in Q1 2005 following an excise increase in South Korea in late 2004. Incidentally, Dunhill's share in South Korea has now grown to over 14%. Dunhill continues to benefit from its rollout into new markets, the launch of the button pack in existing markets, and new formats such as Fine Cut, Top Leaf, and Essence.

Kent volumes rose strongly to 21 billion, helped in part by higher-than-normal shipments in Japan ahead of the July price increase. This will, of course, have a corresponding impact on Q3 volume and profit. Kent also continues to progress well in Russia, Romania, and Chile.

In addition, it is worth mentioning that in Switzerland, a brand migration project commenced in June with the objective of switching Barclay consumers to Kent. It is early days, but the migration is going to plan.

Lucky Strike continues to be affected by the low industry volumes in Germany. The second quarter performance saw a significant improvement over the first quarter with share improvements in Germany -- now 5.8%, Spain, and Italy. Lucky Strike continues to benefit from packaging innovations. And in Germany, a roll-your-own variant has been launched.

Pall Mall's outstanding 45% increase to 21.3 billion follows product and packaging innovations in many markets in Europe, and launches in Africa and the Middle East and Asia-Pacific. In Germany, Pall Mall has a record share of 4%, and is growing strongly in the other tobaccos product segments, and now has 6.5% of total tobacco in Germany, up over 1.5 percentage points. In Italy, Pall Mall now has 6% share of the market, while in Malaysia, Pall Mall has grown strongly to over 30% of the value-for-money segments, with an 8% overall market share.

Turning to the regions, Europe saw like-for-like volumes up 2%, with growth in Russia, France, Austria, Switzerland, The Netherlands and Spain, offsetting low volumes in Germany, Ukraine, and Italy. On a like-for-like basis, profit was ahead 17 million pounds at 380 million pounds, with good results from Russia, Hungary, France, and The Netherlands.

As I mentioned at the preliminary results presentation at the end of February, pricing activity continues to be intense in a number of European markets, and shows no signs of abating. As a result of these activities, we saw lower profit in Germany, Spain, and Poland. However, despite those competitive activities, profit rose overall in Western European markets. In Russia, market share strengthened, and profit increased impressively with higher volumes, improved product mix, and a focus on productivity.

Asia-Pacific recorded a 5% rise in volume, and an 18% rise in profit to 305 million pounds. Profit growth was mainly attributable to Australasia and Malaysia, assisted by generally stronger currency. Volume growth was seen in several markets, most notably South Korea, reflecting volume distortions last year as a result of the excise increase at the end of 2004. In market share terms, both Dunhill and Vogue had an excellent quarter in South Korea, where the overall share is now close to 16%.

Pakistan and Bangladesh both saw good increases in volume, although profit in Bangladesh was affected by higher costs as a result of the currency devaluation.

Latin America enjoyed a 4% uplift in volume, with growth in most markets. Strong local currencies and generally good performances saw profit ahead 13% at constant rates and 27% at current rates. There were good volume and market share performances across the board.

In Brazil, profit was ahead with higher cigarette volumes, a better product mix, and the benefit of a stronger real. However, the stronger local currency also had an adverse impact on leaf margins, where shipments were in line with less year. Profit was lower in Argentina due to the price competition and changed product mix. Mexico, Chile, Venezuelan, and Central American maturity and the Caribbean area all contributed to the strong increase in profit.

Africa and the Middle East recorded strong profit growth, up 18%, but volumes were affected by the share loss in Turkey and supply chain problems in West Africa and the Caucasus. South Africa benefited from the strength of the rand; cost savings; good performances from key brands, thereby improving mix; and some trade loading ahead of a price increase earlier this month. As with Japan, the loading effects in the second quarter will affect volume and profit in the third quarter.

In Turkey, higher margins following industry price increases and lower costs ensured a continued and significant reduction of losses. The value-for-money segment, however, has been under competitive pressure from new launches, and the price repositioning of a number of brands impacting Viceroy, which led to a decrease in volumes.

In the America Pacific region, profit rose 19 million pounds to 225 million pounds while volumes were up 7% to 23 billion. It's been a long time since we announced volume increases in America Pacific.

In Canada, despite the strength of the dollar, profit was down 14 million pounds to 136 million pounds, largely due to volumes being 10% lower and a total market that declined 9%. The value-for-money segment of cigarettes has risen to 46% of the total market, and Imperial Tobacco Canada's share of that segments has increased 1 share point year-on-year to 38%, while share of the premium segment has also strengthened from 68 to 69%.

In terms of retail pricing in Canada, the average weighted price per pack of 20 has risen to [8 dollars Canadian 65 cents] for premium, and $0.04 to [6 dollars Canadian 46] for value-for-money, reflecting excise increases implemented in Ontario in February and Newfoundland and Labrador at the end of March. As a result, illicit trade continues to rise.

In Japan, share has reached 9.6%, with all three key brands -- Kent, Lucky Strike, and Cool -- growing volume. Profit was significantly higher as a result of increased volume, improved mix, and lower costs.

Now, before I hand over to Paul, I thought it worthwhile to point out how the regions with the highest proportion of emerging markets have been a source of sustainable growth over recent years. I draw this to your attention because some commentators see emerging markets as an area of potential volatility and therefore concern.

If we added Eastern Europe, which would include Russia, that area would also show consistent growth over the period. In fact, interestingly, the markets that have experienced the greatest volatility over the period in terms of profit and volume are the developed markets of Western Europe, North America, in Japan.

And with that thought, I will now hand you over to Paul Rayner.

Good morning, everyone. We've referred to the benefit that we've had from exchange gains during the first half. And the next two slides show how those gains have affected net revenue and profit from operations.

In terms of net revenue and on a like-for-like basis, the growth at constant rates was just under 6% on volume growth of 2.6%. Net revenue has benefited in Latin America from the phonecards distributed by Souza Cruz and in Europe, a vending business acquired in Switzerland. Excluding these factors, net revenue would have been up at around 4.3% at constant rates and 8.5% at current rates, which is still very good growth.

If we look at profit on the same basis, at constant rates, the 9% rise in profit at constant rates on increased volume of 2.6% reflects improved pricing, and also the timing of spend in some markets. At the profit from operations level, exchange gains had a positive impact of 46 million pounds in the first quarter and 23 million pounds in the discrete second quarter. And at current rates, for the remainder of the year, most of that exchange gain will be reversed.

In contrast to previous quarters, you may have noticed that the bars on the revenue and profit charts show growth for each of the regions at both constant and current rates of exchange, with the only bar south of the line being volume in Africa and the Middle East, due mainly to reduced volume in Turkey, which is still unprofitable.

As you can see from this chart, each region has recorded improved profit per mille at current rates on a like-for-like basis. The groups profit per mille was up 12% at current rates to 4.13 pounds per mille. At constant rates, and also on a like-for-like basis, the groups profit per mille was up by 6%, up in all regions except for America Pacific, where it was slightly down.

Each region with the exception of America Pacific has improved its operating margin. The slight decline in America Pacific reflects lower volume in the high-margin Canadian market, with the group's overall margin improving from 27.7% to 28.9%.

Paul has already discussed the drivers behind the regions' operating profit, so I'll comment on unallocated costs. And these were up 4 million pounds at 60 million pounds, with increased pension costs being a significant factor. Profit from operations was up 13% at 1,389 million pounds.

During the first half, there were two exceptional items -- firstly, a restructuring charge of 48 million pounds, which mainly relates to the UK and Canada restructurings. The second charge relates to the sale of Toscano, the Italian cigar business. On the 10th of March, we announced the sale of this business to Maccaferri for EUR95 million, subject to regulatory and government approval, and the sale was completed last week on the 19th of July.

Taking into account the changes in the terms of trade in Italy and backing out for various exceptional items that I mentioned on the previous slide, profit from operations on a like-for-like basis was up 15% to 1,389 million pounds.

Net finance costs at 124 million pounds are higher than the prior year by 21 million pounds. And we'll cover the details of this on the next slide.

Our share of the post-tax results of associates increased by 47 million pounds to 243 million pounds. And if you exclude the exceptionals in the associates, it increased by similar amount -- 49 million pounds to 226 million pounds. The Reynolds American contribution excluding those exceptionals was 36 million pounds higher to 157 million pounds due to improved pricing and productivity, the timing of shipments and the impact of the strength of the U.S. dollar.

Net finance costs, excluding the fair value and exchange differences, which are driven by IAS 39 and 21, were 140 million pounds, which is in line with the guidance given you earlier this year of 70 million pounds a quarter. However, total net finance costs were 21 million pounds higher at 124 million pounds, reflecting the impact of derivatives and exchange differences under IFRS, as well as higher interest rates. The fair value and foreign exchange gains are distorted by a number of items, and at the 2005 year-end, we decided to exclude some of these from the adjusted diluted earnings per share calculation. So for the purpose of the adjusted diluted earnings per share calculation after adjusting for these differences, net interest rose from 120 million pounds in 2005 to 128 million pounds in 2006.

Here, we show the underlying tax calculation for subsidiaries. This tax rate is 30.6%, which is lower than the guidance given in the first quarter announcement. And that's the result of a prior year tax credit which came through in Canada. If the tax credit was excluded, the underlying tax rate would have been 31.8%. We now expect the outturn for the full year to be between 30 and 31% as we expect some more tax credits in Canada in the second half of the year.

You'll note that the 2005 tax rate has been increased by 0.7% to 31.3% as previously reported to 32% as a result of excluding certain IAS 21 and 39 gains from the adjusted earnings per share calculation. So profit for the period rose 9% to 1,078 million pounds.

If we move to the adjusted earnings per share calculation, during the half year, the group purchased a further 17 million shares at a cost of 239 million pounds, which brought the average number of shares in issue for this calculation to 2,085 million shares compared to 2,125 million shares in the prior year. The profit from operations excluding exceptionals on a per-share basis increased by 15% to 0.666 pounds, and after the inclusion of associates and the charging of net finance costs, profit before tax increased by 18% to 0.713 pounds. The lower effective tax rate, partly offset by higher minorities, resulted in adjusted diluted earnings per share being up 20% to 0.4911 pounds.

These are the drivers of the increase in adjusted earnings during the period. The subsidiaries' profit performance was helped by favorable exchange rates. But even at constant rates, it was around 9% ahead, but closer to 7% if you exclude the effects of trade loading in certain markets. Associates in the share buyback together with the favorable tax rate were also favorable factors partly offset by a higher minorities charge arising from the improved profitability of Brazil and Malaysia. A slight negative was the terms of trade in Italy that we had last year. Note that the exchange line there at the bottom only reflects translation differences during the periods, but it is broadly indicative of the impact of currency movements.

Finally, cash flow. Net cash from operating activities declined 94 million pounds to 786 million pounds, reflecting adverse working capital movements and higher outflows for restructuring costs. Barring any unforeseen stock buildup, a significant part of this adverse working capital movement is expected to reverse in the second half. However, restructuring costs are expected to again be higher in the second half as a result of one-off costs associated with the productivity program. The higher capital expenditure mainly arises from investment required, which is associated with the factory footprint program, which is expected to continue.

The other net flows of 51 million pounds in 2006 principally reflect the purchase of owned shares to be held in the employee share ownership trusts. The other net flows in 2005 of 71 million pounds principally refers to the proceeds of the brand sale to Gallaher.

Borrowings net of cash, cash equivalents, and current available for-sale investments, were 5,764 million pounds, up [for 411] million pounds from the end of last year. These principally reflect the net cash outflow of 582 million pounds on this slide partly offset by the impact of exchange.

Thank you. I'll now hand over to Jan for questions.

Thank you, Paul. Before we take questions, I thought maybe I could just very briefly pick up the other announcement we issued earlier this morning. You're bound have one or two questions, and we're not going to want to be too keen to take further questions.

Essentially, what we have said this morning is that we will be making an offer to acquire the minority [shares] of our subsidiary in Chile for an amount of roughly 100 million pounds -- details in the press release. Although this is not a big acquisition from our point of view, we think it's a smart use of capital. It will be earnings per share enhancing, and certainly the returns on this investment will compare quite favorably to the returns that we would normally get, for example, on our share buyback program -- which, by the way, is not to suggest that this in any way is going to impact on the current share buyback program, which will continue to run at the current rate of about 500 million pounds a year -- simply just a point of reference.

What we also said this morning, just to clarify, is that with regard to -- although -- because we do continue to look on an ongoing basis at the minority holdings in a number of group companies, but with regard to Souza Cruz, we have no current intention to make a bid for the minorities of our Brazilian subsidiary. And I might also just add in passing that with regard to our associate in Malaysia, I'm sure you're mostly aware of the fact that restrictions on foreign ownership of [product equality] companies in Malaysia are such that it is extremely unlikely that we will at any stage make an offer to acquire the minorities there.

I don't think we would like to say much more about this this morning. I'm sure you'd understand that when you get to sort of deals of this nature, there are also some regulatory issues that we need to consider. So I think that should answer any questions you might have had.

So on that basis, we take any questions that you might have on our results this morning. As of course is customary, [you can] ask that in each case you just give your name and the name of the institution that you represent. The two Pauls will mostly take the questions. While [either] in each case [wants to do some] thinking is just quickly summarize the question for the purposes of the webcast. So who's up first?

ABN Amro. Two questions -- you given your basis for raising the first half dividend. Traditionally, the rates of first-half dividend growth for many companies is indicative of their view of full-year growth momentum. I wonder if you could say whether you're a traditional company.

Secondly, Paul Adams, you have said that pricing competition remains intense in Europe and shows no signs of abating. Can you say seven months into the year whether you think the reduction of industry pricing power is just a 2006 phenomenon, or whether the deterioration is more fundamental and longer-lasting?

Two questions then -- fine. The first question relates to our current dividend policy, which I will gladly pick up myself, and the second question which I think Paul Adams will be commenting on is -- Paul is invited to comment on the current pricing situation in Europe and as to how Paul sees the medium and longer-term trend in that area.

Just on the dividend quickly, can I say -- I think -- are we a conventional company? I don't know, and I don't particularly care. I think we announced last year with very good reason that what we are going to do in the future is announce an interim dividend which is typically one-third of the prior year's total dividend. The primary purpose is that we want to take out of the equation the inevitable speculation surrounding the size of your interim dividend, and what it may or may not indicate with regard to full-year results. We don't want any of that, and that is why we [don't want] people to read anything into the 12% dividend increase in the first half.

Whether that is conventional, I don't know, but personally, I think it is quite sensible, particularly for a company that prides itself in its ability to focus always on long-term, long-term growth. As you know, we don't care too much for quarterly and half-year performances. Paul, do you want to comment on the European pricing situation?

A couple of points to make. First of all, I have said on a number of occasions -- not necessarily in this forum, but on a number of occasions that I think that the industry's ability to take price has less to do with the consumer's ability to pay higher prices and more to do with the industry's willingness to take those price increases. In other words, the fact that we don't take price increases -- or indeed, that there are price decreases -- has more to do with industry action than it is to do with consumers' ability to pay.

So because of the pricing situation in Europe, does this mean that there is less pricing power by the industry? Not necessarily -- I think it's just industry behavior rather than [their power or] otherwise.

The other thing to say is that there tends to be a focus on Western Europe by industry commentators for understandable reasons. If you look around the world, pricing can be pretty fierce in other parts of the world. We've seen low pricing in West Africa. We've seen low pricing in South Africa. We've seen low pricing moves in Latin America and in some parts of the Far East. So as I sort of scan the globe, we can see some pretty aggressive and competitive pricing elsewhere other than in Western Europe.

To get to the nub of your question, I like to think that the situation that we're seeing in Western Europe now is particularly intense, and that it will abate over time.

Next?

[Adam Spielman] -- two questions. One, absolutely following up on David's, you just said that industry pricing has to do with competitive intensity. And you said that it will abate in time. Are talking sort of six months, or are we talking three years in Western Europe?

And you have also said that there is also pretty [sporty] pricing in the rest of the world in many other regions. And I guess the question there is, is that because some of the aggressive competitors that have made Western Europe so damn difficult are beginning to spread to Turkey or South Africa or Nigeria or wherever? Or is indigenous pressure, if you like?

And another question, if I may, separately -- Australia. It's been a great profit driver for you for many years. You don't talk about it in that much detail. I was wondering if you could just explain in a little bit more detail what's really driving the profit.

You say that volumes are up because you are gaining share. Can I just confirm that the gains of share mean to say that volumes are -- in a declining market, why are you gaining share so much? Is it brand innovation? Is it the global drive brands?

You also say merchants are up. Presumably, I imagine that's a combination of cost-cutting and also price increases. And if you can just summarize in Australia, if there's one factor beyond all else which is driving your profit up, is it price increases? Is it cost cutting?

Well, there are two questions here. The first is really a follow-up to the earlier discussion on pricing. And I guess Paul has asked us to analyze it further than to try and determine to what extent the key driver of the pricing activity in Europe to some extent driven by quite aggressive international competitors -- is that impacting potentially pricing activity in other parts of the world? So Paul, you will no doubt deal with that.

And the second question [he had was about] Australia -- recognizes the very high levels of profitability of our business in Australia. What are the key drivers? Is it volume? Is it share? And what are the key drivers behind between the very high margin that we achieve in that country?

Okay, as you might imagine, Adam, I'm going to duck on what's going to happen on pricing in Western Europe. We're not the price leaders in Western Europe, and I don't know what our competitors are going to do on pricing. So I can't give you a feel. I can tell you what my hopes are, but I just don't know.

But common sense suggests that whilst we have got pretty intense pricing activity at the moment, this is not a particularly sustainable situation for anybody. In Poland, I don't think the industry is making money, and certainly in Spain -- huge reductions in profitability. So I can't see anyone happy with that situation. And these situations tend to get resolved over time. That's much as I know and can predict.

Competitors in the rest of the world, yes -- we see our competitors going out, trying to build market positions in the rest of the world, and do so by coming in at low prices. We've seen that in South Africa, we've seen that in West Africa, and we've seen that in Latin America, and we've seen that in some parts of the Far East. So without finger-pointing, as I have said before, we tend to see ourselves as more sinned against than sinning when it comes to pricing.

But yes, people are going for volume. And in the absence of good brands, strong brands, global brands, they tend to go for price as a means to achieve the share.

[Is that getting] worse than it was?

I would say that's been happening for the last 2, 2.5 years, as people have been searching for volume growth. Everyone knows the rules of the game is to get organic volume growth -- at least most people think it's to get organic volume growth, and that's what they're trying to achieve.

In Australia -- I don't know if Paul wants to chip in on Australia. The reason why we're doing well in Australia is twofold. Yes, we are growing share in a declining market. We are growing share in a declining market because we're innovating behind very strong brands -- principally Winfield and Dunhill. Dunhill has done very well in Australia -- so global drive brand representation there. So we are driving share in a declining market, and that's helping our revenue line.

The Australians have done a terrific job in terms of reducing costs -- absolutely outstanding job on reducing costs. And it's a combination of the two that is driving margins.

Yes, but they did get a kick along from price increases in the six months, because there were price increases in August '05 and February '06 that have helped the six months. So if you wanted to split between price and cost savings for the six months, there would be more in price improvements.

Lehman Brothers. Just to come on to Canada, it looked between the first and the second quarter there was quite a big step up in terms of the premium segment production -- I think 57 to 54. I just wonder if you can be more specific about whether you think there's anything specifically that drove that in the second quarter -- whether that's a worrying new trend, or whether you see returning to stability moving forward through the rest of the year into '07?

And then the second question, just on provisions -- last year, we noticed some big provisions -- for example, the vending cost in Japan, about 15 million. Just wonder whether you could give us any idea to any provisions that we should be aware of in the first half, and maybe what the [next] is in terms of provision made and provisions utilized in the first half of the year. Thanks very much.

Can I ask whether you mean provisions in Canada or more generally?

(multiple speakers) provisions across the group -- other provisions outside of the restructuring provisions.

Okay. Very briefly, then -- the first question that we'll get is a question on Canada. And it asks Paul to comment on the development of the premium sector from Q1 to Q2 and what are the trends there? And the second question goes with the question provisions in the group and the extent to which provisions had been utilized or made in this period, which may an impact on profit.

Yes, let me slightly reverse it, but it answers your question. If I look at the growth in the value-for-money segment, just because I have the numbers here -- if you want to write this down -- if you start with Q2 of 2005, the value-for-money segment was 41% of the market -- I've rounded. But Q2 was 41, Q3 was 43, Q4 was 46. Q1 was 45, and Q2 was 46.

So Q2 is the same as it was in Q4 2005. And again, my little simple mathematics shows that over those last four quarters, the value-for-money segment has increased by about 1.25 share points per quarter, which is not good. But it's not horrendous, either.

The other thing to bear in mind is that our corporate share actually increased in Q2, and our share of the value-for-money segment increased in Q2 behind the growth of Peter Jackson, which is doing very well. So whilst the Canadian situation is intense in terms of price competition, and the fact that the value-for-money segment is still increasing and the market size is obviously decreasing, so it's not a good situation in Canada. We're not exactly falling on our sword, either

In terms of the provisions, there's nothing significant like the Japan vending provision you referred to that hits the operating profit that comes to mind. The main things are, as you said, the restructuring costs. And they will continue in the second half as we close the Southampton and Canada factories. And there could be a significant provision in the second half if we're successful in the discussions in relation to closing the Zevenaar factory. That would be a significant provision in the second half. Nothing else comes to mind.

Deutsche Bank. Just coming back to Canada, can you tell us a little bit more about your thinking behind moving to direct store distribution there -- what the benefits would be and what the costs would be, and is that something that you hope will help to tackle the contraband problem, or has that really got different sources? And second question, just briefly on the supply chain issues in Africa and Middle East region -- can you tell us what they are, and if they're going to be resolved soon?

Two questions. The one is, again, a follow-up question on Canada, and rights to the recent decision to move to direct store distribution. And I guess we were asked to comment on the cost versus the benefit and what it means for us and the impact that it may or may not have on the containment of the illegal sector. And the second question relates to the supply chain problems in Africa Middle East region and what it means us.

Okay, DSD in Canada, direct store delivery -- why are we doing it? Canada is, as you all probably know, is getting increasingly restricted in terms of marketing. Most marketing freedoms have gone, and even at point of sale now, there's very little that you can do.

Therefore, the ability to talk to retailers, to have a relationship with retailers so you can talk to them about what you're doing with your brands and what innovations there are in your brands becomes increasingly important. So we feel that we want to get closer to the retailers. We feel that there is a competitive edge in having that relationship and being able to talk about your products to retailers, and that's why we're going direct store door. That is linked also to recruiting something like 300 trade marketing representatives that will then go out and talk to retailers. So we want to be very much more in control of our own destiny when it comes to servicing the retail trade and having that communications point with them.

We're also able to capture the wholesale margin, which is very useful. Obviously, there will be a cost involved initially. But we should get -- that should break even pretty quickly in terms of grabbing the wholesale margin and offsetting the costs. That's the reason behind DSD.

Africa, Middle East -- we had a problem with a distributor in the Caucasus, which led to some interruption there. West Africa, we pulled back from a distributor in West Africa -- a contract manufacturer and distributor who happened to be Imperial. We didn't feel we'd be getting tremendous value for money from that relationship, so we decided to go our own way. Imperial are fighting hard game, God bless them, and it's taking a little bit of a while to get back into the market.

[Christine Jaspenski], ABN Amro. I just wanted to ask Paul Rayner -- when you talked I think in particular to your volume and profit slide, you talked about the timing of spend. And I wonder whether you could elaborate a little bit as to whether it's a first half, second half weighted issue in terms of profit?

Question for Paul Rayner to comment on the question of spend -- Paul has indicated during his presentation that there is -- that the timing of spend may have an impact on the relationship of H1 or H2 earnings. And Paul, any comment?

Yes, that's right. If you look at the main -- principally marketing spend, it seems to be skewed towards the second half. It would be probably closer to a 45, 55 split. So that's why we referred to it. And it would be one of the factors obviously influencing the second-half result.

JPMorgan. Two questions -- the first on Pall Mall, which has being your fastest-growing drive brand -- I think for the first time this quarter is now your biggest as well. I wanted to ask has that brand now got sufficient equity and scale for its price gap to be narrowed relative to the premium segment? Or do you see continuing to grow at its current [like] -- continuing to rely on prices as it primarily does at the moment?

The second question was on the decision at Engle -- the reaction from Moody's -- positive reaction from Moody's -- does that change your view on your ability to use debt financing for future deals?

Two questions. The one relates to Pall Mall and the spectacular growth of Pall Mall, which is now indeed our single biggest global drive brands. And the question from Michael to Paul is at what extent has the brand now got sufficient brand equity such that it can move away from being what you suggested as being a pure price proposition to something that can actually generate higher margins.

Second question relates to the comment by Moody's to remove the negative outlook comment in their assessment of our credit rating as a result of the Engle decision, and what impact that may or may not have on our borrowing situation. Paul -- want to take the first on Pall Mall?

Pall Mall, as you say is doing terrifically well. We're very pleased that. We see Pall Mall as a midprice value-for-money brand. So we don't sort of see it as a sort of bottom-end price fighter. If we had a brand to do that, that would be Viceroy. So we see Pall Mall as a midprice value-for-money brand.

If you look outside of Western Europe, you will see that what I've just described in situ. So if you go to, for example, Eastern Europe, you will see Pall Mall at a mid price.

The reason why that is the case is that in those markets, if you like, emerging markets, there is a broader price gap. And therefore, there is room for a midprice brand. And that is where we put Pall Mall, and Viceroy is the price fighter.

And if you go to Western Europe, Western Europe tends to have much more squeezed pricing. There isn't room for three price points. And since Pall Mall is our value-for-money brand, that tends to fall to the bottom of that. It is not a premium brand; therefore, it must be at that lower price point.

So we are comfortable with it there. I mean, that's the only place it can go. Does Pall Mall have equity? Yes, it does. Do we like it having equity? Yes. That's why we are able to grow share, because if you are competing with a brand that has some equity against brands which don't have equity, that brand will do well. And that's why we're doing so well with Pall Mall, particularly in Western Europe. So we are quite comfortable with where it is.

In terms of Moody's, no, it doesn't really change our attitude. We have always wanted to use debt finance to do acquisitions. And our ratings position is a touch stronger because they have taken off the negative outlook, which is good.

I mean, the real issue is are there any deals out there worth doing, because rating agencies usually look positive to doing acquisitions if they are cash flow accretive. And the ones that we would do would be cash flow accretive. So the negative outlook really hasn't been an inhibitor on us doing any deals. I mean, rating agencies don't like using your cash for share buybacks, but they are very happy for you to raise debt to do acquisitions if they make financial sense. And we have always said that we are always on the lookout for deals that make financial and strategic sense. But we don't see any.

Any more?

Sorry, just thinking about Canada -- David Hayes from Lehmans again. It just to go back to Canada and the point about the direct distribution -- should we factor in a period of disruption in the second half about -- you kind of feel intuitively that you're going to be destocking the channel and restocking your own warehouses simplistically, and therefore, there could be a period of actually no external sales. Is that something that you're anticipating in the second half and that we should factor [in the fact]?

Another question on Canada briefly, which is to say -- is there any risk of us being faced with a disruption of supply as a result of the decision to move to direct distribution?

Yes, it's a fair point. The wholesalers have got product in their warehouses, and they will sell those out as we switch to our own direct distribution. So for a time, there will be a lower sales.

(inaudible question - microphone inaccessible) we should -- big enough -- you maybe can't quantify that on -- sort of month's sales or two weeks, or is that possible to give us a feel for sort of the extent that that might [influence] --

I don't have a figure in my head for that.

All right, anything else -- right at the back?

Dresdner Kleinwort. Could you help reconcile your price/mix with your cost of goods sold? I mean there has been a lot of talk about price competition, but with volumes up 3 and sales up 6, obviously, your price/mix is improving. Could you sort of go through the markets -- the major markets where that is happening? And if your price/mix is going up plus 3, why was your sort of cost of goods sold as a percentage of sales going up at the same time?

Paul Rayner will now have [cash] -- on the question that relates to the question of the price/mix changes and price/mix and the relationship that would have with cost of goods sold. And I guess, Paul, you are being asked to comment on some of the major markets that may be relevant.

I think -- yes, it is a very good question, Chas. It is mainly price. I mean, the mix is a bit all over the place, obviously, because you have got significant geographic mix factors in the various regions, so you have got obviously a positive geographic mix factor in Africa/Middle East with volumes down in Turkey. But basically -- very low margins, so profits are well up, even though volumes are down. But you have got negative geographic mix because the volumes are up in Europe, because the volumes are up in Eastern Europe, where the margins are lower.

But if you analyze the costs on a per unit basis, you can see basically in most of the regions, costs on a per unit basis are actually coming down. And that is a function of reduced supply chain costs, so the benefits of the supply chain programs coming through; reduced overheads in indirects; and slightly higher marketing spend.

But if you go through and look at it on a constant currency basis -- so you have got to take out the exchange, obviously, because we had significant exchange gains. But if you look at it on a constant currency basis, costs per unit are down in Europe. They are down in Latin America. They are down in Asia-Pacific -- down quite significantly. And the only place where they are really up is Africa and the Middle East. And that is just a function of some higher brand spend in some markets.

So the costs savings are coming through in cost per mille if you look at the numbers.

It's very difficult to give an answer on the price/mix, Chas, because what's happening is that there's deterioration in the geographic mix. So for example, as you are losing volume in Canada, you are losing margins. So there is a big geographic mix swing up there.

And secondly, even if you are selling more premium brands, but there has been a price war in the market, so the whole market has gone down, you may be selling more premium, but you are not getting an impact on your margin. So it is very difficult to pick out the isolated components that you are looking for.

Yes?

MainFirst. Just a couple of quick ones -- one is on consolidation in the industry, because there was a point made this industry morning on the broadcast that you saw consolidation in the industry as inevitable, but right now you didn't see any catalyst for that, largely because you felt that there was sort of revenue and earnings performance of the companies in the industry were quite rosy. I was wondering what you had in mind as being the catalyst for that kind consolidation that you see as inevitable, and whether or not the sort of lack of rosiness in a number of European markets would be enough to constitute a catalyst, particularly if it were to continue?

And second one, I was just wondering if we could just have your update in-house on your opinion on the third outstanding court case in the United States -- just on timing [it out]?

Two questions, the first of which I will probably just respond to myself, and second one, Neil, I am going to want you to deal with that.

The first question picks up to comment which I made this morning on Cantos about industry consolidation and the fact that whilst we see further consolidation, we don't see that as being obvious in the short term. And the second question deals with what is described as a third court case in America. Neil, maybe you can pick it up when you -- maybe you can pick it up when you take the -- when you give the answer, you can clarify the question as well.

Chris, on industry consolidation, what I said this morning is that the conventional wisdom continues to be that this industry at some point will have fewer players. And I know that if you ask Imperial, they will say exactly the same. If you ask JT, they will say exactly the same. So I don't disagree with that.

I just said this morning that to some extent, everybody seems to be doing pretty well at the moment. The industry as an industry seems to be in fairly good shape. People in many cases have increased earnings, and there probably isn't enough pressure around at the moment to force people to begin to negotiate deals.

Now, I am bound to be wrong, and maybe somebody will announce something big tomorrow morning. I don't know. It is just my view that there will be further consolidation, but it is not obvious to me when it might be, how it might be. And certainly, it is not obvious to me who the first consolidatee might be. And I don't think we would want to add to that, because there isn't really much more to the comment than just that.

And the second question -- Neil, do you want to pick up on the legal situation? But you might just clarify the question as you are doing so. Neil Withington, our Legal Director.

I was going to say, this might seem a little legalistic, but I would like to understand the question before I give the answer. (laughter)

Just really your expectations of the timing of any resolution on DOJ (multiple speakers) since the last time we -- since we last met, we have had Engle.

No movement on the DOJ. There is still nothing. It's still with Judge Kessler. The industry is waiting for her to give her decision. I guess we're moving into the summer phase. I have no idea whether or not that court is in recess at the moment. But no further update, Chris.

Yes?

JPMorgan. Could you comment while you are up there on the situation in Canada, where we had Manitoba pass a tobacco cost recovery act, and where you see the Canadian situation developing?

Neil is just asked to comment further on the development of the legal situation in Canada.

There aren't really any further developments in Canada, as such. I mean, the only -- the current issue with respect to Canada revolves really around British Columbia on medical cost recovery. And that case is progressing extremely slowly. Our view has always been that other provinces will watch what happens in BC before deciding to take action on whatever they might put into laws. And the fact that somebody passes a law is one thing. What they actually do with that law is another.

So we have not seen any particular movement on Manitoba. And we're seeing pretty slow progress on the BC litigation front currently.

If I may follow up then -- so what is your expectations for when we might see the BC case come to trial?

That's really in the hands of the BC government --

The question --

Sorry; the question was when does the BC case come to trial -- sorry, yes. It is in the hands of the BC government -- I wouldn't have thought for at least another three or four years at the earliest would be my sense.

I am not encouraging more questions on legal matters, but if there are, can we have them now?

I get them when I stand up.

Yes, I know -- yes?

Two -- just on the BC -- I think in February, there was a hearing about whether the international people could [avoid] themselves from the trial. I remember the last time I asked you this question, you said it was going to be in a couple of months' time. The ruling happened three months ago. Any -- [is it] overdue?

No, not overdue; still not handed down. So the situation is -- the question related to where the courts in British Columbia on the non-Canadian manufacturers being involved in that case, and the answer is we have not heard anything yet. We are really in the hands of the courts when they put their judgments out, Adam.

Thank you, Neil. Well, I think that is probably enough for this morning, unless someone is desperate to ask one more questions. But it is probably time to close. Anything else?

Well, I can only just say thank you all for coming.