奧馳亞 (MO) 2005 Q3 法說會逐字稿

Good morning and welcome to Altria Group's third-quarter 2005 earnings conference call.

My name is Elsa, and I am your conference call operator.

Today's call is scheduled to last about one hour, including remarks by Altria and the question-and-answer session. (OPERATOR INSTRUCTIONS).

I will now 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 third-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 third-quarter 2005 results yesterday and hosted a separate webcast.

Since the food business was covered in detail on that webcast, our discussion of Kraft this morning 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 Vice President and Chief Financial Officer, will summarize the highlights of our major operating Company's performance during the third 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 Altria.com.

And now it is my pleasure to introduce Dinny.

Thank you, Nick, and good morning, everyone.

Altria's results in the third quarter was solid overall driven by strong results in our tobacco businesses, partially offset by continuing challenges at Kraft.

Diluted earnings per share from continuing operations rose 7.8% to $1.38 versus $1.28 in the third quarter of last year.

As detailed in schedule seven of our news release, the earnings per share growth of $0.10 was due to $0.08 from operations, reflecting improvement from tobacco partially offset by lower income from food. $0.10 per share of tax benefit resulting from a favorable foreign tax law interpretation received in the third quarter related to the repatriation of earnings under provisions of the American Jobs Creation Act, which combined with the $0.10 per share benefit announced in the second quarter of 2005, totals $0.20 for the full year on this onetime dividend repatriation.

$0.03 per share favorable impact from the reversal of the 2004 accrual in the amount of $115 million related to tobacco quarter buyout legislation, $0.03 due to favorable currency and $0.06 from a change in the tax rate versus the same period last year reflecting lower ongoing income tax rates at PMI due principally to changing geographic mix of earnings and lower repatriation costs.

Partially offsetting these favorable items were a net $0.06 per share for 2004 items, including the onetime gain from investments at SABMiller. $0.06 per share for PMCC's increase and its allowance for losses by $200 million triggered by recent developments in the troubled airline industry. $0.04 per share for Philip Morris USA's share of losses that the government has incurred on the disposition of pooled tobacco stock accumulated under the previous tobacco price support program. $0.02 for asset impairment and exit costs and $0.02 for higher shares outstanding.

We narrowed our 2005 projection for full-year diluted earnings per share from continuing operations to a range of $5.05 to $5.10 versus our prior forecast of $5.00 to $5.10 and believe we will achieve the high end of that range.

In our news release, we have provided ample detail of the components to our guidance.

Also mentioned in our news release was SABMiller's recent acquisition of Bavaria, the second largest brewer in South American.

As a result, Altria's economic interest has been reduced from 33.9% to 28.7% of the enlarged SABMiller.

Turning to domestic tobacco, Philip Morris USA had an excellent quarter characterized by strong income growth and solid retail share performance driven by Marlboro.

Operating company income rose 4.8% to $1.2 billion primarily driven by lower wholesale promotional allowance rates and the $115 million reversal of the 2004 accrual related to tobacco buyout legislation.

These were partially offset by lower volume, charges for the dispositions of pooled tobacco stock, and the provision for the Berkin (ph) case of $56 million excluding the interest charge.

Cigarette shipment volume of 47.9 billion units was down 0.9% compared to the third quarter of last year, but was estimated to be essentially flat when adjusted for the timing of promotional shipments and trade purchases related to the July 4th holiday.

Retail share advanced 0.2 points to 50.1%, driven mainly by Marlboro which achieved a record 40.1 share of market in the third quarter.

With its strong business fundamentals, Philip Morris USA is on track to deliver moderate growth in retail share and operating Company's income growth in the low to mid single digits for the full-year 2005, including the Berkin payment.

Turning to our international tobacco business, in the third quarter, PMI's operating Company's income grew 19.7% to $2.2 billion driven by higher pricing, the impact of acquisitions of $137 million and favorable currency of $80 million.

These increases were partially offset by unfavorable mix, higher R&D marketing and selling expenses.

Excluding the impact of acquisitions, favorable currency and impairment charges of 33 million, PMI's operating company's income was up 9.6%.

Cigarette shipment volume in the third quarter increased 9% to 217 billion units, driven by continued growth in Eastern Europe and the Middle East and recent acquisitions -- Sampoerna in Indonesia and Coltabaco in Colombia.

These were partially offset by lower shipments in PMI's new European Union region, reflecting total market declines mainly in Germany and Italy.

Excluding acquisitions, PMI's cigarette shipment volume increased 0.8% versus the third quarter of last year.

PMI's total tobacco volume, which includes 2 billion cigarette equivalent units of other tobacco products, was up 9.4% and 1.2% excluding acquisitions.

Turning to a brief review of PMI's third-quarter results from a regional perspective, in the European Union region PMI's cigarette volume declined 4.2%; however, income was up solidly on both a U.S. dollar and local currency basis.

In Germany the total cigarette market declined 13.1% in the third quarter.

However, this was largely offset by higher volume of other tobacco products, principally tobacco portions, which are taxed at a significantly lower rate than cigarettes.

In total industry consumption of cigarettes and OTPs was down 3.3% in the third quarter.

For the year-to-date September 2005, total tobacco consumption was down 3.7% compared to a decline of 7.5% for the same period last year.

PMI's share of total tobacco shipments declined 0.1 points to 28.7% compared to the third quarter of 2004 -- the smallest quarter-over-quarter decline in the past three years.

PMI's cigarette industry share of 36.7% rose 0.2 points versus the prior year quarter driven by Marlboro and next.

In addition, PMI's share of OTPs increased 6.3 points to 12.9% with its share of tobacco portions increasing 10.2 points to 18.7%.

Later this year the European Court of Justice is expected to issue its final binding judgment on the taxation of tobacco portions in Germany.

PMI is hopeful that by the end of the first quarter of next year tobacco portions will be taxed at the same rate as cigarettes.

In Italy, the total cigarette market declined 8.4%, reflecting lower smoking incidents due to higher cigarette retail prices and increased smoking restrictions, adverse trade inventory movements and one less selling day.

Although PMI's cigarette shipment volume was down 6.2%, market share was up 1.9 points to 52.9%, driven by Marlboro's resilience, Diana's strong recovery and Chesterfield's good performance.

Importantly, PMI's market share in Italy has improved sequentially for the last four quarters.

During the quarter, the new law that establishes a minimum reference price below which cigarettes can not sell for three Euros per pack went into effect in Italy.

Going forward we are cautiously optimistic that cigarette market trends will improve in Italy and PMI's share will continue to grow.

In France PMI's volume and share performance in the third quarter was robust, driven by the continued success of Marlboro and the Philip Morris brand.

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

Moving on to Eastern Europe, Middle Eastern Africa, volume grew 5.7% due mainly to continued growth in the Ukraine, Turkey, Egypt and Saudi Arabia.

In Russia PMI's cigarette volume was flat, reflecting adverse trade inventory movements, although in market sales were up 3.5%.

Market share grew 0.6 points to 27% in Russia driven by Muratti, Marlboro, Parliament and Chesterfield.

In Turkey shipments increased 13% and share grew by over 5 points to 43% on the strength of Marlboro and Parliament, the price repositioning of Lark and the recent launch of Bond Street.

Turning to Asia, volume increased 40% driven by the acquisition of Sampoerna.

Excluding the Sampoerna volume, shipments in Asia were up 0.8%, driven mainly by growth in the Philippines largely offset by declines in Hong Kong, Taiwan and Australia.

It has been just over three months since PMI completed its acquisition of Sampoerna in Indonesia, and thus far, results are encouraging with key brands -- Dji Sam Soe, A Hijau and A Mild -- all performing well.

PMI is successfully integrating Sampoerna into its global operations.

In Japan shipments were up nearly 1% despite a 2.5% decline in the total market.

PMI's market share rose 0.3 points to 24.9% driven by Parliament and Virginia Slims and the recent launch of Marlboro of Ultra Lights Menthol.

Launched in late July, Marlboro Ultra Lights Menthol has quickly gained a 0.6% market share in Japan and has contributed to Marlboro's accelerating share gain in this important market.

Turning to Latin America, PMI shipments were up 12.6% due primarily to the acquisition of Coltabaco in Colombia and higher volume in Mexico, partially offset by declines in Argentina and Brazil.

Excluding Coltabaco, shipments were down 1.4%.

Total Marlboro volume in the third quarter was up 0.4% due mainly to higher shipments in Eastern Europe, Middle East and Africa region, largely offset by declines in Germany and Italy.

Absent Germany and Italy, Marlboro was up 2.9%.

Also in many top income markets, Marlboro achieved share gains as listed in our news release.

For the full-year 2005, PMI is on track to deliver volume growth of approximately 5%, including the acquisitions of Coltabaco and Sampoerna.

Excluding these acquisitions, PMI projects volume growth of about 1%.

Operating company's income growth is forecast to grow at double-digit rates, including the benefit of the Sampoerna acquisition and despite the recent strengthening of the U.S. dollar.

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's net revenues were up 4.4% to $8.1 billion, driven by volume growth, positive mix and net pricing, as well as a benefit from favorable currency of $118 million.

Kraft's ongoing volume was up 1.3% reflecting gains in the U.S., Eastern Europe and Latin America, partially offset by a decline in Central and Western Europe, particularly Germany were higher pricing has impacted category consumption.

Operating income declined 6.8% to $1.1 billion due to higher commodity costs net of pricing and higher pension and postretirement costs, partially offset by volume growth, positive mix, cost reductions and favorable currency of $27 million.

To conclude, despite continuing challenges at Kraft, Altria achieved solid third-quarter results fueled by strong progress in our domestic and international tobacco businesses, and we are on target to deliver on our earnings per share forecast for the full year.

And now I'm happy to take your questions.

(OPERATOR INSTRUCTIONS).

Rob Campagnino, Prudential Equities.

Good morning.

Two questions, neither of which you will answer, but I have to ask.

How would you characterize your view and maybe Louis' view of Kraft at this point?

Is it frustrated, disappointed, impatient?

And maybe if it is impatience, does that manifest itself in terms of any strategic decisions that you might make with respect to that business?

Well, Kraft -- (inaudible) I'm sorry.

We are disappointed with Kraft's results.

We would have expected that by this stage that their profits would be growing compared to last year.

The fact is that we are totally focused on building their portfolio for the long-term.

That is why we are investing in marketing and selling.

The situation has been exacerbated by commodity costs.

This has been felt by the entire food industry.

Kraft is no exception.

The fact is, of course, with commodity costs, they are cyclical, so they are up just now, but they eventually will have to moderate.

So in summary, yes, we are disappointed, but we believe we are doing the right things, and we are going to continue to press forward in building the brand portfolio of Kraft for the long-term.

Okay.

Fair enough.

PM USA has spoken publicly about opportunities outside what I would characterize as your traditional cigarette business.

I'm not going to ask for specifics, but talk broadly about what maybe the strategic rationale was behind that decision to look around?

I think what Dave Varan (ph) said at your conference, I think the Prudential conference in September, was that Philip Morris USA was going to use its strengths, which include terrific distribution, strong R&D and some good manufacturing facilities, and that they were going to use these strengths to sort of push out to adjacent industries.

I think this is a strategy that has been followed successfully by many other companies, and I don't think Philip Morris USA is going to be any exception to that.

As I said, it is just a question of using their strengths to lever themselves into businesses that are adjacent to their current businesses.

Fair enough.

Thank you for your time this morning.

David Adelman, Morgan Stanley.

A question about PM USA.

If you strip out the various unusual items, the lease buyout, the reserve reversal, the Berkin charge, you have a situation where I think operating profit was up 11 or 12% this quarter.

That was clearly a substantial step change in the rate of profit growth.

Should we principally attribute the improved -- the sequential improvement in that business to somewhat lower promotional spending Q3 versus Q2, or are there other factors?

I think lower promotional allowances was clearly the leading factor in Philip Morris USA's better performance.

Philip Morris USA has also benefited, David, this year from a significant decline in the incidence of counterfeit.

And so their volume has done pretty well, and I think you look at their year-to-date volume, it's very down slightly, but in fact you adjust for inventories, etc., it is pretty flat.

So they are doing well on the volume side, and they have lowered their promotional allowances.

And so I think those are the two major reasons for their good performance.

And then in Italy, what is your gauge of the consumption decline, whether it is in the third quarter or year-to-date, and has that caused you to reevaluate the potential impact of subsequent inevitable smoking bans in other markets?

The total market -- reported total market was down about 8.5% in Italy in the third quarter.

But when we make adjustments for inventory distortions and industry trade buying patterns this quarter versus last year's third quarter, and the fact that this year's third quarter had one less selling day, then the market was actually down more like 4%.

So half of the reported rate.

And as far as PMI's volume, I think I reported volume was down a little over 6%, but our actual volume was probably in the region of down around 2%.

As far as the impact of smoking restrictions, we believe the total market in Italy is going to be down a little over 6% this year, and smoking restrictions are going to have an impact of between 2 and 3%.

So not as bad as we estimated at the beginning of the year.

And am I correct did the last phase of the German tax increase and the reduction in your stick count to 17, is that now in effect, and can you give us an early read on what you gauge is happening to consumption?

Obviously it is early.

That is in effect.

Those prices are in effect.

Marlboro is selling at EUR3.80 for a pack of 17.

Early reading is mildly encouraging, but it is early early days as yet, and so I would not like to be very firm with predictions going forward.

And then one last quick thing, in 2003 -- 2003, 2004, the EU was really besieged by these very very substantial multiple substantial excise tax increases in very important profit centers for the Company.

And I'm just curious, I mean are you getting any indications that in major high profit margin markets you're going to be faced with any repeat of that over the foreseeable near future?

No, I think, in fact, with regard to Western Europe, David, and I know I'm not answering your question directly, but let me just give you a feel for Western Europe, and I'm talking about our original Western European region because that is the best way to make comparisons.

In fact, the dynamics look pretty good.

The decline rate for total tobacco consumption for the year-to-date September was about 2.7% compared to 6.2% at the same time last year.

And even if you look at cigarette volume for the year-to-date September this year, it was down 4.7% versus 9.5% last year.

So the dynamics are improving the total market.

Of course, our market share, both in terms of cigarettes and total tobacco, is also improving.

So we feel quite solid about what is happening in Western Europe.

Now, as far as difficult markets going forward, I think Spain is something we will have to look at, primarily because a low-priced segment is emerging in Spain.

Cigarettes priced at below EUR2 a pack have grown very rapidly and now account for close to 20% of the market, and they have almost doubled their share quarter to quarter.

So that is a bit of a watch out.

But I think France is doing well.

Italy should do better next year.

Germany would be -- tobacco portions hopefully being taxed at the same rate of cigarettes, the situation should also improve.

So I would say coming back to your original question, the watch out probably is Spain.

Christine Farkas, Merrill Lynch.

To get back to Germany, how are you running this business?

Is it still running at close to full capacity, and how do you view investments when it sounds like you are essentially making a bet that the tax benefit goes away?

And if it does not go away, what kind of investment would it be required to make?

You're talking about the investment in tobacco portions equipment I presume?

Correct.

Yes.

Obviously, as long as tobacco portions have the tax advantage, we are going to go all-out in maximizing our market share in that segment.

We have grown very well there.

When and if tobacco portions lose their tax advantage and, therefore, lose their attractiveness, we will be able to convert quite a bit of that equipment to cigarette manufacturing equipment.

So I don't see that as a problem.

Currently are you investing or have you increased investments in the last couple of quarters in the OTP market there?

Again, are you talking about investment in equipment?

In equipment capacity.

Yes, I think we are now coming -- we are coming pretty close to our capacity.

I think we're in good shape in terms of capacity.

Okay.

Great.

Moving to France, you've seen some terrific growth this quarter.

What is the right growth rate?

I know there were some easy comps, but you have had easy comps for the last couple of quarters.

Can you talk to what you think the right growth rate there is for PMI, and if I remember correctly, I believe you have introduced a low-end brand, Basic, in that market.

What has happened to that brand?

Well, first of all, regarding the appropriate growth rate, you know that is a very difficult question to answer.

We want to continue increasing our market share in that market.

We have done that this year at quite a high rate, and that is probably because of pretty good comparisons.

But going forward maybe we won't be able to increase market share at that rate, but we will certainly be able to increase our market share because we've got a terrific brand portfolio in France.

And the fact is that we have got Marlboro and Philip Morris at the top end of the price spectrum, and then we've got other brands at EUR4.50, which is the low-end, and the gap really there is very small.

It is about 11%.

And Basic is doing well.

L&M is doing well.

So we are well represented in that segment, and we've got a good portfolio in France.

Okay.

Moving to the U.S., clearly Marlboro had a blockbuster quarter this quarter up 50 basis points, but your other focused brands -- the Parliament, Virginia Slims and Basic -- netted out zero gains in the quarter.

What can you do -- what is your view here of these other or non-Marlboro focused brands, and how will you attempt to pick up share there?

I think we are doing a good job there.

Parliament, in fact, is growing -- it is tough to grow market share for brands in a market where there is very limited marketing (inaudible), and despite that, we're doing well with Parliament.

Its share I think was up .1 compared to the same quarter last year.

Basic is pretty flat.

Virginia Slims was down slightly, but that, too, is actually a very good performance.

So, although, as you said, those brands were flat, I think that performance is really very good when you consider the environment in the United States.

Okay.

Can you comment on the Marlboro Menthol brand?

Specifically did that brand grow in line with your broader Marlboro category?

Yes.

It did?

And have you seen any changes in the competitive landscape with Reynolds deemphasizing Kool or emphasizing Kool and deemphasizing Salem?

No.

Did not.

Okay.

A question on the premium category share growth, which is rising.

Do you think this is sustainable given the current environment?

Do you expect to see continued growth in the premium part of the business?

You know, the premium segment has been continuing to grow for the last many quarters, and people ask us, how is this possible with gas prices going up, etc.?

But gas prices have been increasing -- were up like 50% in the first half of this year, and the premium segment was growing.

Gas prices were up in the third quarter, and the premium segment is growing.

So I think one cannot sort of make any assumptions there, except to say that as long as we keep the gap between the premium segment and the lowest priced cigarette segment at this sort of mid-40% range, I think the premium segment will continue to grow.

Could you give us what the average price of Marlboro was and the average lowest affected price during the quarter?

During the quarter, average Marlboro price was 3.82.

Lowest affected price was $2.62 per pack, which is a gap of $1.20 or 46%.

Bonnie Herzog, Citigroup.

I just have actually a few questions.

I just want to start with one on PM USA.

Actually I had a question on your wholesale leader program.

You did just make some changes recently, and you have made changes to that program I think every year.

So I'm curious how has the participation level been?

In other words, over the years, has it been increasing or decreasing as you have been making changes?

Can you talk about that? (multiple speakers)

As far as the trend is concerned, well, look, first of all, the most recent change we've made to the wholesale leaders program, we have two levels, level two and level one.

And level two, which is a higher level, covers about 90% of our sales.

And obviously we want to reward those wholesalers who are doing well, who are efficient, and they fall into level two, and make it a slightly better reward than the people in level one.

And that is the way it should be not just in this business, I guess in any business.

And so I don't see much change in that.

You know, we sort of change the numbers or the gap impact -- we've increased the gap slightly between level one and level two.

But broadly the idea is still to reward people who are efficient and effective.

And then actually maybe just shifting over to your retail program, similar I know you have different levels or more levels.

My understanding has always been that you also reward differently, and there is probably an added incentive of trying to upgrade retailers, trying to get them to your higher levels, and is that still I guess an initiative by your Company, and could you talk about that a little bit just in terms of the different levels and upgrade the retailers?

Well, sure.

You know, we have some four levels of retailers, and in fact, as I said it, at the end of the second quarter, one of the programs that we had for the top retail level was really very successful this year and has continued to be successful.

And we are happy with that because obviously we want retailers to participate more and more at the higher levels of our programs.

Shifting overseas and I guess I was hoping you could talk a little bit more about Sampoerna.

You did make some comments about it, but I was curious if you could tell us if you feel you have been meeting or exceeding your original expectation for the acquisition of Sampoerna, and have you discovered or possibly identified any additional opportunities again based on the acquisition that we should know about?

And then can you remind us again when you plan to have the Sampoerna operation fully integrated into your business?

Well, first of all, let me tell you we're very happy with the Sampoerna acquisition.

It has turned out to be very good.

It is meeting and in some cases exceeding our expectations.

So we're very happy with that.

I did mention earlier that, in fact, the process of integration has started.

In many respects, it is largely integrated.

But you have to go function by function, and I think over a period of some time we will get it fully up to the standards of Philip Morris International.

But the whole Sampoerna acquisition really has worked out very well.

Can you give us some examples of where you have exceeded expectations?

Well, we think the people, the management of Sampoerna are terrific.

We think the brand portfolio is actually superb, and that the evidence of that really is the way that Sampoerna's marketshare has been growing for the year-to-date.

It is up significantly.

So it is both our brands and the people.

And if I think back to the discussions we had when you announced this deal, I think one of the benefits that you saw in growing this business was the export business.

Is that correct?

I don't think we specifically pointed that out.

I don't particularly remember that comment.

The fact is that we have some sales outside of Indonesia, but most of the sales obviously are in Indonesia.

But that is not an area that you see or growth opportunities for the business -- that you can take that business further in terms of exporting?

No?

That is not high on our priority list.

Let me put it that way.

That is fair enough.

Okay.

Just shifting, my final question is on SABMiller because you certainly did make the comment about your economic interest being reduced to 28.7%.

So I'm curious what your intentions are for this business.

Can you talk about that?

We're very happy with our investment in SABMiller, and it has done very well as a business.

Our share of the market cap of SABMiller is well over $8 billion, which is terrific.

And yes, our equity interest in SABMiller is reduced from 33.9 to I think 28.7% as a result of the Bavaria acquisition.

But now we have this share, a lower share of a larger pie as it were.

So we have no other plans at this stage.

We are happy with where we are.

Well, thank you.

Chris Growe, A.G. Edwards.

I just had I think three quick ones for you.

The first one was -- forgive me, if this was asked -- but was there any acceleration in the decline in the German market once the tax increase went into place?

I guess I'm trying to understand how people are going to consume in that market.

Is it by the pack or even by the actual stick I guess?

Any indication you have gotten so far?

No, it is a bit too early to tell you, Chris, and certainly people are going to continue buying by the pack.

Another one was if you could update us on your Japan progress.

It seemed to go pretty well in the quarter, so it sounds like the integration is going quite well and sort of the handover is going well on the Marlboro side.

Is that true?

Yes, the handover is going very smoothly, and as I mentioned in my earlier remarks, Marlboro's share is actually accelerating.

The brand I think is at about 10%, and its share grew 0.7 points in this quarter versus the same quarter last year, and we have just launched Marlboro Ultra Lights Menthol, which is doing extremely well.

So we're very happy with the performance of Marlboro and the distribution issues are well resolved.

Okay.

And my last question just is relative to PMI, and there has been a number of markets, I think you mentioned Spain as sort of a washout market.

But Argentina, Poland, even we have heard of recently Malaysia, are markets where you have had deep discount competition really seemingly taking better hold of these markets.

Has there been an increase in that activity?

So should we be incrementally concerned by PMI's volumes in '06, or for example, could better Japan volumes and Turkey volumes offset that?

Any thoughts you have on that?

First of all, let me correct you when you said washout in Spain.

I don't think it is a washout in Spain.

We have a terrific business in Spain, which is doing very well.

We have over 35% marketshare, and even though in this quarter our marketshare was down, if you look at it on the year-to-date, our marketshare is up.

We are going to continue to face low-priced competition in a number of markets.

You mentioned some of them.

We have been facing that for the past three or four years.

We have done well.

We have navigated our way through those issues, and we continue to do that.

And you are right, we have a number of terrific markets that are growing.

Again, you mentioned some of those, and they will make up for the problems we face in markets where there is low-priced competition, which is going to crop up from time to time.

It is a fact of life.

We are going to have to live with it, and we're going to have to succeed despite those challenges.

So something on the order of like 2% volume growth, is that realistic for PMI on an organic basis?

Right now would that be too high?

I would say 1 to 2%.

At this time, we would also like to invite members of the media to ask questions. (OPERATOR INSTRUCTIONS).

Judy Hong, Goldman Sachs.

Just looking at PMI's operating profit growth in the quarter, I think were you said it was up 9.6%, stripping out acquisitions and currency, which seems to be an improvement from the second quarter were you saw I think it was 6%.

I am just wondering how much of that is coming from improving mix trends that you were seeing in some of the developing markets versus a more stable trend that you are seeing in Western Europe.

And I guess in relation to that, maybe you can speak more broadly about the segment trends in some of our developing markets like Russia where we are seeing consumers really trading up to the premium brands?

Look, our mix is still unfavorable when you compare it to last year, and that obviously is because despite the improving trends in Western Europe, Western Europe volume is still down, and our volume in lower margin markets such as Russia, Ukraine, Turkey is up.

And I think you have got to accept that as a sort of given going forward.

And --

Well, I guess I was trying to -- sequentially, if you look at the progression second to third quarter, whether the improvement -- the sequential improvement is because you're getting better product mix improvement in developing markets versus broader or maybe more stable geographic mix as a result of Western Europe stabilizing a bit more?

Yes, there is some of that, but also what helped us in the third quarter was we had the Marlboro impact in Japan, which certainly helped us in the third quarter.

Okay.

Then just thinking about PMI more broadly in the context of more challenging currency environment, how would you think about investing, continuing to invest more aggressively behind the brands when you don't have the currency upside going forward?

I think we have addressed this in the past, and we have said look, our first priority is to support our brands.

Obviously it becomes easier to do that when you have currency favorability.

But even in a situation where currency goes against us, we will first do what is best for the brands.

And if that means some short-term impact on our profitability, we will just have to accept that.

Okay.

And just a clarification on -- for PM USA, just a clarification on that 138 million charge related to the U.S. tobacco buyout pool.

Am I correct in thinking that this is the full liability that you are expensing in the quarter?

Yes.

Okay, and then just any color in terms of next year's tax rate because this year obviously there has been a lot of movement on the tax rate?

Yes.

Well, look, our tax rate is obvious -- has been coming down basically because of reducing foreign tax rates, geographical mix being one of the driving factors of that.

And if you look over the last three or four years, our tax rate has been coming down, and one would hope that that trend would continue.

But, frankly, from year to year, you have actually got to do the calculation.

And we would only be able to have a better idea of that in the early part of next year when we give you guidance for 2006.

Christina Burke, Dow Jones.

I was just curious if you had any update on Marlboro Ultra Smooth?

How is that doing in customer hits?

Yes, we have three test markets for Marlboro Ultra Smooth, and we're doing -- we're meeting our expectations.

We are -- obviously some of the test markets are doing slightly better than the others, but they are sort of meeting our expectations, and we are learning a lot, and that is what test markets are all about.

Any ideas about possibly expanding those test markets to other markets?

Not as yet.

William Booth (ph), Wellington Management.

A question on Germany and Poland.

Could you look at those two country together and give us an idea of the cross-border trade and the impact on profitability?

Because some of Germany's problems that we are seeing today in terms of downturn is offset by the strength in Poland?

Yes.

Look, it is very difficult to give you exact numbers on that.

There have been sort of what they call pack tests done in Germany where you pick up empty packs and, based on that, figure out how much of the sales are sort of coming across from other countries.

And based on those tests that have been done, I think the number is like 10% of German volume is coming in from adjoining countries.

So there is that impact, and the German authorities are doing whatever is possible to try to limit that cross border traffic, but the fact of the matter is that it is not -- it is very difficult to fully control.

The margins in Germany are obviously higher than the margins in Poland.

So not only us but other manufacturers lose out when you get this cross-border sale coming in.

But again to sort of give you any number is almost impossible.

So Marlboro produced in Poland has a lower margin than Marlboro produced and sold in Germany?

Yes.

Ann Gurkin, Davenport.

A couple of questions starting in Malaysia.

Can you help me, is there a price war erupting over there or not?

Where?

In Malaysia.

No, I think what happened was there was one of our competitors reduced the price of one of their brands to an increased stick count.

And on a temporary basis, PMI reduced the prices of some of their brands.

So we hope this situation is temporary and that there is not interruption of a price war.

Okay.

And then switching back to the U.S., given the consumer faces higher energy costs, gas costs, heating costs, etc., do you think if you wanted to put through a price increase could you still do so this fall?

I'm not going to talk about pricing.

I'm sorry.

Do you think the landscape could handle higher prices, say, in the next three to six months?

I'm not going to talk about pricing.

Thank you.

How about given the shakeup in the House with DeLay temporarily stepping down, do you think we will see any kind of renewed focus on FDA legislation for tobacco products?

I don't -- I really don't have a good feel for that situation.

We would like to see FDA legislation go forward.

We are continuing to work on that, but it is kind of difficult right now to say what the chances are.

Thomas Russo, Gardner Russo Gardner.

Good day.

Good results.

Congratulations.

I'm curious about the comments relating to the minimum reference pricing in Italy.

And then what you might expect from other markets were you are either able to convert from ad valorem to specific or else other markets where you are able to introduce a minimum reference price like you have done in Italy.

What are the prospects on other markets, and what will be the impact do you think in Italy as a result of this upcoming move?

Well, I think the impact in Italy is quite favorable for us.

Obviously we are at the premium end of the market.

The price gaps had grown pretty large, as you know, in Italy, and the price gap between Marlboro and the lowest end had gone up to over a Euro a pack.

They have now come back to about EUR0.80 a pack because the lowest price is EUR3 per pack and Marlboro is at 3.80.

And that has benefited us, and our market share as a result is doing very well.

The MRP is also obviously in place in France, and as you know, Tom, we have done very well in France where we have got an MRP.

There is an MRP coming into Belgium.

In fact, we will already be in Belgium.

Yes, it is in Belgium.

And that is an important market for us.

So I think we're going to do well there.

We are just -- because our portfolio is that the premium end, MRPs and METs, which literally excise taxes, help our portfolio.

And obviously we are working hard in as many markets as we can to get this implemented.

Thank you.

At this time I would like to turn the floor back over to you for any further closing remarks.

Well, thank you very much.

We appreciate you joining us on this call this morning, and we look forward to talking with you again next quarter for the fourth-quarter and year-end results.

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.