奧馳亞 (MO) 2003 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Altria second-quarter earnings conference call.

At this time, all participants have been placed in a listen only mode and the floor will be open for questions and comments following the presentation.

I would now like to turn the floor over to your host, Nick Rolli, Vice President of Investor Relations and Financial Communications.

Sir, the floor is yours.

Thank you all for joining us.

Today, Dinny Devitre, Senior Vice President and Chief Financial Officer of Altria Group Inc., will be hosting this call.

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

First, as you know, we issued our 2003 second-quarter earnings release this morning.

To get a copy, you can go to the investor relations web site at Altria.com.

For those of you who are listening via the audio webcast, we are also providing summary slides for second-quarter results for Altria Group Inc. and its family of companies, Kraft Foods, Philip Morris USA and Philip Morris International.

Second, this call will be limited to a discussion of our business results for the second quarter of 2003.

We will not be covering litigation or regulatory issues.

Third, Kraft Foods announced its 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 today's call.

Fourth, today's remarks may contain projections of future results and I direct your attention to the Safe Harbor statement at the end of our news release for a review of the various factors that could cause actual results to differ from projections.

Now, it's my pleasure to introduce Dinny Devitre.

Good morning.

Altria's second-quarter results indicate that the fundamentals of our domestic and international tobacco businesses remain solid, driven by the success of Philip Morris USA's promotional programs and by PMI's widespread share gains and strong operating companies income growth aided by favorable currency.

However, Kraft's performance was adversely affected by increased trade inventory reductions as well as global economic weakness and intense price competition.

Altria's diluted earnings per share for the second quarter of 2003 were down 0.8%, or one cent, to $1.20, including six cents per share for charges related to the tobacco growers settlement and initial costs to relocate Philip Morris USA's headquarters to Richmond, Virginia.

During the quarter, the three major credit rating agencies lowered Altria's short-term and long-term debt ratings following the $10.1b judgment on March 21st against Philip Morris USA in the price litigation.

Recall that Altria's access to the commercial paper market was eliminated, which resulted in unplanned borrowings against a portion of its revolving credit facilities.

In early July, Altria successfully negotiated a new, 364-day revolving credit facility to replace a facility that was due to expire on July 14, 2003.

The new facility is for $2b, and I'm happy to report that it was oversubscribed.

Since Altria has no access to the commercial paper market and needs to maintain an adequate cash balance, our $4.8b of cash at June 30, 2003 reflects the draw down on the long-term revolvers to fund both Altria and Kraft's normal working capital requirements.

As stated in our release, Altria is projecting 2003 full-year diluted EPS of $4.50 to $4.60 per share, including eight cents of incurred and projected charges in 2003 for the tobacco growers settlement and relocation of PM USA's headquarters move to Richmond.

Let me turn to Philip Morris USA, our domestic tobacco company.

Philip Morris USA continued to show improving fundamentals in the second quarter with sequential growth in retail share as its enhanced sales and promotional programs had their intended effect.

Operating companies income decreased 30.3% to $1b.

The decrease was due to higher investment spending behind Philip Morris USA's brands, as well as charges in the second quarter of $191m, partially offset by higher volume.

Philip Morris USA's shipments increased 4.1% to 48.2b units in the second quarter, reflecting the timing and nature of promotional programs, as well as a favorable comparison versus the prior year.

Last year, shipments in the second quarter were adversely affected by trade inventory depletion following Philip Morris USA's April 2002 list price increase.

Turning to retail share, based on the IRI/Capstone total retail panel, Philip Morris USA's retail share in the second quarter was 48.5%, an increase of 0.2 points versus the first quarter, aided by Philip Morris USA's enhanced sales and promotional programs.

Combined retail share for Philip Morris USA's focus brands, Marlboro, Parliament, Virginia Slims and Basic, was 46.1%, reflecting growth of 0.3 points versus the first quarter of this year.

Marlboro showed continued resilience, increasing 0.3 points versus the first quarter, to 37.8% at retail, while Parliament's share was up 0.2 points to 1.7% at retail versus the first quarter.

In the second quarter, total retail share for the premium category at 72.4% was 0.5 share points to head of the first quarter with Philip Morris USA slightly increasing its leading share (indiscernible) category at 61.1%.

Over the past three quarters, the deep discount segment has remained essentially flat at retail, reflecting narrowed price gaps.

That trend continued in the second quarter with the deep discount category up 0.1 share points to 10%.

As I've stated in the past, Philip Morris USA is committed to increasing its premium share.

To this end, Philip Morris USA introduced Marlboro Blend No. 27 in March and initial results indicate that the brand has met all expectations.

Last month, Philip Morris USA launched Parliament Ultra Lights for its retail introduction in the third quarter.

While it is too early to measure results, it's an excellent product with potential to contribute to Philip Morris USA's premium share growth.

In addition, test marketing for premium Chesterfield was recently initiated.

Overall, we feel good about the underlying strength of Philip Morris USA's brand portfolio and its retail share trends that reflect both Marlboro's resilience and Parliament's continued momentum.

To sum up on Philip Morris USA, we are encouraged with the improving fundamentals of our domestic tobacco business despite lower income this year.

First, Philip Morris USA has delivered sequential retail share growth since implementing its enhanced sales and promotional programs in the third quarter of last year, while deep discount growth has moderated.

Second, 31 states have enacted or are in the process of enacting complementary legislation to the MSA-related escrow legislation already enacted by the states.

The main provision complementary legislation is to ensure that nonparticipating manufacturers make escrow deposits on units sold, or lose entitlement to tax stamps.

Third, progress has been made over the past several months in closing the allocable share loophole in the MSA-related escrow legislation that has been enacted by the states that has been exploited by a number of smaller, non-participating manufacturers.

To date, 14 states have taken steps to close the loophole.

Fourth, Philip Morris USA has taken action to minimize counterfeit product and filed lawsuits against over 2300 retailers and is working with law enforcement agencies to reduce illegal cigarette sales.

PM USA also filed 18 lawsuits against more than 50 Internet sites for violation of trademark laws.

Fifth, following a severe increase in the year-end average state excise tax from 44 cents in 2001 to 67 cents in 2002.

So far this year, there have been fewer tax increases and the absolute level of the individual state tax increases has been smaller on average.

In July, the weighted average tax rate is 69 cents per pack.

Finally, our focus on strategy continues to be effective.

Marlboro, always our top priority, continues to show resilience with sequential retail share growth, and Parliament shows promise as one of the fastest-growing premium brands in the industry.

Given all these factors, Philip Morris USA's business remains on track and is meeting its objectives.

Turning now to our international tobacco business, PMI delivered operating companies income of $1.6b in the second quarter, an increase of 14.3% versus the prior year, driven by favorable currency of $125m, volume gains, higher pricing and separation charges of $25m in the second quarter of 2002, partially offset by unfavorable mix.

PMI shipment volume increased 1% to 187.4b units, as declines in Italy and worldwide duty-free partially offset a 3.5% increase in other markets.

The decline in duty-free volume of 10.6% was due to reduced international travel, reflecting the effects of the war in Iraq and the SARS epidemic.

In Western Europe, volume was down 6.7%, driven primarily by decreases in Italy, France and Germany, although market shares were up in both France and Germany.

In Italy, volume declined 20%, due mainly to Marlboro and Diana, which remain under pressure from super-low-priced competitive brands.

The surge in discount volume is having a negative impact on government revenues, as Italy's excise tax structure is highly ad valorem in nature.

While the government is well aware of the issue, its actions to adopt a minimum tax are complicated by the current privatization of ETI.

PMI is working on possible solutions to address the issue.

In all major Western European markets, with the exception of Italy, PMI increased its share of the total industry in the second quarter, driven by the resilience and power of its brand portfolio.

In Central Europe, volume was up 3.1%, as good performances in Switzerland, the Czech and Slovak Republics, Greece and Romania were partially offset by lower volume in Hungary and the Baltic's.

Marlboro, L&M and Chesterfield all posted volume gains in the quarter.

In Eastern Europe, the Middle East and Africa, volume advanced 15.4%, fueled by a 19% increase in Russia, driven by premium brands Marlboro, Parliament and Virginia Slims, which all continued to report strong double-digit volume growth in the quarter.

Market share in Russia was up 2.7 points to 24.6%.

In Asia, volume declined 4.7% due to the timing of shipments to Japan and lower volume in the Philippines in Indonesia, partially offset by higher volume in Korea, Taiwan, Thailand and Singapore.

In Japan, PMI's market share rose to 23.7%, an increase of 0.1 points versus the same quarter last year, driven by Marlboro and Lark.

Industry shipments in advance of the July tax-driven price increase adversely distorted PMI's market share performance.

Volume was strong in Korea, driven by the success of Lark, which was introduced at the end of last year.

In Latin America, volume rose 2.8% due mainly to Argentina, where Marlboro and L&M continued to perform strongly.

Shipments were also up in Central America and Brazil.

In the quarter, PMI achieved widespread market share gains in the key income markets of Austria, Argentina, Belgium, France, Germany, Greece, Japan, Korea, the Middle East, the Netherlands, Russia, Singapore, Spain, Switzerland, Turkey, the Ukraine and the United Kingdom.

Total Marlboro volume was down 0.6% in the quarter, due mainly to Italy and worldwide duty-free.

Excluding these markets, Marlboro volume was up 2.1% in the quarter and the brand enjoyed widespread share gain.

PMI's strategy is to grow Marlboro's volume by maintaining and where possible improving its already first-class quality, as well as by leveraging its vitality and appeal around the world.

As you all know, PMI's long-term volume target is four% annual growth.

Given the challenges in Italy and worldwide duty-free, this year, volume growth is expected to be in the 3% to 3.5% range, a robust performance given the current economic environment.

Let me now turn to our food business.

Kraft announced its second-quarter results yesterday and revised its full year 2003 earnings guidance to a range of $2 to $2.05 a share.

Kraft Foods' volume increased 1.7%, driven by new products, the shift in Easter timing, higher shipments in beverages, desserts and cereals, and growth in developing markets, partially offset by divestitures.

Volume was negatively impacted by an accelerated pace of trade inventory reductions and soft consumption across some key categories, driven by prolonged economic weakness and consumer down-trading.

Operating income increased $9m, or 0.6%, to $1.6b, reflecting $92m in pretax integration charges incurred in 2002, volume growth, pricing and a favorable currency variance.

These were partially offset by higher commodity and benefit costs, increased promotional spending in certain categories to narrow price gaps and the adverse impact of product returns from new biscuit product launches that fell short of expectations.

Kraft Foods North America posted an operating companies income increase of 1% to $1.4b, while Kraft Foods International operating companies income decreased 1% to $296m.

To conclude, Kraft Foods, as you are well aware, had a difficult quarter, but is increasing marketing investments for the balance of this year and 2004 to strengthen support behind certain U.S. businesses to improve volume and share trend.

Philip Morris International delivered widespread market share gains and 14% operating companies income growth, aided by favorable currency.

Philip Morris USA's shipments have stabilized since implementing its enhanced promotion program, and the business has achieved sequential retail share growth since the fourth quarter of 2002.

This concludes my introductory remarks.

Now, I will be happy to take your questions.

Thank you.

The floor is now open for questions.

Judy Hong from Goldman Sachs.

I want to start off with the international tobacco business.

You indicated that PMI's full-year volume growth is now expected to be around 3% to 3.5%, which means that for the balance of the year, you're still looking for volume growth of about 4%.

Can you just elaborate on what you think is going to happen to some of the weak markets in the second half of the year that you think will get better to drive the 4% growth?

Or any other brand investment that you're making right now that you expect to drive stronger Marlboro performance in the markets that you are already doing well?

Fundamentally, most of our businesses are doing well.

As I said, we had a volume problem in Italy.

Volume was down in France and volume was down in worldwide duty-free.

I'm happy to say that the most recent trends in each of these markets, in fact, is improving, compared to the major part of the first half.

So we are already starting to see improvements in France, stability in Italy and worldwide duty-free is turning around also has international travel picks up.

So you add that to our basically fundamentally strong businesses around the world, and I think we will have a pretty strong second half.

We will be able to get the volume growth target of the 3% to 3.5% for 2003.

Are you satisfied by the volume that you're getting in those markets?

Obviously in the past, you've not been able to invest a lot because currency was not going your way.

Now that currency is coming back and you're investing into more brand-building types of investment, yet volume doesn't seem to be coming through as robust as maybe one would expect it.

I understand part of that is isolated to some of the markets that are seeing unusual factors.

But can you just elaborate on whether you're satisfied with the level of growth that you're seeing with the investment that you're making?

Yes.

We are actually satisfied the level of growth we're seeing.

As I said, the second quarter was an anomaly in some ways.

The second half looks good.

We made investments in a number of markets around the world.

That is starting to pay off, either in market share gains and/or volume gains.

So we feel good about it.

Many of these investments take time to fructify in terms of additional volume, but we've made the investments and we've made them in areas where we know they're going to work, so we're pretty confident about the situation.

Turning to PM USA, if I look at the operating profit per thousand in the second quarter, it looked like it went up from around $14 in the first quarter to something like $26 in the second quarter, almost doubling in magnitude.

I guess part of it is probably just the volume growth and just being able to absorb a lot of costs.

But is there anything that you're doing in the business, whether on the cost side or on the mix side, that is driving, really, improvement that we're seeing in the profit-per-thousand picture on a quarter-over-quarter basis?

Actually, our margins went up from something more like $16 to close to $26, or $25 and change.

In the first quarter, we had expenses related to the inventory buy-down, when we went for the off-invoice promotion.

So those were sort of onetime expenses.

You'll see our margins are more in this $23 to $26 range.

Okay.

Can you tell us what the price gap is now between Marlboro and the deep discounters?

The price gap bounces around between 45% and 50%.

The lowest end of the market is at about $2.35 per pack and Marlboro is closer to $3.50 a pack.

So that gap is between 45% and 50%.

Sometimes, it's closer to 45%, sometimes closer to 50%, but we believe that that's the range where it's going to stay and we believe that within that gap range, we can do well and we can grow the Marlboro share.

Thank you.

David Adelman from Morgan Stanley.

A couple of things -- first, how long are you willing to suffer this level of buying and share erosion in Italy, awaiting the government to change its tax policy before you do something, which I you'd prefer not to do on pricing?

Obviously, we wouldn't like to suffer this another day more, but we are realistic.

The fact of the matter is that Italy's excise structure, as I said, is highly ad valorem in nature.

Almost 95% of the tax is ad valorem.

The government is losing revenues with prices where they are.

I think not only is it in our interest but very much in their interest to do something about it.

So I don't know when it's going to happen.

We hope it will happen soon, but you know, it remains to be seen when exactly the tax structure is going to be fixed.

Also, in Italy, given BAT's purchase of ETI -- I mean, you have to make a decision.

There are positives and negatives of going along with them on manufacturing/distribution, going on your own, trying to develop a third party to do it for you.

Do you have a preliminary view as to which way you're likely to go?

It's still too early to address this issue, David.

I mean, this only happened yesterday.

Obviously, we're going to assess the situation; we're going to evaluate our options -- and we have many options -- and we will come to a well-considered decision in the foreseeable future.

On Kraft, Dinny, do you think 200m in incremental marketing in the back half of the year is sufficient, given what appears to be the magnitude of the problem?

In other words, it appears (indiscernible) Kraft is just taking something out of its or Philip Morris' traditional playbook, which is to aggressively attack quickly pricing gaps.

But do you think that's sufficient, or is there a deeper problem there in your view?

No.

I think the businesses in Kraft, David, are fundamentally sound.

They have a problem, a clear problem with price gaps, and also a problem with being somewhat light in the recent past on advertising for their brands.

I think they've identified the problem, and I think the plans they have are going to fix the problem.

Last question, Dinny.

Can you characterize what you're seeing in different U.S. states and U.S. tobacco business as they enact the distributor certification legislation, and then those states that have both that and allocable share legislation in terms of what's happening with low-end pricing and low-end market share in those states?

Actually, low-and pricing is coming up, David, and the problem -- when I referred earlier to the price gap -- the problem is that some of our major competitors have a lot of free product out in the market, which is holding down that lowest average price.

When you actually look at the net price of the lowest priced brands, they are coming up.

In fact, if you look at the deep-discount segment, as I mentioned, it has slowed down.

The growth has slowed down; it's pretty flat.

If you drill a little deeper, you'll see that the deep-discount segment is made up of the SDMs and in NPMs (ph).

The SDMs are basically flattened out or declining, as reflected by USA Gold, which is the leading brand there.

It's the in NPMs (ph) that are still growing slightly, but even their growth is starting to slow down.

As we increase the enactment, I guess, of allocable share legislation, I think you're going to see further pressure on the NPMs.

I'm feeling quite confident now that NPM share growth will also start slowing down.

Thank you.

Robert Campagnino from Prudential Securities.

Good morning, gentlemen.

To follow up and actually just rephrase David's question a little bit -- and not ask whether or not the incremental spend at Kraft is enough -- but it seems as if there's a number of analysts out there even questioning Kraft's fundamental strategy at this point, increasing promotions to try to reach what many see as maybe lofty volume and share goals.

Can we get your view and just overall level of support for what Kraft is doing at this point?

Well, obviously, they have our complete support on what they're doing at this time.

It's very clearly a problem of price gaps, which gets exacerbated in the current economic environment, and, as I said, being a bit light on advertising.

They've looked at each of their categories.

They've looked at each of their problem areas and they've, I must say, worked assiduously in developing the right fix.

They plan to implement it over the next six months.

As I said, we are confident it's going to work.

Okay.

You mentioned, tangentially, (inaudible) free products as one of the issues facing the competitive environment in the U.S.

It seems to me that one of the things that could potentially derail and potentially the largest thing that could derail -- you're operating profit expectations for PM USA is what RJR does in the back half of the year.

It seems to me RJR has increased promotions sequentially each of the last three months in terms of free product, as you mentioned, and also looking at the absolute amount of their buy-down from July to August.

How concerned are you, or what is your expectation for their level of promotion, going forward?

We are not concerned.

We've been competing in this market successfully for a long period of time.

We've seen situations like this; we've managed through situations like this.

Frankly, there's a limit to how much any competitor can finally do in terms of increased promotions without causing serious financial damage to themselves.

Okay.

Two just sort of housekeeping questions -- can you give us the IRI/Capstone number, the old measure for the second quarter, just so we have some basis of comparison?

The old IRI/Capstone for the second quarter of this year?

Please.

We don't have that.

Okay.

Just a quick commentary on maybe underlying consumption trends in the second quarter as you see them.

Yes.

As far as consumption trends for the total market is concerned, we've looked at these numbers based on data from the federal government on excise taxes, from the state governments on state excise taxes, and then we've looked at imports from the U.S. Customs.

When you put all that together, we see the market continuing to decline on a 12-month basis at between 1% to 2%.

Now, in the most recent period, this decline could be in the range of more like 2% to 3%, but if you look at the long-term decline rate, it stays at between 1% to 2%.

Thank you.

Martin Feldman from Merrill Lynch.

Thank you.

Good morning, Dinny.

Dinny, can I talk a little about Philip Morris International?

Obviously, you had some very strong profit growth -- up 14.3%, or 14% this quarter.

Given the reduction in your volume estimate or volume growth rate for the second half of the year, would you still expect the Company to achieve -- for the full year -- around the 10% operating profit growth you forecasted at the beginning of this year?

Yes.

Would it be right to assume that the second-quarter growth of 14% will have been the fastest growth in the year, as far as I can see, for two reasons.

One, you had particular strength in the Euro.

This has, in fact, declined a little bit in the last few weeks.

Secondly, your comparisons get a little tougher in the third and fourth quarters.

That's a fair assumption.

Okay.

Dinny, clearly, you've stabilized the discount segment of the market and you've got Marlboro once again growing and your four core brands are doing okay.

Are you satisfied with what they're doing, given the amount of investment you've put into PM USA?

I mean, I know it's easy to say yes, everything is working fine, but you put a tremendous amount of money into the business.

The margin is off pretty substantially.

The unit profitability you described earlier is off again reasonably substantially.

Given the investment, are you satisfied with the returns at this point?

Yes.

I think, Martin, you've been around the cigarette business long enough to know that to turn around a big business like Philip Morris USA requires vigorous action.

Last year at this time, their market share was declining, the deep-discount segment was growing, counterfeit was rampant, state excise taxes were increasing sharply.

Compare the situation today where they've had three quarters of sequential share growth.

The deep-discount segment is essentially flat.

Counterfeit cigarettes are still available, obviously, but we've taken vigorous action and I think, overall, the availability of counterfeit cigarettes is not increasing.

Finally, state excise taxes are still increasing but at a more moderate rate.

So if you put all that together, you've got to say they've done a remarkable job in turning the business around.

You can never answer the question that, you know, is the amount of the investment right?

Is the turn right for the amount of investment put in?

But the fact is, we've succeeded and that's what's important.

So if we take all of that into account, whether we look at reductions in the rate of discounting and the overall package, do you think that, at this point, the price gap has to shrink through further promotional activity, or do you think full-priced cigarettes retail prices on average have gone as low as they need to go?

I think it's the latter.

That's useful.

Finally, just a quick question on your interest cost -- given the over-subscription on the debt financing you've just arranged, how effectively -- how much has your interest cost gone up by -- or the rate, not the actual dollar amount -- given the downgrades?

I mean, over the course of the next twelve months (indiscernible) 2004?

Well, commercial paper -- you can borrow on the commercial paper market at, say, 1.2 -- 120 basis points.

We pay -- on the draw down on our revolver, we're paying about 100 basis points in excess of that.

Thanks very much.

Bonnie Herzog from Smith Barney.

Good morning.

I want to circle back to I guess PMI and talk a little bit about the underlying operating income growth.

If you exclude currency in the quarter -- I know it was a robust 14% growth -- but if you exclude currency, I believe PMI's operating income grew around 3.5%.

So, looking at your 1% volume, I'm just not sure you're getting as much leverage as you could.

I just would like you to maybe address that.

Then kind of going forward, I know you mentioned you're hoping for the 10% this year operating income growth but of course, that must include quite a bit of favorable currency effect.

What's a good underlying operating income growth for PMI, kind of long-term?

You are right.

PMI's income was up 3.5% in the quarter.

PMI spent back most of its currency gains really on managing price gaps and on continuing business building initiatives in many markets.

The fact of the matter is, Bonnie, that we have suffered from the dollar's strength in the past five years, whereas many of our competitors benefited.

In fact, between 1997 and 2002, we gave up about $2b in currency unfavorability.

So it's our turn now to enjoy the benefits from a weaker dollar and we're doing exactly that.

We've always said that our long-term OCI growth-rate target for PMI is 10%.

We still feel comfortable with that target.

Can you also talk a little bit about some of the recent actions by The WHO and how that's going to impact your business in the long-term, even looking out two, three-plus years?

Yes.

We actually supported most of the framework from WHO and the important thing is that the framework is going to create a level playing field in most markets around the world.

That's important to us because in the last few years, a number of our competitors have sort of played to different rules.

With the WHO framework, we will get a level playing field and I think that will be good for everyone, including us.

Okay.

Then just one final question -- obviously, with the rating agencies and the downgrade, you've stopped your share repurchase program.

I was just hoping you could kind of talk to when you are expecting to see your company resume the share repurchase program, and then talk a little bit for us about going forward with the recent tax cut on dividends -- how we should look at or forecast what you're going to do with your free cash flow in terms of allocating it between dividends and share repurchases, going forward.

Should we assume a higher percentage, maybe 60%, 70% a year free cash flow might be allocated towards dividends in the future?

As you know, in the past, our allocation in payouts to shareholders was -- our policy was to go 50-50 in dividends and share repurchases.

I think, in light of the new tax environment, we will probably favor dividends a little more over share buybacks, but the actual decision on that and how much to give through buy-back and how much to give through dividends obviously lies with our Board of Directors.

As far as when we're going to go back into share repurchases, you know, we've said that as long as we have bank debt and we don't have access to the capital markets, we really cannot go back into buying back our shares.

That remains to be the case today.

Thank you.

Phillipe Gussence (ph) from Credit Suisse First Boston.

Good morning, Dinny. (indiscernible) fixed income at CSFB.

Congratulations on the new bank facility, obviously.

You indicated it was oversubscribed.

Can you perhaps share with us why you decided not to take up the higher amount that would have been available, given that the previous line was $3b?

Well, we felt that $2b was sufficient.

Okay.

Any major changes, Dinny, in terms of covenants in the facility?

No, no major changes.

Was there any request from the banks that whenever the market opens up for you again that you would term out some of the current borrowings?

Say that again, please?

Was there any request on behalf of the banks for you to term out some of your current borrowing's whenever the capital markets open up for you again?

No.

As I said, basically, the terms remain unchanged.

Finally, do you plan to file the new agreement as part of the next 10-Q?

Yes.

Thank you.

Chris Growe from A.G. Edwards.

Good morning.

I have just a couple of questions.

Relative to excise taxes, are those up, I would say, just in line with your expectations?

Do you have a rough guide for kind of the second half that we've had a couple of these go in recently -- for how much they could be up, I should say?

You're talking of the United States?

Yes, PM USA.

(indiscernible).

The weighted average state excise taxes ended up at 66 cents a pack at the end of last year.

The current weighted average is running at about 69 cents a pack.

We hate to see increases, but the arithmetic works out that by the end of the year, the average weighted state excise tax is going to be somewhere between 72 and 74 cents a pack.

Which is the bottom line with what you were planning anyway, if I recall?

That's right.

Okay.

On the new products that you've launched in the U.S., are those gaining shelf space?

Are you able to measure the cannibalization rate for Blend No. 27, for example?

Obviously, there is some cannibalization, but there's a net increase as a result of Blend No. 27.

Blend No. 27 has done well in terms of its retail market share and distribution, and we're happy with the results so far.

You've given some information before on the price gap between Marlboro and a deep discount.

I realize there's a point in time, but last quarter, there was a price for the deep discount of like 2.42 cents.

Is there really deflation, or is it simply just a matter of timing?

I should clarify how we measure that bottom average weighted price.

What it really is the weighted average lowest price in our sample of convenience stores.

So that price includes not only the net price of the brand but also what free product is available.

In many cases, the lowest price doesn't have to be a deep brand.

It could be one of our competitors' bands, a brand that is up offering a lot of free goods.

So, it's the increasing free goods in the second quarter that has that price from the first quarter.

Thank you for that.

My last question is on foreign exchange.

I think you just made the comment that PMI sent back most of its foreign exchange improvement this past quarter.

Yes.

Would that be anticipated to continue, then, through the second half of the year, I assume?

Yes.

Thank you.

Thomas Russo (ph) from Gardner Russo Gardner (ph).

Good job in tough circumstances.

I have a question, again, following up on the price gap.

Talk for a moment about the price gap to, say, Lauralard (ph) and RJR.

Then speak for a second on the cost of those free product giveaways.

It must be quite considerable in light of all the charges that they're forced to make to underwrite those costs.

In terms of the national rollout, how competitive can RJR and Lauralard (ph) be to meeting your nationwide $3.50 price on Marlboro?

Tom, the fact is that on free products, most of the companies -- based on our calculations -- are running roughly one% of their volume in free products with the exception of RJR, who have a higher ratio than that.

So that's the situation with free product.

What was the other part?

Two other questions -- you've answered it well.

Two other questions -- could you speak a moment about the valuation and the bidding process at ETI?

I was intrigued by the price paid.

The last question -- just have a look at the FDA environment in the U.S. as it relates to the prospects for risk-reduced product, and then the possibility of a rollout of the paper select product?

Those are the other questions.

As far as the ETI price, I will leave it to you guys to judge whether it was a reasonable price or not.

We're not going to comment on that.

It was a pretty good price.

As far as the FDA is concerned, Mike Semansic (ph) appeared before a Congressional committee recently and discussed this issue.

His remarks were extremely well-received, and we are hopeful that FDA legislation is going to come through in the not-too-distant future.

As far as Paper Select is concerned, we have it on the Merit brand.

We're ready to go national with all our bands, whenever it is required.

New York legislation, ignition-propensity legislation is still not through, but we are all set and whenever we are required to do it, we will do it.

Okay.

Last question -- you had mentioned that the discount, deep-discount segment had stopped its growth, and there was a lot of confusion several weeks ago about the actual magnitude of that market.

How can you assure us that that 10% -- you captured the full amount of that market?

There was confusion.

That's a very good question, Tom, and I should be very clear on this.

When I say 10%, I'm talking of the measure that we have from our total retail panel survey.

If you actually put shipment data together, the deep-discount segment is probably closer to 13%.

But whether we're talking of 13% or 10%, I think the growth is what is important, and I think there the growth has moderated considerably from the levels that they were running at last year.

Even if you look at the 13% number, we believe it's like 0.1 or 0.2 up on the previous quarter.

Of that higher number?

Yes.

Michael Frost (ph) from J.P. Morgan.

Hi, thanks;

I just wanted to follow up a bit on the dividend, and every August the Board meets to discuss the dividend, and in the past it has pretty much moved the dividend rate up in line with earnings growth.

Given that this year there's not really going to be any earnings growth, yet we do have this interesting tax issue in front of us, I just wonder what the outcome might be with respect to any increase in the payout ratio, and what the kind of debate might be at the Board meeting in deciding what the dividend rate will be.

Thanks.

Well, obviously there will be a good debate.

But you know, they will make a decision, a well-considered decision in August, as they always have.

So we will just have to wait till them.

Okay, thanks.

The floor is now open for questions from the media.

Jessica Wall (ph) from Reuters.

Good morning, everyone.

Moody's downgraded Kraft yesterday, and it was partly because of concern that Altria could seek financial release from Kraft.

I'm just wondering if you could comment on whether Altria would try to tap Kraft for money to use in PM USA tobacco litigation?

Absolutely not.

Kraft has an independent audit committee and in any event, there's absolutely no question of Altria tapping Kraft for funds for Philip Morris USA.

I should also tell you, as with regard to your comment on Moody's, it was just the outlook that was changed; the basic ratings remained unchanged from Moody's.

Okay.

Do you think that the outlook on Kraft ratings, given the connection that the ratings agencies seemed to give them with the PM U.S.A. business -- do you think that those ratings outlooks or any of the changes that have happened so far are uncalled for?

Yes, I think they are uncalled for.

Switching over to the USA business, can you give any expectation for what you think volume will do in the rest of the year, both at PM USA and also for the deep-discount segment?

I think the deep-discount segment, hopefully, will continue to remain fairly flat, maybe grow moderately.

Philip Morris USA's volume in the second half should be a bit better, in terms of comparisons, than the first half.

Okay.

As far as retail share for Virginia Slims and Basic, they were down a tiny bit from the first quarter.

How do you plan to focus on those brands to turn that decline around?

Both Virginia Slims and Basic did lose marginal share.

I think that's just really for the second quarter.

If you look at it over a sort of longer period of time, Basic is declining slightly;

Virginia Slims is essentially flat.

Okay.

Do you have any plans to focus your promotional spending specifically on those brands?

No specific plans but from time to time, obviously, we will do whatever's necessary to keep those brands in good shape.

Thank you.

Christina Burke (ph) from Dow Jones.

Good morning.

I was just curious.

Given the fact that you've been seeing some good results with Marlboro Special Blend No. 27, do you want to do any other further line extensions this year?

Can we expect any new product launches?

We don't really speak about our plans in this regard, but you know, over a long period of time, if you look out a few years, certainly, there will be line extensions coming out from Marlboro.

Also, kind of switching to the issue of kind of some of the legislation that's going on to address the nonparticipating manufacturers issue, I was wondering -- do you expect to see more legislation like we saw in Minnesota with the tax on certain manufacturers?

Also, I'm wondering about how you feel this kind of legislation could hold up if there were to be a challenge, given that it just taxes one specific type of manufacturer.

I don't have a specific view on how well that special fee in Minnesota is going to hold up.

We will have to wait and see.

Obviously, it's a reflection of the fact that the states are feeling the effect of loss of revenue from the NPM's exploiting the loophole.

It sort of gives us confidence that they are going to take action to do something about it.

Do you expect to see other states besides Minnesota use this type of strategy?

I think that's quite possible.

Okay.

You mentioned that you felt that some of the actions by the rating agencies were unjustified.

I was wondering how regularly your dialogue -- you've had some kind of dialogue with the rating agencies.

How that has been progressing?

Yes, we have constant dialogue with the rating agencies and it's ongoing.

They present their point of view to us.

We present our point of view to them.

Right now, there's a gap in our views but hopefully, in the not too distant future, there will be some convergence.

Christina Burke Have you had any indications of that to base that opinion on?

No, I wouldn't give you much hope right now on that.

What kind of catalyst could they be looking for?

I think you'd have to ask them that but basically, they are looking for further clarity in the litigation environment.

Thank you.

That's all the time we have for questions for today.

I would like to turn the floor back over to Nick Rolli for any closing remarks.

I just want to say thank you for joining us again this morning.

If you need any further information, certainly you can reach out to the Investor Relations department here.

We will be sending out a notice in early October to discuss the 2003 Altria Group third-quarter conference call.

Again, thank you very much for joining us.

Thank you.

That does conclude today's teleconference.

You may disconnect your lines at this time, and have a wonderful day.