奧馳亞 (MO) 2002 Q3 法說會逐字稿

Good morning and welcome to the Philip Morris 2002 third quarter earnings conference call.

My name is Mandy.

I'm your conference call operator.

Today's call is scheduled to last about one hour, including remarks by Philip Morris and the question and answer session.

To ask a question, please dial one followed by four on your touchtone phone.

I'll now turn the call over to the vice president of investor relations and financial communications for Philip Morris.

Good morning and thank you all for joining us.

Today Mr. Dinyar Devitre, senior vice president and chief financial officer of Philip Morris companies, ink.

Will be hosting this call.

Before I introduce Dinyar, I'd like to make a few announcements.

First, we issued our third quarter earnings release this morning.

If you don't have a copy, you can find it in the investor relations section of our web site.

Second, the call will be limited to a discussion of our business results for the third quarter of 2002.

We will not be covering litigation or regulatory issues.

Third, our reported results include an after tax gain of approximately $1.7 billion, resulting from the July closing of an agreement to merge Miller Brewing Company with South African Breweries forming sab Miller, the world's second largest brewer.

The gain is excluded from our underlying results.

And beginning with the third quarter of 2002 Philip Morris companies is recording its share of sab Miller's net earnings based on its ownership percentage.

As has been our standard practice to assist in measuring our performance, our results today treat the Kraft Foods initial public offering as if it occurred on January 1, 2001, and the cessation of good will amortization under a new U.S. acting standard as if it was adopted for the full year 2001.

Also, the business review that follows refers to 2002 underlying operating results and volumes compared with those for 2001.

Fourth, Kraft Foods announced its third quarter results yesterday and hosted a separate conference call.

Since the food business was covered in detail on that call, our discussion of Kraft will be limited on this morning's call.

Fifth, today's remarks -- I direct your attention to the safe harbor statement at the end of our news release for review of the various factors that could cause actual results to differ from projections.

And finally, media representatives who follow Philip Morris are on the call in a listen-only mode.

Now it's my pleasure to introduce Dinyar Devitre.

Thank you, nick, and good morning, everyone.

I'm pleased to provide details of our 2002 third quarter results.

In the quarter operating companies income rose 3.5% to 4.8 billion dollars.

We met our earnings per share target of $1.26, which reflects growth of 8.6% or 10 cents ahead of the prior year.

The 8.6% es growth was driven equally by base business growth and the favorable impact of the reduction in our shares outstanding.

Importantly, during the first nine months of this year we repurchased 93.5 million shares of common stock at a cost of $4.6 billion, and we plan to spend more than $6 billion on share repurchases for the full year 2002.

I will now review each operating company's performance starting with Philip Morris USA, our domestic tobacco company.

As you know, the competitive environment in the United States cigarette industry continues to be very challenging.

Industry shipments as reported by management science associates declined by 3.1% in the third quarter.

Despite one extra shipping day in third quarter, PMUSA's volume declined 6% to 49.4 billion units versus the corresponding prior year period.

As a result of the volume growth of deep discount cigarettes and sharp increases in state excise taxes.

Operating companies income declined 3.7% to $1.5 billion, as lower volume and higher promotional spending were partially offset by higher pricing.

As we pointed out on September 26, the factors affecting the domestic cigarette business include weak economic conditions and heightened consumer frugality.

The continued growth of cheap domestic and imported cigarettes, sharp increases in state excise taxes, volume growth from certain manufacturers, both domestic and foreign, some of which are not confined with either the master settlement agreement or MSA-related state escrow legislation.

And the influx of illegally sold cigarettes, including counterfeit cigarettes.

As a result of these factors, the deep discount segment has grown share at the expense of the industry's premium segment.

Since July we have implemented some programs on Marlboro that are proving to have the intended effect of restoring share growth.

Recent data show that for the month of September, Philip Morris USA's total share as reported by IRI capstone improved to 49.4% versus a July low of 49%.

Encouragingly, this improvement was driven by sequential strength in Marlboro which grew 0.9 points to 38.1% for September versus 37.2% for July.

Importantly, these trends were even stronger in convenience stores, which as you know make up the industry's largest trade cloth.

PMUSA's retail share in convenience stores increased from 52% in July to 53% in September, up one full share point.

And Marlboro's performance improved by 1.5 points in convenience stores from July to September, moving up from 41.3% to 42.8%.

Recent IRI data also shows that although the discount category from smaller manufacturers increased in the third quarter, their shares remained relatively stable for July, August, and September.

Let me remind you that our full year 2002 projection of results includes the effect of lower volume as well as the cost of Philip Morris USA's activities which include price and product promotions for Marlboro and PMUSA's other focus brands and increased retail coverage with a larger sales force.

We are confident that Philip Morris USA is well positioned to balance income and share growth for Marlboro and its other focused brands in 2003 and beyond.

First, we are very encouraged by the resilience shown by Marlboro, which as I mentioned has gained nearly a full share point at retail since July.

Second, we begin that Philip Morris usa's marketing investment to safeguard the long-term growth of the business is strategic and well timed.

We think that it is important to take early action to defend and grow our market share.

We also anticipate that industry dynamics should improve in 2003.

Firstly, the payments will be coming down next year.

Secondly, the level of payments made by the nonparticipating manufacturers and subsequent participating manufacturers may increase, there by narrowing their cost advantage.

And thirdly, there may be the favorable impact of the measures to stop the flow of illegally sold cigarettes.

Philip Morris USA is aggressively pursuing ways to address this issue, including working with state and federal authorities and our distributors.

As just one example, Philip Morris USA is advocating legislation at both the federal and state levels to deal with contraband and counterfeit products.

As you all know, Philip Morris usa has established a successful track record within the U.S. tobacco industry of consistently balancing market share growth and income growth.

From time to time this balance may shift.

Yet Philip Morris U.S.A remains intensely focused on insuring the long-term success of the business.

Turning now to our international tobacco business.

Philip Morris International operating company's income of $1.6 billion increased 8%, due mainly to higher pricing, lower costs, and favorable currency of $11 million.

Shipment volume increased 2.3% to 187.8 billion units, reflecting good volume performances in western, central, and eastern Europe partially offset by lower shipments to Japan due to the shutdown of west coast shipping ports.

PMI anticipate that these shipments will be reflected in Japan's fourth quarter volume results.

Had it not been for the shutdown, PMI's shipment volume in the third quarter would have been up in excess of 3%.

Turning now to a discussion of PMI's performance by region I'll begin with western Europe.

Total volume in western Europe was up 1.8%, due primarily to gains in Germany, Griece, Italy, and Spain, partially offset by the timing of shipments in France.

While shipments were down in France, Marlboro's market share continued to advance adding 20 basis points in the third quarter to 29.8%.

Importantly, PMI's volume and market share in Germany continued to improve, reflecting Marlboro's turn around.

In fact, low-priced trade brands recorded their first year-over-year share decline in the month of September since June 1996.

In germany, Marlboro shared advanced 30 basis points versus the prior year to 30%, driving PMI's overall share 40 basis points to 36.9%.

Marlboro's strong growth momentum across the highly profitable western Europe region drove PMI's overall share to 39.2% in the third quarter, an increase of 10 basis points versus prior year.

Turning to central Europe, middle eastern Africa, volume was up 3% as gains in the Czech republic, Romania, and Turkey were partially offset by lower shipments to Saudi Arabia due to price competition and declines in Egypt and Poland reflecting weak economic conditions and continued intense price competition.

L & M continued to perform strongly [INAUDIBLE] region with volume doubling versus the corresponding period a year ago driven by gains in Turkey, Poland, Romania, and Saudi Arabia.

In eastern Europe volume was up 14.3%, driven primarily by Russia.

In Russia where volume was up 24.4%, premium priced particlement and Virginia Slims performed strongly while mid-priced L & M and Chesterfield also continued to grow robustly, due in part to increased market coverage by our distributors sales force.

In the quarter PMI also launched next in Russia, which contributed to overall volume growth.

The success of PMI's strong brand portfolio in Russia drove its market share to 21.8% year to date in August, a gain of 3.7 points versus prior year.

In Japan, while shipments were down due to the shutdown of west coast shipping ports, in-market sales were up 4.3%, driven by the continued strong growth of both [INAUDIBLE] and Marlboro..

Overall, PMI's market share in Japan advanced 1.2 points to a record 23.7%.

Elsewhere in Asia, volume was up 0.5% as gains in the Philippines, Taiwan, Malaysia, Thailand, and Australia were largely offset by a significant decline in Korea.

In Korea, the lower volume reflects a continued reduction in consumption following tax-driven industry wide price increases, coupled with lower industry sales and heightened competition in the market.

In Latin America volume was down 0.8% in the quarter.

But year to date volume up is slightly, a solid performance given the extremely difficult economic conditions in the region, particularly in Argentina.

PMI's volume performance in the quarter reflects lower volume in Mexico, partially offset by gains in Brazil and Argentina.

In Argentina, PMI shared advanced 1.1 points to a record 65.6% due to the continued strength of our mid-priced Philip Morris brand.

In Mexico the decline reflected the affect of differing trade purchasing pattern as a result of year over year timing of price increases.

Despite the difficult economic environments in certain international markets, PMI achieved solid quarterly results and grew share and key markets.

We were very pleased with PMI's share performance in Austria, Belgium, the Czech Republic, Germany, Greece, Japan, the Netherlands, Russia, Switzerland, and Turkey.

In addition, shares were also up in many other markets, including Argentina, Brazil, Indonesia, the Philippines, the [INAUDIBLE] Republic, and Taiwan.

PMI is well positioned to deliver continued volume and income growth in the future.

Virtually all its major income markets have solid growth momentum, including western Europe, Japan, and Russia.

While many other strategic markets are strongly positioned to increase their contribution to PMI's volume and income results next year and beyond.

Let me now turn to our food business.

As mentioned earlier, Kraft Foods reported its results separately yesterday.

So I will touch only on highlights of their performance.

Kraft Foods had a strong quarter both in north America and internationally.

Worldwide Kraft Foods volume increased 3.3% on an underlying basis.

In north America volume increased 3%, due primarily to strong results in beverages, desserts, and cereals, and new products.

Internationally, volume was up 4.2%, benefit from acquisitions, new products, and strength in marketing programs.

Kraft Foods worldwide operating incomes company was up 6.4% to $1.6 billion.

Kraft Foods North America delivered operating companies in income growth of 6%, driven by volume growth and productivity and savings partially offset by higher marketing investments.

Kraft Foods international operating company income was up 8.3%, driven by higher volume and productivity in [INAUDIBLE] savings, partially offset by [INAUDIBLE] Kraft Foods, Inc. is poised for continued volume and income growth due to its ability to drive growth through innovation, particularly through new products and by continuing to generate solid productivity savings in North America and internationally.

In summary, we delivered good results in the third quarter.

Although Philip Morris USA's performance was affected by several unfavorable factors, we are confident that our strategies should restore the share growth of Marlboro and Phillip Morris USA's other focused brands in 2003 and beyond.

Our international tobacco business delivered solid volume and income growth while gaining share in key markets, including Germany.

Our worldwide food business continued to perform well, delivering strong income gains and higher volume.

Our cash flow remains strong, allowing us to maintain our commitment to returning value to shareholders in the form of dividends which we raised 10.3% to an annualized rate of $2.56 a share in August.

And share repurchases, which as I mentioned earlier, will exceed $6 billion for the full year 2002.

Our overall results in third quarter were good, especially in the face of the very difficult and challenging economic environment in the United States and elsewhere around the world.

The power of our world class portfolio of food and tobacco brands together with our superior global infrastructure and financial resources to support expansion and growth give us confidence that we can continue to project, full year, underlying diluted earnings per share growth 3-5% for 2002 and full year underlying diluted earnings per share growth of 8-10% for 2003.

This concludes my remarks.

And now I'll be happy to take your questions.

The floor is now open for questions.

If you have a question, we ask you to please press the numbers one followed by four on your touchtone telephone at this time.

If at any point your question has been answered, you may remove yourself from the cue by possessing -- pressing the pound key.

We do ask all parties to pick up their handsets while posing their question to insure optimum sound quality.

Please hold.

Our first question is coming from Rob Campenino from Prudential Securities.

Good morning, gentlemen.

Good morning.

Can you speak to the September retail price gaps in the U.S.?

Yes.

We're sort of looking at price gaps in [INAUDIBLE] stores And measuring the net price gap between Marlboro and the lowest price brand that we find in our sample of stores.

And in September the net price of Marlboro was about $3.80 a pack, where as the lowest priced brand was $2.40 a pack for an absolute price gap of about $1.40 and a relative gap of about 58%.

That's a fairly significant increase from the August data.

But that also, am I correct, doesn't reflect the bulk of your increments of spending?

That's exactly right.

Switching to Japan for a moment.

Since the lockout ended last week, have you shipped any products from the west coast ports?

Yes.

We've started to ship products from the west coast ports.

So what we're looking at really is a timing difference of about 1.2 billion sticks from quarter to quarter?

It will probably be a bit more than that, rob.

But you're exactly right.

It's a timing difference from quarter to quarter.

And last question.

Increased pension expenses are an issue in the market for a number of companies right now.

Are there any issues at either Philip Morris or Kraft associated with that?

I don't think so.

I think we're well set.

We're well funded.

Our pension funds are well funded.

We're always looking at our rate of return.

So I think we're in good shape.

Excellent.

Thank you, gentlemen.

Thank you, Rob.

Thank you.

Our next question is coming from Judy Hung of Goldman Sachs.

Hi, Din yar, how are you?

Hi, Judy.

A few questions.

First of all, PMUSA.

Can you talk about your outlook for the fourth quarter shipments?

You have an easier year over year comparison in the fourth quarter.

You've got all of this incremental marketing spending in the marketplace.

With these factors would you expect shipments to show vast improvement from what we saw in the third quarter, maybe even up slightly?

And are there any other factors that we should be are considering in looking at the fourth quarter shipments?

I'd love to give you a prediction for the fourth quarter, Judy, but I won't because there's just too many moving parts.

The situation is too fluid.

There are many things going on in the markets simultaneously.

It would be irresponsible of us to give you any predictions for fourth quarter volumes for PMUSA.

I will say, though, that you're correct in assuming that our promotional expenditures in the fourth quarter are going to be higher than last year.

And you have an easier year-over-year comparison also?

That's true.

So it wouldn't be reasonable to assume on a sequential basis we should see improvement in terms of the shipment numbers?

I hope so.

Then moving to PMI, can you give us the Marlboro's volume growth in the third quarter?

PMI -- Marlboro was down in the third quarter in terms of volume -- our volume declined about 1.8%.

But you've got to remember that Marlboro is, in fact, doing very well in the really important markets, the profitable and developed markets of the world, including western Europe, Japan particularly.

And where it's losing volume are in markets which are facing economic difficulties.

I'll give you a few examples.

We've lost volume obviously in Argentina.

We've lost volume in Turkey.

And we've lost volume in Egypt.

But in most of these markets we have a good portfolio of brands which includes mid-priced brands and lower priced brands so we were able to make up for any volume losses of Marlboro, even in those markets.

So I hope that answers your question.

I guess to expand on that question.

If p you look at PMI's volume growth in the quarter, it was up 2.3%, and even still up 3% which is below what I think you like to see volume growth in this business.

It looks like really markets like Korea and some Latin America countries are showing some weakness.

I was wondering if you could just talk about how you envision performance in these markets really playing out over the next year.

Do you expect to see acceleration to the kind of the 4% unit growth number in this business as we move into 2003?

Judy, our volume in the third quarter if you adjust for the Japanese shipments not leaving port were in fact, over 3%.

And going into 2003 -- our long-term objective for PMI's volume growth rate remains at 4%.

We think we can do that.

There will be times like in the third quarter this year where a number of markets were just very, very difficult economic conditions.

And in that kind of an environment to do even what we did, which is over 3% on an adjusted basis is really very good and very robust.

Going forward our target remains 4%.

We see no reason why we can't get that rate in the years ahead.

And to do that I guess you expect improvements in the economic conditions over the next year to drive that kind of unit growth?

I think that certainly will help.

Final question.

Do you have projections for the currency next year?

It looks like in the third quarter you had a favorable currency.

I'm just wondering if you have any projections for next year's currency.

It's always difficult to make an exact prediction.

I will tell you if the Euro stays where it is, obviously we're going to get some favorabilities results there.

On the other hand, the Latin American currencies, you know, are not looking good.

The Brazilian, the Argentine peso, the Mexican peso, the Venisuala [INAUDIBLE], all of these currencies are depreciating.

Then we also have a big business in Russia and the Russian ruble is depreciating rapidly so we have favorabilities thankfully with the Euro.

Then we also have some unfavorable currencies to cope with.

Thank you.

Thank you.

Our next question is coming from David Adleman of Morgan Stanley.

Please state your question.

Good morning.

Good morning.

Dinyar, the 8-10% EPS growth next year, what assumptions are you making about deep discount manufacturers raising prices in the U.S. to get there?

We haven't made any specific assumptions, David, about exactly what their prices are going to be.

You are aware that our MSA related payments come down next year by about 6 cents a pack.

On the other hand, the payments by the MPM's and SPM's -- and I'm talking about the non-grandfathered SPM's are supposed to go up from approximately 31 cents a pack to 39 cents a pack.

Now, it's sort of difficult to predict exactly how much of that will come through.

We're hoping a large portion of it will sort of flow through into the market.

But as I said, we haven't made any specific assumption on how much the price gap will be narrowed as a result of that.

The observation that you made in the release that higher state excise taxes adversely affected your volume.

Are you referring to the trade buying in certain states in advance and then deloading subsequent to the tax increases?

Or are you seeing an accelerated pace of consumption decline due to higher state excise taxes or both?

I think it's a little bit of both.

But I will say whenever we have tax increases of the type we've seen, you will get a temporary decline, even of take away.

But what we see then is after a period of time the buying comes back.

That's what we're seeing in this particular instance.

And in western Europe, the share only being up 10 basis points.

Traditionally that business over the last several years has gained 50 basis points a quarter.

You highlighted France and Germany were up more than 10 basis points clearly.

Where were you not performing well in western Europe from a retail share point, particularly your shipments were up 2% that surprised me a bit.

We actually gained market share in all markets, David, in Italy.

Our market share was down basically because of a timing issue.

But in Italy we are fully expecting our overall market share to be up in 2002 versus 2001.

But in the third quarter it was down.

You don't get many questions about it but on the capital corporation side, can you talk about the exposure you're you have to aircraft leasing, the risk of having to have a write-off?

U.S. air is in bankruptcy.

United indicated recently they may enter bankruptcy.

US Airways did announce bankruptcy.

But after the mandatory 60-days, they reaffirmed the lease that we have with them.

That really reflects the fact that most of the planes we've leased to the major U.S. airlines and some international airlines are new generation aircraft basically.

And generally most of these aircraft are sort of the workhorse planes of the airlines.

These are the kinds of planes they need.

And even when they cut back their fleet, we find that the planes we have on lease are the planes that the airlines want to keep.

So we feel pretty good about our airline portfolio going forward.

We'll have to wait and see what united airlines actually does.

But I think we should be in fairly good shape with United Airlines also.

One last thing.

The business performance in Egypt and Saudi Arabia, do you think there's an extent to which you're being impacted by either an anti-western or anti-American backlash?

Yeah, I think, David, that if you take an iconic brand like Marlboro, you are going to be affected by anti-American sentiment.

We are noting in some markets that anti-American sentiment is affecting our sales.

We found this in the past, too.

It lasts for a short period of time.

Then people forget about things like this and sales get back to normal.

Thank you.

Thank you.

Thank you.

Our next question is coming from Martin Feldman of Merrill lynch.

Thanks.

Good morning, Dinyar.

Good morning.

Den yar, clearly the Marlboro's performance between July and September must be gratifying for the company.

I guess my question is -- you're investing heavily in the brand at the moment.

You've indicated you intend to invest more heavily in the fourth quarter than you did in the fourth quarter last year.

Next year you have the MSA payments that clearly allow the company a very substantial degree of flexibility.

But what do you see happening to Marlboro's share or PMUSA's share when you pull slightly off the promotional accelerator?

Do you manage -- do you maintain the gains that you've enjoyed since July?

I mean, is there a threat when you start to withdraw some of the money just to allow it to fall to the bottom line?

You know, we always have to -- we always monitor this.

We always have to almost experiment with this.

We've got to look at this carefully from time to time.

We will obviously put -- take our foot off slightly off the accelerator from time to time.

And we just have to wait and see how Marlboro reacts.

We feel pretty confident, Martin that Marlboro has the kind of equity and the kind of reputation with consumers that will allow it to do well even at lower levels of promotion.

We just have to wait and see.

You have to understand one thing.

Right now the economy is so tough that this level of promotional spending I think is necessary.

As we go forward, we'll look at it carefully and we'll be very flexible, sort of almost on a month to month basis.

Talking to some tobacco company salesmen and wholesalers in the business, they reflect what you said earlier that's often in the past and previous years and previous decades, when you've had sharp excise tax rises, it takes the consumer perhaps six to nine months to be accustomed to those excise tax increases.

And you alluded to that fact in an earlier question.

Do you think that the fact -- the moment you've had MSA hikes, margin-related hikes, and sharp excise tax hikes all combined with the weak economy means it will take the consumer longer than has been the case in the past to get accustomed to the current absolute level of pricing?

Maybe a little longer.

It's sort of difficult to make estimates on things like that.

But it is true that a number of factors have come together in terms of state excise tax increases, MSA increases, plus the weak economy all coming on together.

That's obviously making it a little more difficult than it has been in the past.

Right.

Just to go back to one of your earlier answers.

When you said we will occasionally take our foot off the emotional accelerator slightly, is that one of the things you hope to be able to do in next year in order to be able to achieve the earnings growth from PMUSA that will contribute to the forecast you're look for of about 9% next year?

Obviously that's one of the things we'll have to look at.

Ok.

Just on the PMI front.

You spoke about Virginia slims and particlements being strong in Russia, and about the Russian market doing well.

You excluded Marlboro completely in that market.

Can you tell us how Marlboro is doing in Russia?

Marlboro's volume in the third quarter was essentially flat in Russia.

But I will say this.

In that category Marlboro, in fact, is doing very well.

It outsells Kent.

It has a higher share than Kent in the major markets -- in the major cities in Russia.

And the market share of Marlboro was up slightly.

I neglected to add that, in fact, although our volume was sort of flattish, our market share was up in Russia.

Why do you think Virginia Slims and Parliaments is higher in market share in present?

Difficult to say.

I think they're both very appealing brands.

They just have a unique appeal.

I think that's what's working for them.

My last question.

Are these estimates broadly correct?

You did speak about the markets where the economies are weak hurting Marlboro volumes.

But I'm estimating Marlboro volumes are down in Turkey about 2 billion sticks and Egypt down about a billion sticks.

Are those more or less accurate?

I think that's a fair assumption, yes.

Ok.

You know what, Martin?

I'd rather -- I'm not exactly sure of that two billion number.

Ok.

I was looking at about 1.8 through July in Turkey and I was thinking it was probably up to about two by now.

Ok.

Thanks very much for taking the questions.

Thank you.

Thank you.

Our next question is coming from Bonny Herzoch at Soloman Smith Barney.

Good morning.

Good morning.

I actually wanted to kind of go back to a question that was asked earlier.

Just trying to better understand your previous guidance that you gave on the call that you had on September 26.

You did discuss a number, a negative earnings impact of about 600 to 650 million.

I just want to make sure that this is clear.

That it's really because of three things.

And that's a volume shortfall, increased promotional spending, and then again you highlighted in your opening remarks that you have some sales force initiatives.

That's correct?

It's those three things?

That are going to impact earnings this year.

That are going to impact earnings this year, yes.

So I guess my question is -- I don't know if you can give us a breakdown in terms of how much will be as a result of, for instance, the volume shortfall but even estimating 20% of that figure -- or of that range.

You work through the math in the fourth quarter and it does appear that your volume is going to be down, you know, mid upper single digits based on that amount.

So I guess my question is, is there a chance that 3-5% earnings guidance is either conservative or maybe you would be approaching closer to the 5% EPS growth for the year.

Can you talk to that in any way?

All I can tell you is that our 3-5% earning guidance is solid.

We will be within that range.

You saw what happened in the third quarter, Bonny.

That our volume was down, and Phillip Morris USA was down.

We had higher promotional expenses.

These two unfavorable factors were sort of offset by favorable pricing.

Going into the fourth quarter we're not going talk to the volume, but we are going to have higher promotional expenditures in the fourth quarter compared to last year.

Can you give us some color on the sales force initiatives?

I'm just curious what percentage has your sales force increased.

Is it 5%?

Maybe give us an idea of what channels in the trade they're focusing on - is it the tobacco outlet channel?

Then I'm also curious.

Is this initiative in response to the deep discount category growth?

Or is it something that you have been planning in terms of maybe increasing your sales force.

Obviously, Bonny, it's not possible for me to give you information regarding how many people we're going to add or what channels we're going to cover because that is competitively sensitive.

I will say, as we said in the past that our retail leaders program is a terrific program.

It's done great things for Philip Morris.

We just feel that placing more resources behind that program through an increased sales force is really going to help us.

Can you talk about-- as the sales force are they out there already?

Have they been trained?

If you've added to the team.

In other words are we going to see the impact of the sales force initiatives in the fourth quarter?

Maybe the money is spent.

But when are we going to see it for your business?

Well, I think that the addition of a sales force is in progress.

The increased coverage is in progress.

And hopefully we'll start seeing the impact sometime next year.

Ok.

And then turning to your international business.

I guess the $350 million increased promotional spending that you announced during your second quarter conference call, at that time you always discuss -- or you did discuss that a portion of it would be allocated to your international business.

Can you talk at all about -- not necessarily the amount but maybe some of the programs that you've put into place and if they've been effective overseas?

What we've done is actually put this money in key select markets around the world.

And most of it really is going behind improving our point of purchase presence.

With permanent programs.

Most of it, again is behind our premium brand.

Maybe just one final question.

In terms of your operating income growth for international -- for your international tobacco business, you reported 8% growth.

And again with a favorable currency impact.

Normally we see, I think, operating income grow for that business double digit.

So I guess my question is, did you experience some kind of impact from the Japan issue in the quarter for income?

That's exactly right.

It was a Japan issue that lured our rate of growth.

Can you quantify that in any way?

Could you say excluding the Japan issue would you have seen operating income of low double digits for PMI?

It would have certainly been up from where it is today.

Closer to the 10% mark.

Ok.

Thank you so much.

Thank you.

The next question is coming from Anne Gerkin of Davenport and Company.

Please state your question.

Good morning.

Good morning, Anne.

Can you update us on the timing of an introduction of a reduced exposure product.

We have a plan to introduce a reduced exposure product next year.

We don't have an exact time, but it will be sometime I think around the middle of next year.

Will you be announcing a test or a rollout?

Any more detail?

I'm not sure at the moment whether it's going to be a test or a rollout.

All right.

And can you update us on how the merit test is going with the fire safe paper?

Yeah.

Merit has fire-safe paper ton now nationally.

It's going fine.

Are you going to expand the use of that paper tore any other products?

What we're waiting right now to see is what New York state does with its exact regulations of fire-safe paper.

And once we receive those regulations we will obviously have to gear our other brands to sell in New York state with those new regulations so that will be the next step.

After that we'll look at other states as and when they arise.

And can you give us an outlook for capital spending for 03?

You know our capital expenditures in the past have run between 1.8 and 1.9 billion dollars Anne.

They've bane little higher in the most recent past and this year because of expenditures related to capital expenditures related to Nabisco integration.

But generally you can take them to be in the $1.8-1.9 billion area.

Thanks very much.

Thank you.

Our next question is coming from Art Fucel of T. Rowe Price.

Good morning.

Good morning.

I think Martin touched on this earlier.

But you talked about in your release as well as your prepared remarks the market share recoveries statistics on Marlboro and your other brands from July to September.

Then you talked about how the pricing picture is going to improve on its own in 03.

I guess my question is with the sharp increase in spending that you're doing in the fourth quarter, do you either not believe that the progress that you've made today is sustainable without this new spending or is the progress that you've made today simply insufficient for your purposes going forward?

I guess I'm trying to understand a little bit better about the justification for this big jump in fourth quarter spending given that you're already talking about progress that's been made from July to September.

Yes.

We've made progress from July to September.

We want to sustain that progress.

And our promotional plans in the fourth quarter will be covering not only Marlboro but our other focus on four brands.

And we fully intend hopefully to see the same kind of progress we've seen sequentially in the third quarter.

But the progress you've seen in the third quarter, in order for that to continue in the fourth quarter, it takes 600 million more in spending.

Is that about right?

That's about right, yeah.

Ok.

Can you tell me what you estimate the profit margins are being earned by these cheaper cigarettes that you said were selling at around $2.40?

What kind of margins do they entail for the maker?

I'd estimate that those cigarettes -- if they pay their taxes legally --.

Yes?

Those cigarettes aren't making more than $1 or $2 per thousand cigarettes.

$1-2 per thousand and that's if they do everything above board.

Right.

Ok.

And finally, is it inevitable that your repurchase program in 2003 is going to drop back down to the historic level or maybe around $4 billion or might you find that you like it so much that you'll keep it going at $6 billion?

Unfortunately I don't think we will keep it going at 6 billion.

You know why we did it at $6 billion.

Yes.

The dividend from Miller.

We'll go back to our historical rate.

Ok.

Thanks a lot.

Thanks a lot.

Thank you.

Our next question is coming from Chris Growey of AG Edwards.

Please state your question.

Thank you.

Good morning.

I just have a couple follow-ups.

I didn't hear -- maybe I missed it.

The premium and discount shipments.

Do you have those numbers available by chance?

The shipments, our reported shipments for the third quarter were 49.4 billion units.

That was sort of 6% below last year.

And on our premium brands our shipments in 2002 in the third quarter of 2002 were 44.7 billion units, which was 4.3% below last year.

Our discount brands had shipments of 4.6 billion units, which was 19.4% behind last year.

Ok.

And then another question I had -- if you could refresh my memory in terms of the price gap and say a manageable price gap for Philip Morris and its premium brands.

You mentioned 58% I believe it was.

What's a more appropriate gap?

What are you trying to manage to?

First, for most of 2002 the gap has run between 55 and 65%.

We think we should bring this gap down to the mid 40s.

Somewhere in the mid 40s range.

That's what we would like to manage to.

Ok.

My final question is on state excise taxes.

It looks like a lot of those increases have already come through and there's very few of those in the offing now.

Is that the correct way to look at this?

And we've hit the peak here at least for now?

Yes.

Of course, on an annualizing basis -- when you annualize the increases -- say the average rate now is about 65 cents a pack throughout the United States.

When you annualize the increases that took place most recently, you're going to get up to about 72 or 73 cents a pack.

Ok.

Thanks so much.

Thank you.

Thank you.

Our next question is coming from William Noblur of Atlanta [INAUDIBLE] Please state your question.

Thanks.

Going back to the international.

One of the things you mentioned as a contributing positive was lower costs.

Could you expand a bit on where that's occurring, how permanent is it, will it be more meaningful on an annual basis?

You're talking about --.

International.

About PMI?

Mm-hmm.

Yes.

The cost reductions that we've been able to obtain through better productivity are permanent.

And has this been helping all along the last year or so?

Or is this just coming on?

Well, it's a program we've had going on for quite a few years.

We have a productivity program, an ongoing productivity program that ensure that we keep our costs as low as possible.

It's been an ongoing program.

We'll continue it in the future.

And also, getting back to the currency impact and expanding on a prior question.

In the third quarter was $11 million benefit.

You mentioned, of course, the currencies that are hurting you -- South America, Russia a bit.

Am I correct in prior years it's been negatives of in excess of 300 million o an annual basis?

That is correct.

So could we be looking at next year a year-to-year benefit looking at the third quarter trend of 300-400 million?

No.

That's too high.

The unfavorable currency this year -- that's 2002, is going to be somewhere between 230 and 250 million dollars.

Then moving forward into next year, as I said, I can't predict really what currencies are going to do.

We have some favorabilities with the Euro, but then we have a lot of unfavorabilities with the Latin American currencies and currencies such as the Russian ruble.

Where we have a big business.

Even if you just stayed at no negative it could be a pickup of 250?

Yeah.

If it was no negative, you're dead right it would be 250.

Thanks a lot.

Thank you.

Our next question is coming from David Ireland of AB and Amro.

Good morning.

A couple of questions.

The first one on PMI.

You implied on September 26 -- I think again with your outlook comment -- that you don't see the need for any abnormal extra promotional spend over and above the $100 million you put into the second half.

You're sounding today sort of comfortable about your competitive position at PMI.

Is that the case that you don't think you need to spend any extra sums in 2003?

At this stage -- actually, we haven't completed our plans for 2003.

But we announced earlier that the extra we were going to spend in PMI was really more a one hf time kind of event.

We'll decide then what our promotional plans for PMI are going to be.

Thank you.

But at the moment, no obvious likelihood of another sort of $100 million stepup?

At the moment, no obvious plan.

Correct.

And a second separate question.

I wonder if you could talk a little bit about the movements of the price segments in Russia and to what extent consumers are trading through the market and creating a proper premium segment.

The premium segment and the mid-priced segment are both growing.

And we found this generally in most developing markets that obviously the major part of the market is sort of centered at the lower end.

As the economy improves and as living standards improve, trade up to mid-priced brand and then eventually to a premium-priced brand.

That's exactly what we are seeing in Russia with both the mid-priced segment and the premiums priced segment growing.

Thank you.

Thank you.

Our next question is coming from Gil Alexander of Darcell Associates.

Police state your question.

Excuse me, sir.

Your line is live.

Do you have a question?

Please hold while we poll for further questions.

Ladies and gentlemen, at this time we do not have any further time for questions.

Ok.

Thank you very much.

That's all the time we have scheduled for this call.

We appreciate you joining us this morning.

We look forward to talking with all of you again next quarter.

We'll be sending out a notice in mid January with the date and dial-in information for the Philip Morris 2002 fourth quarter and year end results conference calls.

So again, thank you very much and have a great day.

Thank you for your participation, ladies and gentlemen.

This does conclude today's teleconference.

You may disconnect your lines at this time.

We hope you have a wonderful day.