奧馳亞 (MO) 2005 Q2 法說會逐字稿

Good morning.

Welcome to the Altria Group second quarter 2005 earnings conference call.

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

In order to ask a question, please press the star key followed by 1 on your touch tone phone at any time.

Today media representatives on the call will also be able to ask questions following the conclusion of questions from the investment community.

It is now my pleasure to turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communications for Altria.

Please go ahead, sir.

Good morning, and thank you for joining us on the call today.

For those of you listening via the audio Webcast we are providing summary slides of second quarter results for Philip Morris USA, Philip Morris International and Kraft Foods.

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

Kraft Foods reported its second quarter 2005 results yesterday and hosted a separate Webcast.

Since the bigs was covered in detail on that Webcast, our discussion of Kraft will be limited on this call.

Our remarks contain forward-looking statements and 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 materially from projections.

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

Far a more detailed review, I direct your attention to the news release we issued earlier this morning, which is available on our Website at Altria.com.

And now, it's my pleasure to introduce Dinny.

Thank you, Nick, and good morning, everyone.

I am pleased to review our 2005 second quarter results.

We delivered solid EPS performance in the second quarter, which reflects the strong business fundamentals enjoyed by our domestic and international tobacco businesses.

Kraft is pursuing the right actions to secure long-term sustainable growth, but its second quarter results lagged our expectations due largely to severe commodity headwinds.

Altria's diluted earnings per share from continuing operations rose 11.1% or $0.14 to $1.40 versus $1.26 in 2004.

As detailed in Schedule 7 of our news release, the earnings per share growth of $0.14 was driven by a net $0.02 from operations, reflecting $0.04 improvement from tobacco, partially offset by lower income from food and Philip Morris Capital Corporation, $0.05 due to favorable currency, $0.02 from a change in the tax rate and $0.08 of various items in 2005, largely due to a benefit of $0.10 related to the American Jobs Creation Act.

These increases were partially offset by $0.01 for higher shares outstanding and $0.02 related to the net charges in 2004.

We revised our projection for 2005 full year diluted earnings per share from continuing operations to a range of $5 to $5.10, up $0.05 from our previous guidance of 4.95 to 5.05.

The increase in guidance reflects approximately $0.03 to $0.04 for the previously announced acquisition of Sampoerna, $0.10 for the tax benefit generated by the repatriation of $6 billion of earnings under provisions of the American Jobs Creation Act,, partially offset by an increase of approximately $0.01 to $0.02 for the USA pool tobacco buyout versus our original estimate and $0.07 of lower currency benefit than originally planned.

Our projection continues to include $0.12 per share in Kraft restructuring charges.

However, it does not include any benefit from the potential reversal of prior year accrued contributions to the National Tobacco Growers Settlement Trust, pending the outcome of litigation.

Turning to domestic tobacco, PM USA had a solid second quarter, based on all major performance criteria: volume, share and income growth.

Operating companies income rose 4% to $1.3 billion, primarily driven by higher volume and lower wholesale promotional allowance rates, partially offset by expenses related to the quarter buyout legislation, higher retailer allowances and increased spending for R&D.

Cigarette shipment volume of 49.3 billion units grew 1.4% compared to the second quarter a year ago, but was essentially flat when adjusted for the timing of promotional shipments and the timing of trade purchases in advance of the July 4th holiday.

PM USA's retail share advanced 0.2 points to 50%, driven by premium priced Marlboro and Parliament and Basic in the discount category.

During the quarter the premium category increased by 0.3 points to 73.7% of the U.S. cigarette industry, and PM USA maintained its share of the category at 62% in the second quarter versus the year-ago period.

The total discount segment was down 0.3 points in the second quarter to 26.3%.

Within this, the deep discount segment, comprised of all other manufacturers' discount brands and major manufacturers' private label brands, was up 1/10 of a point to 11.8% in the second quarter.

To sum up, PM USA's business fundamentals are strong, led by the outstanding retail share performance of Marlboro and its other focus brands, Virginia Slims, Parliament and Basic.

New products will continue to advance the brand equity of PM USA's portfolio, with the most recent introduction, Parliament Blue, in a contemporary new package will be available at retail stores in the test market beginning in late August.

In addition, PM USA is effectively addressing the problem of counterfeit cigarettes and illegal Internet sales to defend the integrity of its brands.

For the full year 2005, PM USA continues to project moderate growth in retail share and operating income -- operating companies income growth in the low to mid-single digits.

Turning to our international tobacco business, in the second quarter PMI's operating companies income rose nearly 38% to $2 billion, due mainly to the absence of the second quarter 2004 initial $250 million charge for the EC tobacco agreement, higher volume and pricing, favorable currency of $136 million, the impact of acquisitions and higher margin in Japan resulting from the expiration of the license agreement with Japan Tobacco.

These increases were partially offset by unfavorable mix, higher R&D and selling expenses, and expenses related to the EC agreement.

PMI's cigarette shipment volume increased 5% to 202.4 billion units, fueled by growth in eastern Europe, the Middle East and Africa, and acquisitions in Indonesia and Columbia, partially offset by lower shipments in western Europe.

Excluding acquisitions, cigarette shipment volume for PMI increased 1.6% versus the second quarter of last year.

In western Europe, PMI's cigarette volume declined 4.7%, mainly reflecting lower shipments in Germany and Italy.

However, PMI's market share grew 0.5 share points versus the second quarter of 2004 to 38.9%.

Income was also up solidly on a local currency basis.

In the important German market, the total cigarette market declined 9.1% in the second quarter.

However, this was offset by an increase of other tobacco products volume, principally tobacco portions.

PMI's total tobacco volume in Germany declined 4.1% in the second quarter, with cigarette volume down 9.7%, while other tobacco products volume more than doubled.

PMI's cigarette industry share of 36.9% declined 0.3 points versus the prior year quarter but recorded a sequential share increase for the second successive quarter.

The environment remains very challenging in Germany, and it appears likely that the cigarette market will continue to decline this year, as cigarette excise taxes are scheduled to increase again on September 1st, and PMI has announced a new pricing structure for its cigarette brands.

At the same times there has been tremendous growth of other tobacco products, specifically tobacco portions, largely due to favorable tax treatment.

However, just last week the Advocate General of the European Commission issued an opinion that the German government is in breach of EU excise duty directives, as tobacco portions for all intent and purposes look like, and have similar qualities, to factory produced cigarettes.

This opinion is not binding.

Nevertheless, final judgments, which are decided by the European Court of Justice, historically follow the recommendation of the Advocate General in the vast majority of cases.

As a result, we believe that there is a high likelihood that the taxes on tobacco portions and cigarettes will be equalized soon after the final judgment.

To sum up on Germany, while PMI is experiencing some temporary obstacles to growth, we are optimistic about PMI's future in this important market.

Marlboro remains resilient, and PMI has successfully established Next in both the cigarette and OTP categories.

Next has achieved a 0.4 share of the cigarette market since its April 2004 launch, while its share of the total tobacco market has increased 2.2 share points.

In Italy, the total cigarette market was essentially flat, as effects of the indoor smoking ban moderated due to warmer weather.

As anticipated, an inventory reduction of approximately 1 billion units by PMI's new distributor occurred in the second quarter of 2005, resulting in PMI cigarette volume declining 6.3%.

However, end-market sales in Italy rose approximately 2%.

Market share in Italy rose 1.6 points in the second quarter to 52.8%, driven by the continued strong recovery of Diana, the improved performance of L&M and Chesterfield, and the resilience of Marlboro, whose share was stable with the prior year quarter.

In France, PMI's business continues to perform very well., aided by a stabilized total marked.

Although PMI shipments were down due to unfavorable inventory movements, market share performance was robust, with share rising 1.9 points to 41.8%, reflecting the strong performance of Marlboro.

PMI has now delivered market share growth in France for the fifth consecutive time versus the year ago quarter.

In Spain PMI shipments were down 1.3%, and market share was down 0.3 points to 34.8% in the quarter. 2005 has been characterized by the rapid expansion of the super low-price segment, which increased to 13% of the total market during the second quarter.

The most popular super low-price brands sell at a 75% discount to major low-price brands in the market, including L&M.

In the second quarter, L&M lost 0.5 share points and was the main cause of PMI's overall share loss.

However, Marlboro gain share.

Moving on to central Europe, PMI's volume declined 3.4% due to the timing of trade purchases in advance of excise tax increases in Romania and intense competition in the low-price segment in Poland.

However, in Greece, volume rose 8.5%.

Volume in eastern Europe, Middle East and Africa grew an impressive 12% on the strength of PMI's portfolio in Russia, Ukraine, Turkey and Egypt.

In Russia, volume was up 11%, fueled by the strong performances of Marlboro, Parliament, L&M, Chesterfield and Muratti, as well as the timing of shipments.

PMI's market share in Russia rose 1 point to 27.1%.

In Turkey, shipments increased 1% and share grew 4.9 points to 41.1% on the strength of Marlboro and Parliament, the recent launch of Bond Street and the price repositioning of Lark.

However, the current il-conceived tax regime in Turkey has put pressure on both industry profitability and government revenues.

Turning to Japan, volume rose 5.4% in the second quarter, reflecting the timing of shipments as a result of the handover of Marlboro from Japan Tobacco to PMI in May.

Underlying end-market sales were down slightly, but market share was up by 0.3 points to 24.6%, driven by Virginia Slims, Rose and Marlboro.

In Japan, PMI is well-positioned for continued share growth, and regaining control of Marlboro significantly improves its profitability in this important market.

In the rest of Asia, shipments rose 25% in the second quarter, primarily because of the acquisition of Sampoerna in Indonesia.

In May, PMI completed the acquisition of Sampoerna and volume of 4.4 billion units was included in PMI's second quarter results.

Sampoerna's key brands, namely A Mild and Dji Sam Soe, are performing very well.

In the second quarter, operating companies income of $74 million related to the Sampoerna acquisition reflected equity accounting from March to May and consolidated results for the month of June.

Excluding the Sampoerna volume, shipments in Asia were essentially flat.

In Thailand both volume and mark share were up strongly.

In Korea, volume was down, stemming from a decline in the total market as a result of the December 2004 DAX [ph]-driven price increase.

However, market share in Korea increased 0.5 points to 8%, driven by the strength of Marlboro.

In Latin America, PMI shipments were up 5%, due primarily to the acquisition of Coltabaco in Columbia in April, partly offset by lower volume in Argentina, Brazil and Mexico.

PMI now owns 98% of the largest tobacco entity in Columbia, which is the fourth-largest cigarette market in Latin America.

Total Marlboro volume in the second quarter for PMI was up 3.2%, reflecting the timing of shipments to Japan, partially offset by lower volume mainly in Germany.

Excluding the timing of shipments to Japan, Marlboro volume was down slightly versus prior year quarter.

However, Marlboro share gains were achieved in many top income markets including Japan, Spain, Russia, France and Portugal.

For the full year 2005, PMI expects volume growth to be approximately 5%, including the acquisitions of Coltabaco and Sampoerna.

Excluding acquisition, PMI projects volume growth of approximately 1%, mainly reflecting the adverse impact of the excise tax increase scheduled for September in Germany.

Operating companies income is projected to grow this year at double-digit rates, including the benefit of the Sampoerna acquisition and despite the challenges in Germany and Turkey,nd the recent strengthening of the U.S. dollar.

Turning to Philip Morris Capital Corporation, operating companies income was 70 million for the second quarter of 2005 versus 125 million in 2004.

Results reflect an unfavorable comparison to the prior year period when PMCC recorded gains on various asset sales.

Consistent with its strategic shift in 2003, PMCC is no longer making new investments and expects that its operating company's income will fluctuate overtime, as investments mature or are sold.

Let me now turn to our food business.

Kraft reported its results yesterday, so I shall contain my remarks to some very brief highlights.

Kraft net revenues were up 3% to 8.3 billion, with a benefit from favorable currency of $185 million, partially offset by the impact of divestitures, namely the U.S. yogurt and U.K. desserts business.

Kraft's ongoing volume was down 1.6%, reflecting the impact of lower volume in Germany, a shift in Easter timing, and weaker category trends in the United States.

Operating income increased 3.4% to $1.3 billion, due to lower exit and implementation costs for its restructuring program.

Excluding those charges, operating income was down, as higher commodity costs increased post-employment benefit costs and increased consumer marketing spending were partially offset by positive mix, cost reductions, and favorable currency of $23 million.

To conclude, Altria delivered a strong second quarter and we're pleased that the favorable earnings impact of PMI's recent acquisition in Indonesia supplemented by an income tax benefit, will more than offset the adverse effect of the recent appreciation of the dollar, allowing us to raise our guidance for the year.

And now I will be happy to take your questions.

[OPERATOR INSTRUCTIONS] Our first question is coming from Bonnie Herzog from Citigroup.

Please pose your question.

Okay, thank you.

Good morning, Dinny.

Good morning, Bonnie.

I wanted to start with a question on Japan Tobacco.

Since you have taken back the rights to distribute Marlboro in Japan, Japan Tobacco appears to have become much more aggressive with increasing its vending machine placements and introducing new brands in the country.

What other significant changes have you seen in the competitive landscape since April?

And are you doing anything different, now that you're in control?

Also, how much did Marlboro retail share increase in Japan during the quarter?

Thank you.

Marlboro retail share increased 0.2 points versus the previous quarter last year.

Yes.

And I would like to first say, Bonnie, that the transition from Japan Tobacco to PMI has gone very smoothly with the Marlboro brand.

And with a brand like Marlboro, which has such strong consumer pull, distribution really is not a problem whether it is over-the-counter or vending.

Distribution for a brand like this really-- is really dependent on consumer pull.

And, as I said, consumer pull is strong.

It's very much like water finding its own level.

Specifically with regard to vending machines, the question of distribution is both a matter of quality and quantity.

And if you look at our performance in the quality locations, it's been very good.

We are over 90% of where we want to be.

And with regard to our overall distribution targets in vending machines, we're on schedule and well over 85% of where we would like to be.

So I would say the transition has gone smoothly.

As far as the main changes, I would say the main changes that, you know, Marlboro is going to get tremendous focus.

As long as it was with JT it was one of their major brands, and they treated it very fairly.

But now that it's back with PMI, you know it is our major brand around the world.

It is our major brand in Japan, and we're going to give it tremendous focus and support.

Okay, that's great.

And then I also have a question on currency.

In the past when the dollar was weakening, I believe you would invest some of those benefits of this improvement on trying to increase your brand equity internationally.

Now that the dollar is strengthening, should we assume that you will now be scaling back that investment?

And if not, I guess I would assume that could negatively impact PMI's operating income growth and margins going forward.

Is that fair?

I think I will address that question in two ways.

First of all, we'll always do what is best for our brands.

Whether the dollar is strong or weak, we always do what is best for our brands.

The second point I would like to make is, if you look back historically in the three or four years leading up to 2003 when the dollar was strong, we may have taken our foot off the pedal a bit in terms of investment and infrastructure and marketing.

And then when the dollar has weakened, we've taken advantage of that situation, reinvested in infrastructure and in marketing.

And we're going to continue to do that.

And as I said, we're going to do what is right for our brands.

And you know, that may affect margins in the short term, but at the same time we've got our eye on growing our overall income at PMI.

Okay.

And then finally, one last question on PM USA.

Your shipment share was a bit stronger than what we were expecting, but your operating income growth was slower.

If you exclude the higher spending for R&D that you mentioned, would operating income growth have been closer to maybe 5 to 6%?

If you could try and help quantify that for us, that would be useful.

Also, I assume going forward we should see PM USA's operating income grow faster since you did recently reduce your promotional spending, specifically your retail buy-down amounts on Marlboro and Basic, so maybe during the second half faster growth.

Again, is that fair?

Look, as far as that retail leaders program reduction, that was really a reallocation of funds because a part of that program which actually dealt with the highest performance level, but it turned out to be more successful and had a higher penetration rate than we expected.

So we lowered so-called reward payments, and that's basically going to be-- it is a reallocation of funds and it is going to be basically neutral to PM USA's bottom line.

And to address the first part of your question, yes volume was up but we had the costs related to the quarter buy-out in the second quarter, as well as higher costs that came about from this success that we enjoyed in the retail leaders program.

But also you mentioned, Dinny, that you have increased spending for R&D.

So that seemed to have impacted maybe more so this quarter your operating income.

Yes.

R&D was up over the same quarter last year.

Double digits?

It was up.

I am I'm just try to get a sense of how much operating income growth could have been if you were to exclude, you know, this increased spending on R&D.

Bonnie, I won't go into that.

I just, you know, reiterate PM USA is committed to low single digits to mid single digits.

In some quarters we'll be at the lower end of that range, in some quarters at the higher end of that range.

All right.

Thank you so much.

Thanks, Bonnie..

Thank you.

Your next question is coming from Christine Farkas from Merrill Lynch.

Thank you very much.

Good morning, Dinny

Good morning, Christine.

I am wondering if you can clarify a little bit for me the dynamics of the central European market.

On prior calls you have indicated you are seeing growth in the premium segment, which would benefit Marlboro but you've noted that on this call there is some increased competition in the discount brands.

Can you clarify the magnitude of any mix shifts in this market?

Yes.

Look, the biggest market in Central Europe is Poland.

And the situation in Poland is that there is tremendous competition at the very low end of the market.

And you know, PMI is determined to maintain its market share.

We have about 36 or 37% market share in that market.

We're determined to maintain and grow that market share.

And that requires us to compete at the lower end of the market, as our competitors are doing.

And so clearly there is a temporary problem in Poland in terms of down-trading.

On the other hand, Marlboro is doing okay.

In fact, its market share is level with the same quarter last year, so I would say we've got our-- we're well represented in most price segments in Poland.

And so we're able to withstand this price competition at the low end of the market.

Okay, so the down-trading then is really more heightened in Poland versus the rest of this market?

Yes.

There's down-trading in the Czech Republic, too, but there the Czech Republic also has a fairly charge and resilient premium segment.

Okay, great.

If I can just move to the deep discount segment, excluding the private label brands, can you estimate what the share was in the second quarter?

About 10%.

About 10, so it's similar to the first quarter, then?

Roughly the same.

Okay.

Great.

On Latin America, and forgive me if you have said this, the volume growth, excluding the acquisition in Columbia, I am assuming was down.

Can you comment on the trends in the Argentine and Brazilian markets?

Yes, it was down.

You're right.

In Argentina, there is a low price segment that has developed basically from-- as a result of local manufacturers there, the extremely low-price brands, and that's sort of affected our volume.

Our market share in Argentina is well over 60%, so we're strong leader in Argentina.

But obviously, our volume has been affected by these low-price brands.

In Brazil our volume was down, again basically due to price competition.

And so in those two important markets, our volume was down.

In Mexico, our volume was down, but it was purely a question of timing, shipment timing.

Our market share, on the other hand, in Mexico is well up.

Okay, that's great.

And a final question on state excise taxes.

As we're seeing the overall rate increase here as more and more states are passing excise taxes, how is this coming in compared to your own expectations perhaps at the earlier part of the year?

And does this at all affect your plans for promotional activity in the second half?

Well, the weighted average SET, based on current calculations, right now is about $0.83.

And we expect that for the full year it is going to be about $0.86.

So that's an increase of about 14 or 15% versus the weighted average in 2004.

And that is a bit higher than we had expected, but we've built that into our sort of business plans now.

And, you know, we'll be able to achieve our income goals regardless of that.

Perfect.

Thanks a lot.

Okay.

Thank you.

Your next question is coming from Chris Growe from AG Edwards.

Good morning, Dinny.

Hi, Chris.

Hi.

Just a couple of quick ones for you here.

At Philip Morris USA, to follow on Christine's question, on the R&D, is it expected to continue then for the remainder of the year?

Is that one of the constraints to better profit growth at Philip Morris USA, you know, sort of a one-time thing?

You know, I think our R&D expenses are going to be up a little-- over the back half of last year will be up again in the back half of this year.

That's basically all I can say at this stage.

Okay.

But we have said that we're going to invest more in R&D.

You know, we're building this research and technology center in Richmond, and expenses related to that expansion are going to be -- are going to occur at Philip Morris USA.

Okay.

A separate question then regarding Germany, you had talked about, in your prepared comments, about a new price structure has been announced.

Does this include going to 17-packs?

And what sort of increase have you put in place then for Germany when this tax increase comes into effect in December?

As far as Marlboro is concerned, the current price is 4 Euro for 19 cigarettes.

After September 1st, it is going to be 3 Euro 80 for 17 cigarettes, over-the-counter.

And in vending it is 4 Euro for 19 just now, and it's going to be 4 Euro for 18 after September 1st.

So that gives you an idea of the scale of the change.

Sure.

And that would still be, I guess, added to-- if you're looking at your profit growth for Germany, you still should expect some profit growth, even given the volume weakness?

Is that part of your expectation?

In 2005, yes.

Okay.

And then my second, or last question then was on Turkey.

It has been a good source of volume and profit growth and even market share growth in the last, call it couple of years.

What sort of constraint will this be for your volumes or your profit growth going forward?

How big is Turkey in that regard?

Turkey is a big contributor to our profitability, but I must say over the years it's been a sort of roller coaster.

It's been, you know, up and down.

And the situation in Turkey is quite complex.

The government has altered the excise structure I think four times in the last 18 months.

And the current structure has an ad valorem component, plus a three-tier specific component, depending upon the inclusion of Turkish tobacco.

And this is caused tremendous dislocation, pricing dislocation, in the market and affected the relative price positions of various brands.

The net effect on PMI has been very positive for our volume.

In fact, I think our volumes are up over 10% in the second quarter, and our volumes are continuing to do very well.

But it has affected our profit ability and the profitability of the industry.

Now, we are anticipating, and we're looking forward to some further change, hopefully favorable change, but we don't know whether that is going to happen and when that is going to happen.

Okay.

And then my last question, then, relative to Japan, have you given some rough guidelines around the profit contribution from the Marlboro business in Japan?

And maybe perhaps also could address, relative to that, the expenses you're absorbing and when those will ease or those continue for the remainder of the year, et cetera?

Many questions, Dan.

Let me just answer by saying I think the guidance we've given is several hundred million dollars of operating companies income benefit in 2005.

And that takes into account only two-thirds of the year.

And of course in 2006 it will be even better because we'll have the full year impact.

Just a quick point, you're still absorbing expenses relative to the build-out of the vending machines, et cetera?

Pardon?

You're still absorbing expenses.

Yes, yes.

Okay, thank you.

Okay.

Thank you.

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

Hi, Dinny, how are you?

Hey, David.

A couple of questions, Dinny.

First, what's your response to the criticism that PM USA is getting a little bit out of balance, too much of a focus on share and volume and not enough focus on profitability on the margin?

Whose criticism that, yours or someone else's?

But anyway, let me answer this way.

You know, I think we've said all along, David, that we want moderate share growth and then low single digit to mid single digit operating companies income growth, and that's exactly what we've delivered in the second quarter.

The share was up, you know, 0.2 points versus the same quarter last year, and it is-- in fact it was flat on a sequential basis compared to the first quarter of this year.

So I think you could describe that as moderate share growth.

And profitability, you know, is clearly in the range that we've spoken about.

So, look, there are going to be times when this criticism will be leveled at us.

But I think you can be pretty sure that we've got back the predictability we always wanted in Philip Morris USA.

And that's going to continue going forward, and that means moderate share growth and low to mid single digit operating companies income growth.

Okay, Dinny, let me ask you a couple questions about some of the western European markets.

In Germany, to the extent that there is equalization between taxation on portions and cigarettes, where do you think that portion consumption is going to go to?

Or stated differently, how much of that do you think goes back to conventional branded cigarettes as opposed to either trade brands or other alternative tobacco products in the market?

Yes, that's a good question, and you know it's something obviously we've thought about.

Look, broadly what's going to happen is some of these smokers, and assuming that the taxes are equalized, the smokers of portions, some will go back to original brands.

Some will go to the lowest priced brands in the market, including trade brands, as well as brands such as PMI has in the market like Next, Basic and F 6.

They're all very well positioned in fact to get the switch back from portion smokers.

Some will unfortunately seek out lower price contraband products.

Now, what the mix is between these three is sort of difficult to say.

A lot will depend also on the German economic situation in 2006.

So I think it would be inappropriate to sort of make any guess as to how this will be split.

But I think you'd have to say that we're well positioned.

PMI is well positioned because, you know, we entered this business later than the others.

Our share is about 14%.

Our competitors have a much bigger share.

So they are much more reliant on switch back to their brands than we are.

Okay.

And Dinny, in Italy can you reconcile at all the Nielsen consumption data that I saw indicated sort of March, April consumption was still running down almost double digits.

And you're saying chew to consumption was probably flattish.

Yes.

That's great news.

I am just surprised by it.

Yes.

You know, and you're probably looking at Nielsen data.

We are actually looking at actual end-market sales data.

And our end-market sales data shows flat.

Okay.

And Dinny, what's the status of a minimum reference price legislation in Italy?

We've been expecting this, you know, for the last few months actually.

And we're continuing to expect it to come through in the next few months.

But I am going to give up on making any forecast for you, David, because every time I make a focus it doesn't work out on the timing of the MRP in Italy.

Okay, although Dinny, leaving aside for a moment the tax situation in September in Germany, I assume that broadly you feel better about your performance and your prospects in western Europe today than you would have three or five months ago.

Yes, we feel pretty good about it.

You know in-- Germany is a bit of a challenge, but we'll have to wait and see what happens after the price increase.

Italy, we're doing fine.

France, we're doing terrific.

Spain, we have a bit of an issue with this low-price, super low-price segment that is emerged.

We're competing in that segment with Next and Basic.

And we're hopeful that this will-- you know, that the government will take note of the revenue impact that all of this is having on their revenues.

And so I'm hopeful that the situation in Spain will be resolved also.

Okay, and then one last quick question, Dinny.

The unusual shipments that you made of Marlboro into Japan, is that a structural change in the market volume, in other words, or in your inventory in the market or will that come out in the second half of the year?.

Look, the fact of the matter is, if you look at our overall shipments to Japan for the first half of the year, they are down a little bit,, about 1%.

And if you look at our end-market sales for the first half of the year, they're down also about 1%.

So our shipments and end-market sales are balanced, if you take six months.

Okay.

Thanks a lot, Dinny.

Okay, David.

Thank you.

Your next question is coming from Martin Steinik from JP Morgan.

Good morning, Dinny.

Hi, Martin.

I want to follow up on Italy.

And I want to understand how surprised you are about this temporary stabilization or decline and deceleration in the rate of underlying volume decline so soon after this public smoking ban was put in place, which is very different than experienced in some other markets like Ireland.

Is this really primarily weather related or are Italians not complying at this point with the ban?

No I think -- I don't think -- all the reports we've heard is that compliance is okay.

There is an improvement in weather.

There is also clearly-- there was a price increase in Italy recently.

The industry took a price increase, and there was preprice increase trade purchases in, you know-- in-- sort of probably which started in May.

So there is a bit of that which will probably come out in the third quarter.

Okay.

And in Spain, the low price brands are becoming a problem.

I am wondering, will the need for Spain as a country to reach the EU minimum tax take levels partly address the price cap issue you're having, or can these discount brands continue to sell at a full Euro less than Marlboro indefinitely?

Spain is already at the minimum EU tax take level.

So they've reached it.

Yes.

That was not an issue.

These low price brands, as you know, have gone up to 13% or 13.5% market share, and-- from, I don't know, 5% last year or something like that.

So that's obviously going to impact the revenue that the Spanish government makes from the tobacco industry.

And I think all European governments, you know, are looking for revenue and are conscious of revenue losses, so hopefully they'll take some action.

Okay.

And in the U.S. business, the R&D costs, would you be able to talk a little bit about your initiatives and the progress you're making on the reduced exposure side?

And what I would like to better understand is if Philip Morris International will benefit from any discoveries, for example, made in the Richmond Virginia facility, if it is a shared endeavor.

Well, PMI will benefit but PMI does its own research, so anything they do, PM USA will benefit.

So it is not that either side has all the answers.

As far as what we're going to be doing at the R and T center, I think we spelled this out.

You know, we're basically very focused on innovation.

We believe that to succeed in this market, in this very difficult market, where the overall market is declining, the only way to succeed in the long term is through innovation.

And innovation can only come about when you make genuine expenditures in research and technology.

And that's what we're going to do.

Okay.

Can I just end by asking you about the credit rating?

The major agencies, of course, persist with their negative outlooks, and I think they continue to give the group a profile on well below what I think the financials would justify.

Is this having any tangible impact on your business, on your flexibility?

And do you have an understanding of what has to happen before the agencies move to upgrade to a level that's justified by what pulling out a P & L and balance sheet and cash flow statement would tell you?

The credit rating agencies continue to tell us that they're waiting for the opinion from the courts on the price case in Illinois and the Engel [ph] case in Florida and that they're not going to make any changes until they get an opinion from those courts.

Frankly, as a-- tangibly at this moment, our credit ratings are not a problem or do not create any problems for us.

Thanks very much, Dinny.

Thank you.

Thank you your next question is coming from Robert Campagnino from Prudential.

Good morning, Dinny.

Hi, Rob.

I am assuming there's no chance in the underlying consumption trends in the U.S., yet your first quarter volume and this quarter's volume were stronger I think than many anticipated.

Are you getting volume back from some source similar to the way you got greater market volumes back a couple years ago?

It is difficult to obviously make an accurate, you know, calculation on that.

But think clearly we believe we are getting volume back from a reduction in counterfeit, and you know we're seeing, for example, Internet volume coming down.

You know we recently, Philip Morris USA, won a face against a major Internet supplier out of Europe.

In addition, the major credit card companies have agreed not to allow their cards to be used for purchases on the Internet.

And all these factors are combining to reduce Internet sales.

So with the reduction of Internet sales, and by the way, the Internet was a vehicle for counterfeit.

We're getting back sales, I think from the reduction in counterfeit and contraband.

In the past, not the recent past, I think you've given sort of a forecast for total dollars related to the translation benefit on currency.

Do you have a similar forecast for the balance of this year?

No, Rob.

For the first half I think our OCI benefited by over $300 million.

You know where the exchange rates are today, and-- but your guess is as good as mine as to what they're going to be for the remaining six months.

I appreciate the confidence.

It's probably not true, though.

And reading through Louie's comments, it almost reads as if your Altria is more disappointed with Kraft's results than Kraft was last night.

You know, it reads as if Kraft lagged expectations.

Am I reading that incorrectly or is there a disconnect there?

We're not disappointed with Kraft results.

You know, clearly there is no doubt that their performance lagged our expectations, as you say and as Louie says in his quote.

The fact of the matter is that certainly Kraft International performed less well than we expected, particularly because of the problem in Germany.

In North America they were faced with very heavy commodity headwinds.

They increased their prices to sort of offset these commodity increases, thereby affecting volume and resulting in slower revenue growth.

On the plus side, you know the fact is that their mix is improving.

But the most important thing is that they are building brand value, and this has a short term cost.

But you know the food business.

It is a tough business.

The only way to create long-term growth in this business is to have strong brands.

And to build strong brands, we've got to reinvest in marketing and advertising.

Okay.

Thank you for your time this morning.

Okay.

Thank you.

As a reminder if anyone would like to ask a question, including any media representatives, please press star followed by 1 on your touch tone phone.

Thank you.

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

Good morning, Dinny.

Hi, Judy.

You know, I look at your operating profit growth at PMI, and you strip out currency, you strip out acquisition, you strip out the benefit of the take-back of Marlboro in Japan, it looked like operating profit was up probably around 1 to 2%, which in the complex of western Europe, volume declined 4.7%, which is a little bit better than what we've seen in the last few quaters.

I'm somewhat surprised that it's not stronger than that 1 to 2% sort of underlying X-acquisition growth.

And more importantly, I am just wondering if you could get-- if you could give us more, you know, insight as to when do we see this number really getting better?

Yes, I think PMI had a good solid quarter, Judy.

I mean, if you follow your logic and keep stripping out all the good things, then you know we'll have flat performance all the time.

The fact is that their underlying business was up 17.5%.

Even if you remove currency they were up close to 10%, 9.7%.

And even if you, you know, remove acquisitions and currency, you know they were up close to 6%.

So that's a pretty solid quarter.

Marlboro, the take-back of Marlboro in Japan, you know, is very much part of ongoing business.

It is going to benefit us this year, it is going to benefit us even more next year.

And in the years beyond, it is going to grow faster and be a bigger part of our Japanese portfolio than it has been in the past and therefore will benefit our overall business.

Okay.

And then going back to Germany, I am wondering if you can talk about your willingness to more aggressively invest in other tobacco product segments, you know maybe outside of portions.

I know you made investments into in portions.

But if we assume you get the equal tax treatment on portions, you know presumably your competitor may come up with other tobacco product that could have favorable tax treatment.

And I am wondering what your willingness is in terms of investing in the capability to be more aggressively compete in the OTP segment.

Yes, we will be ready to compete in the OTP segment.

And unfortunately it seems that every few years, you know one of our competitors comes out with some product which tries to find a loophole in the system.

And we're ready for, if that happens again.

We will compete and we will compete aggressively.

Does that require more capital investment, in terms of building the infrastructure beyond what you have on the portions to get ready for that event?

Not really.

And I should tell you on the portions, for example the capital expenditure we made on the portions, over 90% of that will be converted back to cigarette manufacturing equipment.

So we really won't lose much CapEx on the portions equipment.

And I think the same would apply to other tobacco products.

Okay, thanks, Dinny.

Thank you, Judy.

Thank you.

Your next question is coming from Chris Barrett [ph] from Bloomberg News.

Yes, good morning.

Thanks for your time.

A couple of quick questions.

What was the average price on Marlboro in the quarter compared with the year earlier?

The average price on Marlboro was 3.72, $3.72 average price.

Compared to the year earlier it was more like 3.54 or something like that.

And it would be, just obviously, fair to assume that the lower promotions, the wholesale list price would explain that increase, correct?

Plus increased SET, state excise tax.

Got you.

And secondly, it looks like your profit margin slipped a bit.

Help me understand the costs that led to that, if I am not miss reading the results.

Profit margins quarter-to-quarter slipped a bit, and that was basically a result of costs related to the quarter buyout, as well as the higher unexpected costs on the retail leaders program.

All right and would that also explain what appears to be a year-over-year cost-- I am sorry, year-over-year decline in margin?

That's what I am explaining, yes.

Okay.

Good.

All right.

Thank you for your time, sir.

Okay.

Thank you.

Your next question is coming from Christina Burke [ph] from the Dow Jones.

Good morning.

I was just curious, last night on the Kraft call there was a question about whether Kraft might be handcuffed by the potential spin-off by Altria making acquisitions.

And I was just wondering what Altria's view as a parent company in the possibility of Kraft making any large acquisitions at this time?

We've been quite open in this, that we're going to look at both tack-on acquisitions and larger acquisitions.

And I don't see any problem there or any so-called handcuffs.

Well, I was just curious about your view on Kraft, just to be specific on Kraft making acquisitions.

I mean would you have--

Yes.

Okay.

Okay.

Thank you very much.

Okay.

Thank you.

Your next question is coming from Thomas Russo from Gardner Russo Gardner.

Hi, Dinny.

Hi, Tom

Talk a bit about the balance sheet.

You're obviously building cash.

You have directed a portion to some meaningful acquisitions.

But, absent those acquisitions, what can and will you do with your cash build-up?

Yes.

Well, you're right, Tom.

You know, cash went up by about $2.8 billion, and that basically reflects the cash flow from operations, as well as the fact that, you know, we had some we had some cash because we had on the balance sheet at the end of the second quarter because we had to pay off a long-term maturity that came due in the middle of July.

And then, you know, we have debt maturities coming due next year.

So besides that, there is nothing more specific I can tell you about our cash build-up.

Okay.

And then you did refer to the slight creep in shares, I gather from option exercise.

And at the same time, you've moved towards a restricted stock compensation scheme.

Right.

What impact would we have seen at the Altria level of the shift in the compensation system towards restricted stock, which I gather would have been picked up in earnings more so than options were?

I'm not sure exactly.

The fact of the matter is that our shares went up by over-- shares outstanding went up by over 20 million shares, I think.

And that was mostly due to the exercise of stock options by employees.

Yes.

And the restricted stock, Cliff [ph] vesting share of expense, has that become meaningful yet?

Yes, because, you know, this is the third year of-- the third year of restricted stock, so you have got a [inaudible] in this year.

Good.

And then just two brief questions, if you could update.

I assume that there is no news on FDA or the prospects thereof, but comment there.

And I also assume that nothing concrete has come out of China, but just your advancing plans there?

No further news on FDA.

You know, I think the bill is before houses-- I am sorry at the committee level.

Nothing much has moved there.

As far as China is concerned, you know Tom, I have no comment other than to say that, just like everyone else, we're in discussions with the Chinese.

Thank you, Dinny.

Thank you.

Thank you.

Your next question is coming from Ann Gurkin from Davenport.

Good morning, Dinny.

Hi Ann.

Good morning.

Good morning.

I was wondering if you could help me.

If i understand correctly, cigarette prices are being raised in Indonesia.

Can you comment on that and what you've assumed in terms of sensitivity of volume to these higher prices?

Yes, cigarette prices are being raised in Indonesia.

As you know, the excise tax went up by 15%.

And they have a system there that-- where they raise the band roll price and so that automatically has an impact on increasing the excise tax.

And what the industry normally does there is that it takes price increases over a period of time, like sort of three or four months, to offset this increase.

And that is what is going on at this moment.

And you know, the industry has faced this before.

We don't see any, you know, specific problem in this excise tax increase.

It is all very much part of the business plan.

Okay.

And then would you give us your outlook for the growth for Marlboro in the second half, organic growth nor Marlboro internationally, just Marlboro?

In your comments you gave us international cigarette outlook.

We are hoping the volume will be up in the second half.

Up slightly.?

Yes.

Okay.

Great.

Thanks.

Okay.

Thank you.

Your final question from Philippe Goossens from Credit Suisse First Boston.

Yes, good morning, Dinny.

How are you today?

Good morning, Philippe.

I have one housekeeping question and then two real questions.

Looking at the balance sheet from Kraft yesterday, there was an increase in the amounts due to Altria.

At the end of the year it was 227, end of second quarter was 501.

Does that line item include more than just borrowings between the two entities?

No.

These are usually-- you know we pay taxes at Altria for all our operating companies, including Kraft.

And Kraft usually owes us those taxes at the end of the quarter.

And also there is a question of dividends payable to us.

Okay, great.

Thanks for that clarification, Dinny.

Then just a follow-up on the earlier question in terms of the cash build-up and balance sheet.

Would it be fair to say, Dinny, that in preparation of a potential or eventual breakup of Altria, that it would make life easier if you were to pay down the all the $3 billion that's coming due next year rather than refinance it and take advantage of low interest rates?

Yes, we will just pay down the debt as it comes due next year.

We're not going to refinance it.

Okay.

That makes sense to me.

And then my final question, Dinny.

Looking at your position in SABMiller, obviously that has been a very good investment for you, based on the performance of the company and the run up to -- to where it's a very good deal.

Can you just kind of refresh our minds one more time how you view your stake in the company on a more longer term businesses?

And then finally, if you were to proceed, would a spin-off -- I know it is a more hypothetical question.

But If you go forward with spin-off, where would SABMiller fit within the three different operating entities?

First of all, I am glad you made your first comment, Philippe.

It has been an extremely good investment for us.

I agree with you.

And you know, with the-- we're very happy also and we support the latest deal that SABMiller has done and the share price is doing well.

And we're really very happy with our investment.

It's turned out to be a marvelous investment.

With regard to where SABMiller will fit, you know, in our structure, it is really too early to comment on that, and obviously we're looking at that.

But it would be inappropriate for me to say anything more on that.

Okay.

Fair enough.

Thank you very much, Dinny.

Thank you, Philippe.

Thank you.

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

Okay.

I just wanted to appreciate and thank everyone for joining us this morning.

And we look forward to speaking with you next quarter for the third quarter results.

Again, thanks very much and have a great day.

Thank you ladies and gentlemen.

This does conclude today's teleconference.

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