奧馳亞 (MO) 2004 Q2 法說會逐字稿

Welcome to the Altria Group Inc. second quarter 2004 earnings conference call.

My name is Maria and I'm your conference call operator.

Today's call is scheduled to last about 1 hour including remarks by Altria management and the question and answer session.

In order to ask a question or make a comment please press star followed by one on your touch-tone phone at any time.

Questions will be taken in the order in which they are received.

I would now like to turn the meeting over to Mr. Nick Rolli, Vice President, Investor Relations and Financial Communications for Altria.

Please go ahead, sir.

Good morning.

Thank you for joining us today.

I have a few brief announcements before I introduce Dinny.

For those listening via the audio webcast we are once again providing summary slides of first quarter results for Philip Morris USA, Philip Morris International and Kraft Foods.

Today's call is limited to a discussion of our business results.

Litigation and regulatory issues will not be covered.

Kraft Foods reported its second quarter results yesterday and hosted an earnings webcast.

That was followed by an update on its sustainable growth plan.

Both webcasts are available on Kraft's website so our discussion of Kraft will be limited on this call.

Today's remarks contain forward looking statements and projections of future results, and I direct you 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 materially from projections.

Today's remarks by Dinny Devitre, Altria's Senior Vice President and Chief Financial Officer, will summarize the highlights of our major operating company's performance during the second quarter followed by your questions.

For a more detailed review I direct your attention to the news release we issued earlier this morning which is available on our website at www.altria.com.

Now it is my pleasure to introduce Dinny Devitre.

Thank you, Nick.

Good morning.

Altria's 2004 second quarter diluted earnings per share were $1.27 up 5.8% or 7 cents including 13 cents in charges for the following items: 4 cents per share for the previously announced Kraft restructuring, 1 cent for the international tobacco manufacturing rationalization and 8 cents per share for the tobacco agreement that PMI signed on July 9th with the European Commission.

Also reducing EPS in the quarter were the impact of higher shares outstanding of 2 cents and lower results from operations of 4 cents of which 7 cents was related to Kraft's operations.

These reductions were more than offset by 15 cents per share for the positive impact of the lower overall effective tax rate reflecting the reversal of tax provisions in the second quarter of 2004.

Favorable currency of 5 cents per share and the impact of last year's tobacco grower settlement of 6 cents.

As a result of the tax benefit, Altria's effective tax rate was 26.6% in the second quarter.

However, please note that the tax rate for the second half of the year will be around 35% and Altria's projected tax rate for the full year 2004 is approximately 33%.

Despite the combined impact of lower earnings per share targets for Kraft due mainly to higher costs for key commodities and charges related to the international tobacco agreement with the EC, Altria continues to project 2004 full year diluted earnings per share in a range of $4.50 to $4.60.

Should exchange rates remain at current levels we project that we will generate EPS at the higher end of this range.

Operating income for the second quarter decreased 6.6% to $3.9 billion due primarily to the impact of the PMI EC agreement and charges for asset impairment, exit and implementation costs related to the food business restructuring and the announced closure of PMI's factory in Hungary and lower results from operations partially offset by favorable currency of 144 million.

Turning to domestic tobacco, PMUSA achieved strong results in the second quarter.

Operating companies income grew 19.6% to $1.2 billion primarily reflecting the impact of pretax charges of $182 million in the second quarter of 2003 for the tobacco grower settlement, as well as higher volume and improved mix in the second quarter of 2004.

Shipment volume of 48.6 billion units was essentially flat compared to the same period a year ago when adjusted for the timing of trade purchases surrounding the July 4th holiday.

Retail share growth for Phillip Morris USA was robust with share up 1.3 share points to 49.8%.

Marlboro was strong increasing its retail share by 1.8 points versus prior year to 39.6%.

Marlboro's price gap with deep discount brands was approximately 45% in the second quarter in line with expectations.

Parliament's retail share declined slightly reflecting a difference in promotional plans versus the second quarter of 2003.

But its underlying strength and demographics remain solid.

Deep discount brands including all other manufacturers' discount brands and major manufacturers' private label brands achieved a retail share of 11.7% in the second quarter, down 3/10ths of a share point versus second quarter of '03, continuing the recent declining trend in this segment.

In addition, imported brands are not growing based on the latest 12-month moving average data.

During the second quarter, Marlboro Menthol 72mm, a new premium-priced cigarette, contributed to incremental share growth for the Marlboro Menthol family.

Also in the second quarter, Phillip Morris USA began shipping a new premium line extension, Virginia Slims Ultra Lights 120mm box and expanded Parliament Lights 100mm round corner box, both scheduled for launch in the third quarter.

On the legislative front, Phillip Morris USA continued to witness progress in several important areas related to the state escrow statutes that were enacted in the wake of the Master Settlement Agreement.

Complementary NPM legislation that toughens escrow deposit requirements has now passed in 43 states and the District of Columbia, representing approximately 85% of industry volume.

This is an increase of 6 states since April of 2004.

An allocable share legislation has passed in 33 states representing approximately 60% of the industry volume, an increase of 9 states since April of 2004.

To conclude on Phillip Morris USA, the robust performance of the business underscores its momentum and the strength of Marlboro and its other focus brands.

Phillip Morris USA is on track to deliver moderate retail share gains and operating companies income growth in the low single digits this year.

Finally, we along with Phillip Morris USA applaud Senate passage of the bill granting the FDA regulatory authority over tobacco products.

As stated in our July 15th press release, essentially the legislation would give FDA the authority to impose performance standards for the design and manufacture of cigarettes in order to reduce the harm caused by smoking.

Provides that FDA's product standards would be consistent on a nationwide basis and would give FDA the authority to combat the existence of counterfeit contraband and other illicit tobacco products.

Overall, we are hopeful that the bill will move through the legislative process and will be signed into law and we look forward to working with all stakeholders in support of this legislation.

Turning to our international tobacco business, operating companies income decreased 8.4% to $1.5 billion due primarily to a $250 million pretax charge for the PMI EC agreement, as well as charges for asset impairment and exit costs related to the announced closure of its factory in Hungary.

We are pleased with the international tobacco agreement with the European community and believe it will go a long way in rebuilding the trust and collaborative relationship between PMI and the EU on a range of issues that are of mutual concern to us, especially working together to combat the sale of counterfeit cigarettes.

Partially offsetting PMI's charges was growth of 8.6% or $138 million of which 118 million was related to favorable currency and 20 million was from operations.

I would like to reiterate that PMI continues to spend back currency benefits in support of its brands primarily through higher marketing, expansion of its sales forces and price gap management.

In the second quarter, PMI shipment volume was 192.7 billion units was up 2.8%, but excluding the impact of acquisitions was essentially flat.

Double-digit declines in France, Germany and Japan were offset by growth of 4.2% in the rest of our business excluding acquisitions.

In Japan the the total market declined 17.4% in the second quarter reflecting a high 2003 second quarter base due to trade buying in advance of the July 2003 tax increase.

PMI shipments were down 11.3%, however, market share was up a strong 0.7 points to 24.4% driven by Marlboro's continued share growth.

In France the total market declined 26.4% and PMI shipment volume was down 20% reflecting the adverse impact of high tax driven retail price increases.

However, PMI's market share rose 0.5 share points in the second quarter to 39.9% driven by the success of Basic, the Phillip Morris brand, as well as benefiting from the continued resilience of Marlboro.

We are very pleased with PMI share performance in France and we are optimistic that volume and share trends in that market will gradually improve.

In addition the French Senate passed an amendment which effectively establishes a minimum reference price below which cigarettes cannot sell thereby ensuring that price gaps remain at approximately current levels.

In Germany, the difficult economic environment coupled with a tax-driven price increase in March has resulted in a 20% decline in the cigarette market during the second quarter of 2004 versus the second quarter of 2003.

However, the overall tobacco market in Germany which includes cigarettes, traditional fine cut products, tobacco portions and low price cigarillos declined by a more modest 12%.

Against this background, PMI cigarette volume declined 21% in the quarter with market share down slightly to 37.2%.

PMI entered the growing tobacco portions category with Marlboro and Next in late April and both are performing well reaching 137 million units or 11.7% share of the tobacco portion segment in June and 238 million units or 8.1% share of the tobacco portion segment in the second quarter.

Overall Marlboro remains resilient in Germany and PMI's cigarette market share is essentially stable.

PMI now has a growing presence in the profitable tobacco portion segment with much room to grow.

Turning to Italy, PMI's shipments were up 2.6% reflecting a low base in April 2003 due to trade purchases in advance of the March 2003 price increase, and two additional selling days in the second quarter of 2004.

PMI's market share was down 3.3 points to 51.2% in the second quarter of 2004 as Diana and to a lesser extent Marlboro remained under pressure from low priced competitive brands.

However, on a sequential basis, PMI's market share in Italy has been stable since March.

In May, PMI launched L&M at 2 1/2 Euro per pack to establish a presence in the lowest priced segment.

While still early to pass judgment, it is performing in line with expectations.

You are aware that on March 1st of this year the government in Italy implemented a minimum tax that was based on last year's most popular price category.

Last week the government issued a decree that provides for the introduction of a minimum tax methodology that is based on current prices and will be adjusted twice a year.

Furthermore, from 2005 onward the minimum tax will increase from 98% to 100% of the tax paid by the most popular price class.

The new most popular price class should therefore increase from 2.50 Euros per pack to 2.80 Euros per pack.

The introduction of current methodology combined with a number of marketing initiatives in Italy that PMI is taking will enhance and increase the retail competitiveness of its brands.

For example, a new more contemporary pack for Diana is being introduced and we are investing in significantly increasing and strengthening the sales force, new retail trade programs and modernization of in-store merchandising.

Total Marlboro volume of 80.6 billion units was down 0.9% in the quarter due primarily to France, Germany and Japan.

But those declines masked strong volume growth from the rest of the world.

For example, in Asia Marlboro was up 15%.

In Eastern Europe, Middle East and Africa it was up 11%.

In the central European region it rose 3%.

In Latin America it grew 3 1/2% and in worldwide duty free Marlboro was up 13%.

In addition, share gains for Marlboro were widespread in the second quarter as detailed in our press release.

To conclude on PMI, it is making significant investments to generate volume growth around the world.

In Turkey, for example, volume was up double digits in the second quarter driven by L&M and the success of Muratti.

Volume results in Korea were particularly strong driven by Lark One, Marlboro Ultra Lights and the recent launch of Elan, a premium-priced slim cigarette.

In the Philippines, volume was also substantially higher due to Marlboro's strong growth and the impact of acquisition volume.

And in Spain, volume gains for Marlboro and Chesterfield drove a 1.6 percentage point increase in market share to 35.7% in the second quarter.

PMI is committed to delivering on its volume and OCI targets.

We believe the most difficult sales declines in western Europe are behind us and we are optimistic about our volume comparisons in the second half of the year.

With that said, PMI expects organic volume growth at the lower end of our previously disclosed range of between 2% to 3% this year and approximately 5% overall including acquisitions and double-digit OCI growth at today's exchange rates excluding the EC agreement.

Turning to our food business, Kraft announced second quarter results yesterday.

Worldwide volume increased 3.6% including 3.1 percentage points of growth from acquisitions.

Volume strength across many businesses was partially offset by challenges and categories impacted by low carb diet trends and softness in some western European markets, particularly France and the Nordic region.

Kraft's operating income declined 23.7% to $1.2 billion due mainly to higher commodity costs, increased marketing investment and the previously announced restructuring program of $138 million.

At Phillip Morris Capital Corporation, operating companies income rose 52.4% to $125 million in the second quarter of 2004, due primarily to $84 million of gains on the sales of assets, partially offset by lower lease portfolio revenues as a result of PMCC's shift in strategic direction announced in 2003.

To conclude my remarks, Kraft is making investments to improve volume and share trends and its sustainable growth plan is on track.

However, commodity costs are a key challenge for Kraft this year.

Phillip Morris International's charge for the tobacco corporation agreement marks solid OCI growth in the second quarter including currency.

Market share gains were achieved in many top markets, although total volume growth was adversely impacted by France, Germany and Japan.

Phillip Morris USA had a very good quarter with a robust retail share growth driven by Marlboro.

And as I said at the outset, we are on track to deliver our earnings per share targets at the higher end of our range should exchange rates remain at current levels.

That concludes my introductory remarks and now I will be happy to take your questions.

Thank you.

The floor is now open for questions.

If you have a question, please press star and then 1 on your touch-tone telephone at this time.

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

Once again, ladies and gentlemen, that is star then 1 on your touch-tone telephone at this time.

Our first question is coming from [Andrew Conway] with Credit Suisse First Boston.

Morning, Dinny.

Hi, Andrew.

Question on the U.S. operating company profit performance up a little over 1% underlying, should we expect an improvement in the U.S. second half of the year?

How do you view your levers to margin improvement?

How should we think about that progress?

I think, Andrew, you've got to look at our guidance for Phillip Morris USA which we have said is going to be -- OCI is going to grow in low single digits.

We're very much on track for that.

For the second half, obviously, volume is going to be lower than last year and so you have to make your own conclusions on operating companies income.

But as I said, the company is on track for low single digits growth for the year.

Okay.

Great.

One final brief question.

As you look, I know it is early, to 2005 on the PMI profit picture, aside from the step up in income from your Japanese business, how should we frame your view of country improvement in terms of margins improving to aid your profit growth in '05?

What are some of the key areas you think we should look at as you frame your margin improvement in '05?

Obviously, you are right.

One of the main drivers of income improvement next year will be the Japanese situation.

But hopefully, also as I said, the worst of the western European problems will be behind us.

We will have lapped that.

So we can look forward to improvement there.

And the rest of the world is continuing to do well.

As I said, Asia is growing strongly;

Eastern Europe, Middle East, Africa is doing well.

And our central European region and worldwide duty free is doing well.

So, basically that's the broad outlook I can give you for 2005.

Thank you.

Thank you.

Your next question is coming from Rob Campagnino with Prudential Equity Group.

Good morning, Dinny.

Hi, Rob.

You had suggested that there was strength in the Marlboro franchise in a couple of regions, actually many markets.

Do you have a Marlboro number excluding France, Germany and, I guess, Japan?

Just trying to get a feel for the global franchise outside of those distortions.

You know, I don't have an exact number, but I think if you exclude those difficult markets, Marlboro was up something like 5 to 7%.

5 to 7%.

Excellent.

And just a quick price gap update in the U.S. and Italy perhaps?

Yes.

In the U.S. price gap was 46% in the second quarter.

Marlboro was at about -- average at about 3.53.

The lowest effective was at about 2.42.

And so that price gap is very much in line with our -- with our planning.

As far as Italy is concerned, Marlboro is at 3.50, 3 Euro 50.

And the lowest priced brands are at about 2.50, although there are still a few left over at 2 Euro 40.

But I would say the bulk of the lowest end is now at least at 2.50.

So that's a dollar on the 2.50 and that's 40%.

Excellent.

Thank you very much.

Okay.

Thank you.

Your next question is coming from Bonnie Herzog with Smith Barney.

Good morning.

Hi, Bonnie.

Good morning.

Dinny, I was hoping you could maybe go back to an earlier question and talk a little bit about the low single digit operating income growth you discussed for PMUSA for the full year.

I believe that's lower than what you originally had guided and I'm just trying to understand what is going on in the U.S. market because I feel like everything that I've seen, things are improving in terms of some pricing power returning to the industry, you know, the gap narrowing although you did just say that the gap seems to have widened a little bit during the second quarter.

So can you help me reconcile why now you are expecting lower single digit -- sorry, operating growth income for PMUSA?

Bonnie, we've always said, we've never moved off the mark on that.

We've always said that PMUSA's operating companies income is going to grow in low single digits.

And I can't recall ever having said anything other than that.

And as I said to an earlier question, you know, our volume for the second half of the year is going to be lower than it was last year.

And, you know, that's just the arithmetical facts.

If I ask it this way, the low single digit operating income growth is low from how you -- from the business's performance historically.

So if pricing power does return, obviously -- or should I assume that then you can beat your guides?

Meaning what is more realistic is mid operating income growth long-term for this business?

No, we are not saying that.

Oh.

We're saying -- we're still saying that our guidance for Phillip Morris USA is low single digits.

Now low single digits itself has a range, and, you know, when we get pricing in the future, that might affect that rate from year to year.

But, our long-term guidance remains low single digits.

All right, Dinny.

Can you go back to your underlying EPS guidance for the full year?

I don't think you walked through it.

Can you help us reconcile because certainly there have been a few one-time charges, help us understand on an underlying basis, you know, excluding the one-time charges what your 2004 EPS guidance would be for the full year?

Is it 488 to 498 as you back out the charges associated with Kraft as well as the upfront payment for the EU settlement?

Bonnie, we, as a matter of policy, are just going to stick to the guidance we've given you of 450 to 460.

You know, it's up to you to develop your own ongoing or underlying numbers.

We've said that our range is 450 to 460.

Actually, we've said now, it is at the high end of that range.

And, you know, we have laid out all the special charges in our press release and in my comments and I think you can work that out for yourself.

I agree.

All right.

Can you talk about the shorter Marlboro Menthol line extension that you introduced in the market?

You stated, and the press release said, that it did generate some incremental volume growth.

Can you talk about what your volume growth would have been in the U.S. excluding that -- that new launch?

No, we don't actually spell out the volume or market share for our sub lines.

All we can say is that the brand is, you know, is doing well both on the distribution and is meeting our market share expectations.

So, let me go out on a limb, volume was down excluding that incremental volume because as you state in the press release you exclude, you know, the 4th of July timing issue, volume very well could have been down in the U.S.?

Maybe slightly.

All right.

In terms of some of your markets in Central Europe, there was some weakness in Poland, Hungary and, I think, the Czech Republic.

Was that more of a result of lost share or the result of just the overall declining market there?

What was the driving factor behind those?

It is basically market decline, particularly if you take a market like -- I think our biggest loss was in the Slovak Republic where our volume was down for two reasons, actually.

The total market was down in the second quarter this year compared to the second quarter last year.

Because last year there was some pre-price increase trade purchases which inflated the market, so compared to that, total market was down.

Plus, we have noticed an increase in the influx of illegal cigarettes into the Slovak Republic and that too is affecting the size of the total market.

Our market share is solid in all central European -- in all the major central European markets.

And in the Czech Republic, our volume was down basically because of very cheap price competition which has affected some of our lower priced brands.

All right.

And then on PMI's business, and this will be my final question, is China, obviously BAT has, I guess, just won the approval to form a Chinese JV and they are making some strides in breaking into this market.

Can you talk about your strategy for getting into the Chinese market and what you have in store?

Yeah.

Look, we've read BAT's press release and also the other press reports.

We are awaiting more clarification on this matter.

If these reports are correct, it effectively means that the main underpinning of the China tobacco monopoly system has been dismantled because the current law does not permit anyone other than the tobacco monopoly to manufacture cigarettes and distribute cigarettes in China.

And we doubt this is the case.

In the final analysis, one's got to say that if BAT is permitted to do this, then PMI too would be given the same and equal access.

And I think finally I've got to say that access to the Chinese cigarette market is going to be a long march.

And I think you will read many announcements between now and when foreign companies gain real access to that market.

And I can tell you that we're in this for the long-term and we're working closely with the monopoly and you can be assured that we won't be left behind.

Right.

So you would pursue it.

Great to hear.

Okay.

Thank you.

Thank you.

Thank you.

Your next question is coming from David Adelman with Morgan Stanley.

Good morning, Dinny.

Good morning, David.

A couple questions about PMI first, Dinny.

The 2% target now for organic volume growth for the full year, isn't that fairly demanding given that you are essentially flat through the first half?

Yes.

It is demanding.

We'll have to have a strong second half.

But everything appears to indicate that we're on track for a strong second half.

So I believe we'll get that number, David.

Okay.

And, Dinny, were you surprised by the accelerated decline to sequentially going to the second quarter in the French total market volumes?

I think it was down about 23% in Q1 and now down 26% in Q2.

Yeah, that was a bit of a surprise.

And, you know, there was some -- I think there were some issues related I'm sure to cigarettes coming into the French market from elsewhere.

You know, one can never estimate really how much that is from quarter to quarter.

But it was a surprise that the market was down 26% in the second quarter.

And Dinny, the alteration in the minimum tax structure in Italy, when does that become effective?

Probably will become effective in the next 60 days.

Okay.

And in Japan, I understand there is some trade distortions, but where do you peg the consumption decline?

Is it perhaps 3%?

Yeah, it's probably 3 to 4%.

Okay.

And two last things, Dinny, one is you quoted again the goal of double digit operating profit growth at current rates of exchange for PMI for the full year.

Does that include the ongoing second half costs of the EU agreement in your forecast?

I mean, it clearly excludes the 250 million charge in Q2.

Well, excluding the one-time charge we'll make the double digit.

So it includes the ongoing expenses start incurring going forward.

Right.

Okay.

And lastly, Dinny, in the domestic tobacco business, should we expect now going forward that the pace of sequential gains in market share overall and for Marlboro will likely slow somewhat?

I mean, this was the first quarter that it sort of -- you're still growing but at a slower rate sequentially.

Is that more likely than not going to be the pattern going forward from here?

I think that's a fair assumption.

I mean, you know, it has been growing at sort of this one-plus rate and I think it is going to definitely continue growing, but maybe at a slower pace.

Okay.

And actually Dinny, one last thing.

The first quarter Q had flagged a likely tax benefit, one-time tax benefit in the second quarter of approximately 4 cents a share and it came in at 15 cents a share.

What incrementally happened?

What was that incremental variance?

Actually, we never said 4 cents, David.

I think someone writing, you know, on the street said 4 cents.

We never actually gave out a number.

Okay.

All right.

Thank you very much.

Thank you.

Thank you.

Your next question is coming from Judy Hong with Goldman Sachs.

Hi, Dinny.

Hi, Judy.

Just a follow-up on the tax rate question, was the 15 cent benefit, was it higher than what you had originally anticipated?

A little bit higher, but we were -- we had -- when you are saying when we estimated it, you know, a little bit higher than we estimated earlier in the quarter, yes.

Okay, so just to clarify the guidance, when you talk about the guidance for the EPS this year coming in at the high end of the 450 to 460, the difference really is that Kraft is coming in weaker than expected?

That's exactly right.

That's all of the difference?

That's all of the difference.

Okay.

And then the question on the Russian business, because it seems that that market was the market that was growing really nicely and in the second quarter it was down and I'm just wondering if there's -- you talked about the inventory issue, but how much of the decline was really inventory related and is there anything going on on an underlying basis that is impacting your performance there?

I tell you, Judy, our in market sales in Russia were up I think over 5% in the quarter.

So, as I said the underlying business is growing and our market share was up I think a point and a half quarter to quarter.

So the underlying business is fine.

Obviously on this very large base you are going to get slower growth rate than we say we enjoyed last year or the year before.

Right.

Because the 5% is still lower than what you've posted prior to this quarter, in market growth, right?

That is right.

And there were some price increases taken in Russia.

Did that impact overall consumption?

It's very difficult to estimate overall consumption in the Russian market.

There is no sort of organized data available, but we don't think so.

Okay.

Thanks, Dinny.

Thank you.

Thank you.

Your next question is coming from Martin Feldman with Merrill Lynch.

Thanks.

Good morning, Dinny.

Hi, Martin.

Dinny, one or two points, if we look at PMI first, am I correct in assuming -- I mean, you refer to double digit growth this year including the benefit of currency, without the benefit of currencies are we looking at more or less a flat number with last year?

Well, you mean for 2004?

Yes.

It will be up a little bit.

Okay.

Okay.

So the low single -- 2, 3%.

Low single digits, yeah.

Okay.

And you've commented in the past, given the attractive nature of the currency, you are investing more heavily in the brands and in your businesses around the world.

Is that still correct?

Yes.

Can you give some color as to how much, perhaps not in number terms, but how much additional investment you are putting behind the brands at the moment and how much latitude do you have if the currency in fact starts strengthening or the benefits start reducing to pull back on that investment?

Yeah, well we are making investments obviously in a variety of things.

We are doing more, you know, basic marketing and advertising where we can do it.

We are expanding our sales forces and infrastructure.

If you take the year to date foreign exchange gains, currency gains for PMI, I guess we probably have invested, reinvested you know at least 2/3 of that back in higher marketing and sales force expansion.

And going forward, obviously we always have flexibility in what we do, you know, in controlling that number.

Dinny, are you satisfied with the results?

I mean, you've been investing, I don't know, for some 18 months now and more aggressively internationally.

Are you happy with the results of those investments?

Yeah, we're happy with the results because I tell you some of the conditions have been very difficult.

I mean, if you look at what's happening in Western Europe, the fact that we've come through with our market shares intact and growing in some markets, in particularly France, that we have been able to stabilize the situation in Italy and that in a very difficult German environment actually we've done very well in holding share and in fact now have entered the portion segment.

And then if you look at other markets around the world, look at some of what we are doing in Asia, for example, in terms of our 15% growth rate there and very strong continued performance in Central Europe and worldwide duty free and Eastern Europe, so yes, we're very happy.

Okay.

In the German market, I think you referred to 8.1% share of the portion's market?

Yes.

For the second quarter and 11.7 for June?

Right.

Should that June number now reflect a fairly stable market share for I think you said Marlboro and Next your two brands in that segment?

Well hopefully we will be able to increase that share, Martin.

So is that growth coming-- is it coming at the growth of mainstream Marlboro or are you winning share from other brands?

No, we are winning share from other brands.

Well not really winning share from other brands, but obviously the total volume of the portion segment is growing.

Right.

Right.

Absolutely.

Turning to the U.S. market again perhaps not referring as much to numbers, but there has been a lot of talk about the discount segment, about the private label segment, but how do you see pricing in the market?

Your ability perhaps or the industry's ability to reduce the amount of free volume just the -- if I can describe it as the disguised pricing environment, how much better do you think it is now than it was 6 months ago and where do you see it over the next few months?

Well I think one thing you can already see is that if you compare the level of promotions say to the same time last year, it is roughly flat.

It has not been growing like it was in earlier periods.

So that's one fact.

If you look at this deep discount segment in total, it has been declining and one reason it has been declining is the escrow statutes have become much tougher.

And the figures I mentioned earlier in my prepared remarks alluded to that.

The number of states that now have NPM legislation and allocable share legislation it has increased significantly and hopefully by the end of 2004 we should be able to cover most of the united -- not we but we will support the coverage of legislation in most states and that will further, I think, dampen the prospects for the deep discount segment.

So I think it's all working in the right direction and -- but at the same time I have got to say that it's still competitive out there.

Okay Dinny, just two quick other questions on PMUSA.

If the proposals that you supported in the Senate do in fact become law, which is obviously still uncertain in regards to FDA jurisdiction, what do you think happens to the deep discount segment as a result of that legislation?

I think the main thing with FDA legislation is going to create a level playing field for everyone.

And I think that's important for the industry.

It's important for consumers.

It's important for the government and, you know, I think there will be some players who will do well in that environment, including many of the smaller players.

And then some players who may not do well.

It just remains to be seen.

Why should some of the small manufacturers have their share boosted as a result?

I just said --

You said some might do well.

Some will do well in terms of meeting FDA legislation.

I see.

Okay.

And a last point, you have been a bit more aggressive on Marlboro Menthol perhaps than you have been in terms of discounting and promotions than overall -- your overall discounting and promotional activity.

Are you pleased with the results of Marlboro Menthol over the last few months?

Yeah, it is doing well.

Where did it land up for the quarter in terms of share?

We don't give sub brand share.

Okay, but --

It's up.

It was up over the previous--?

Yeah.

And sequentially up.

Okay great.

Thank you.

Thank you.

Thank you.

Our next question is coming from [Philippe Aguson] with Credit Suisse First Boston.

Yes, good morning, Dinny.

One housekeeping question before my actual question comes.

Do you have a D&A and CapEx number for the quarter please?

A what number?

A depreciation and amortization and CapEx.

The CapEx number was a little over 700 million for the second quarter.

Yeah and then the depreciation and amortization?

Depreciation and amortization, I have this here for the first half.

It was about $717 million.

Okay.

And then the question I have, Dinny, in the previous quarter conference call, you indicated you were renegotiating your bank lines.

Can you perhaps give us an update in terms of what you ended up doing?

Yes.

We've got the -- as far as Altria is concerned, we didn't need the 364-day revolver, so we didn't renew that, and we have got our long-term revolver of $5 billion which we have through July of 2006.

Okay.

And do you happen to know by any chance how much is outstanding under that 5 billion?

We -- we had not used any of the 5 billion at the end of the quarter.

Great, thanks so much, Dinny.

Thank you.

Our next question is coming from [Martin Steineck] with J.P. Morgan.

Hi, Dinny.

Hi.

You mentioned FDA legislation.

Could you comment on the impact this might have on your new products, and should we expect you to wait on the bill to pass before launching potentially reduced exposure products you've talked about through the course of the year?

Well look, it all depends.

If FDA legislation is passed, you know, before the end of the year then obviously people at Phillip Morris USA are going to be in touch with the FDA with regard to the reduced risk product and have discussions with them and then based on that they are going to make a decision whether to go forward right away or to wait.

But a lot will depend on whether FDA legislation is passed this year or not.

All right.

And the other thing I wanted to ask you about is in PMI.

I think you said that the worst volume declines in Western Europe is behind you.

I want to understand better what you're seeing in the market, particularly France and Germany, that gives you that sort of confidence given the cross border trade in the EU session countries.

Well, in France I think what is giving us confidence clearly is that our market share is up.

Our market share was up 0.5 points in the quarter.

The other very encouraging fact is this new amendment passed by the French Senate last week which basically sets a floor price on cigarettes.

So we don't believe the gap is going to get beyond what it is today which is about 11% between Marlboro and the lowest end.

That is encouraging.

And finally I think we are going to start soon lapping the worst period of the decline in France.

That actually started last year.

In terms of the total market I mean.

Right.

Right.

Okay.

I guess a final question, I just wanted to return to Bonnie's question on China.

I guess if BAT has managed to open the Chinese market, given its history, its brand equity with the triple fives brand, its Virginia blend brands, do you think Phillip Morris can have a competitive advantage in the market and have a proposition for the Chinese smoker?

Very much so.

Marlboro has a tremendous image in China.

And you've got to remember a number of markets in the Asia region were originally Virginia markets and over a period of time changed to blended cigarette markets.

And in China you notice the same thing.

If you go to Southern China, for example, its blended cigarettes do very well in Southern China and that trend, we believe, will grow northwards through the country.

Thanks so much.

Thank you.

Thank you.

At this time we would like to invite our press and media audience to ask questions.

If you have a question please press star and then 1 on your touch-tone telephone.

Our next question is coming from [Jessica Woll] with Reuters.

Good morning, everybody.

Good morning, Jessica.

Going back to something you said earlier, I believe it was in response to Martin Feldman's question about the U.S. tobacco business.

You said that if you compare the level of promotion to the same time last year it is roughly flat.

Are you talking about PMUSA's promotion offers all, Marlboro promotions or the whole industry?

I'm talking the industry.

Okay.

What about your promotional levels, where are they?

Also roughly flat compared to same time last year.

Okay, and do you expect the level to stay flat going forward?

Well, we're not going to spell out our strategy going forward.

I'll take that.

Just leave it at that.

Fine.

And I just wanted to get some clarification on your full year outlook.

You said that you see earnings at the high end of the 450 to 460 range, but that's if exchange rates stay at current levels?

Right.

Okay.

And any update on plans to resume share buybacks?

No.

No further update.

Okay.

Thank you.

Thank you.

Thank you.

Our next question is coming from [Kristina Burke] with Dow Jones.

Good morning.

I just wanted to clarify the question that you had earlier on how FDA regulation could impact your test to -- your test of the reduced risk cigarette.

I'm just curious because if you look at the timing with Congress going into recess, I'm just wondering about timing issues.

Because I had thought that the test was supposed to occur for reduced risk cigarettes sometime in the second half.

Was that supposed to be a very late in the year event?

Yes, that was supposed to be a late in the year event.

Okay and so your idea is that if, you know, you'll see what kind of progress is made?

That's right.

And -- now, by the time any legislation that goes into effect, I'm expecting that there would be some kind of delay in the period in which the FDA actually, you know, begins to take over control of the tobacco market and then also by the time they could create a standard for what would qualify as reduced risk.

Right.

But right now does the legislation include -- you know, the legislation being discussed right now, does that include any standards for what would qualify as reduced risk?

Or do you have any sense of what they might be looking at?

I think the FDA is going to follow the Institute of Medicine guidelines.

And as I said earlier, you know, depending on when this thing passes, if it passes before the end of the year or whenever, I think if it's close to when PMUSA was originally planning to introduce the reduced risk product, I think there is a good chance that Phillip Morris USA will confer with the FDA about the best way to go forward.

Okay.

And the standards that you have been applying in your development of the product are the standards you are anticipating the FDA will use?

Yes.

Okay.

Thank you very much.

Thank you.

Thank you.

Our next question is coming from Chris Growe with A.G. Edwards.

Hi Dinny.

Hi Chris.

I have not joined the media yet.

I just have a couple questions for you.

First of all, and these are really as follow-ups to many earlier questions, but the price gap in the U.S. -- I should say the deep discount, I know it can be a moving target, it has come down.

I was just curious if there has been any incremental promotion or just reduced prices you have seen on that front?

With the deep discount brands?

Yes.

Deep discount-- what I have shown quarter to quarter sequentially it has come down a little bit, a few pennies.

I'm just curious if there is anything that could be driving that or if it's a trend?

It's a trend.

And with the economy improving I think that also tends to dampen the deep discount segment.

So, do you believe pricing will continue to move down.

I'm sorry, did you say that, for deep discount?

Sorry, no.

I misunderstood your question.

I thought you were asking me the trend of the deep discount segment.

I meant on the pricing side.

On the pricing side, a lot of that really is the effect of promotional offers and that sort of changes quarter to quarter.

I don't see any particular trends there.

Okay.

I just have made the assumption that, of course, with the allocable share legislation and that kind of thing that we should see some gradual increases in pricing over time.

Yeah I think if you look at that over a period of time like 2 or 3 quarters you will see that.

Okay.

And then as a follow-up on Germany, just so that I'm clear, in the press release you had talked about the market being down about 20%, but that does not include the Roll Your Own, is that correct?

You are talking about market decline of 20%?

Yeah, that does not include the Roll Your Own.

Does not.

So do you have like a consolidated sort of Germany number for Altria because you had a nice ramp in this quarter for the Roll Your Own?

Yeah, Germany number in total -- look, our volume was down on cigarettes about 20%.

We added about, you know, 230 million on portions so that's not going to change that 20% number too much.

Okay gotcha, yeah.

And then there was an excise tax increase in Germany as well, and if I recall you were holding out in terms of passing that along.

Is that still the case in Germany and as price has gone up have retails reflected that yet?

Yes they have.

They went up.

That, in fact accounted for the very large decline in the German market in the second quarter.

That's what I wanted to be clear on.

The last question is more of sort of a modeling question for Phillip Morris Capital Corporation.

These gains on the sale of assets I assume are more one-time in nature, is that correct?

So the underlying decline in the business is more agressive than what I thought.

Is that a trend though?

No, I think you've got to--you know, selling assets is very much part of their business now as they unwind their portfolio.

And as assets come to end of lease or early buy out options, you know, we're going to continue to have sales of assets.

Okay.

And just one last one on the earnings guidance, I was not clear on this before, but if you hit $1.27 per share in the quarter on that number, using that number for this quarter you are saying the higher end of your 450 to 460 guidance range, right?

Right.

Okay.

Thank you.

Thank you.

Thank you.

Our next question is coming from Ann Gurkin with Davenport.

Good morning.

Good morning.

Just one more question, Dinny, can you give us the growth of the low price tobacco products -- the growth of that segment in Germany, France and Italy?

Yeah.

In Germany the lowest segment increased its share of industry from about 25% to about 27%.

In France it grew from about 21% to about 23%.

I'm giving you quarter-to-quarter.

Last year versus this year.

Right.

Okay.

And in Italy it grew from about 10% to about 13%.

Okay.

That's all I have.

Thanks very much.

Thank you.

Thank you.

Our next question is coming from [Chris Whitcomb] with Lehman Brothers.

Please pose your question.

Hi.

I just wanted to go back to Italy and pricing, I was wondering if perhaps you could give us how that translates into actual retail prices in Italy, what you expect average retail prices to go up by?

You mean as a result of the minimum tax?

Sure.

We think the 2.50 brands will go up to at least 2.70 and maybe 2.80.

And would you be likely to have an increase of that sort of magnitude?

No, because we're already, you know, at that minimum price.

Yeah, but you wouldn't actually use that as an opportunity to move sort of Marlboro --

No, I don't think so I think we'd use that opportunity to narrow the price gap.

So price gap management?

Yeah.

And I was just wondering, another couple follows, about sort of lapping being an opportunity, lapping difficult quarters for seeing things improve, but obviously we had some of the more difficult quarters in Germany came into the market a lot later than they did in France.

Does that mean the worst is not yet behind us in Germany?

Well, in Germany the actual bad quarter in Germany has been the second quarter which was the result of the price increase at the end of March.

Prior to that, you know, the German market was declining at a much lower rate.

Sort of 3 or 4 percent.

Which is what I mean.

Is the drop going to be bad quarters to lap for some time.

Does this mean that we should be looking for similar quarters to Q2 and Q3 and Q4?

No, I think Q3 and Q4 should improve because you know the effect of the price increase will gradually abate.

Just finally one thing related next to Germany, Austria, I mean you talk about sort of across border movements into Czech and Slovak Republic, I mean what are you experiencing in Austria?

Are we seeing any improvement in the situation there?

No, the total market is still declining in Austria.

Excellent.

Thank you very much.

Thank you.

Thank you.

Our next question is coming from [Donald Lipkin] with Bear Stearns.

Yes, hi, could you tell me what's your estimate of what percentage of the total domestic market IRI/Capstone is capturing?

In terms of market share -- well, it is probably capturing over 95% of the market.

Okay.

And do you feel that the -- obviously the part that it is not capturing is probably -- would that be mostly discount to deep discount segment?

Or could it be-- it must be mostly deep discount segment.

No.

It is things like Indian reservations and internet sales.

Okay.

And would you say that those are either growing or falling in terms of its market share -- not market share but volumes sort of inline with the rest of the market or it is pretty impossible to say?

Very difficult to say.

I'd say internet sales account for about 2 1/2% of total volume.

Probably growing slightly.

Great.

Okay.

Thanks a lot.

Thank you.

Thank you.

Our final question is a follow-up from Martin Feldman with Merrill Lynch.

Thanks, Dinny.

Hi, Martin.

Just two questions going back to PMI and it is just a point of clarification.

You said excluding currencies you thought PMI's operating income this year would be up in the low single digits, is that correct?

Excluding currencies, yes.

Excluding currencies.

And my point is just, was that correct?

Low single digits?

Yes, that is correct.

And did that include or exclude acquisitions?

That low single digit number?

That low single digit number -- let me just sort of get my -- my mind wrapped around what you're asking me there.

That would include acquisitions.

Okay.

So sort of ex-acquisitions and ex-currencies the business is more or less flat?

Yeah, you would say that, yeah.

Okay, and just a follow-up, I think when Andre Calantzopoulos spoke a year ago at CAGNY he referred to a push by PMI to perhaps introduce more regional brands and in some cases a greater number of lower price point brands.

He highlighted tester field at the time.

How is that push going within PMI?

It is going well.

You know, I think if you look at most of these brands that we are working with in Central Europe, Eastern Europe and Asia the sort of what you would call non-international brands are doing well.

Right.

What do they represent as a proportion of all of PMI's volumes.

I don't have that number with me, Martin, but it is probably pretty low at this stage.

Okay.

But Dinny, given excise tax hikes, given some of the problems in the big markets, should we expect to see sort of accelerated growth and further investments in some of those lower end brands?

Yes.

Okay.

Thanks for taking a second question, Dinny.

Okay, Martin.

Well thank you very much for join us this morning on the call.

We look forward to talking to you again next quarter and we'll send out information in mid-October about our third quarter earnings conference call.

Again, thank you very much and have a good day.

Thank you.

This does conclude today's teleconference.

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