奧馳亞 (MO) 2007 Q2 法說會逐字稿

Good day, and welcome to Altria Group's second quarter 2007 earnings conference call. Today's call is scheduled to last about one hour, including remarks by Altria management and the question-and-answer session. (Operator Instructions) Media representatives on the call will also be able to ask questions following the conclusion of questions from the investment community.

I'll 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 the second quarter results. Today's call is limited to a discussion of our business results.

Our remarks today 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. For a detailed review of our second quarter results, I direct your attention to the news release we issued earlier this morning, which is available on our website at altria.com.

I'd also like to focus your attention on our new reporting segments following the Kraft spin-off last quarter. Altria's reportable segments are now US Tobacco, European Union, Eastern Europe, Middle East and Africa, Asia, Latin America and Financial Services, and you'll note in our news release we're providing re-stated segment data for 2006 and the first quarter of this year.

And now, it's my pleasure to introduce Dinny Devitre, Altria's Senior Vice President and Chief Financial Officer. Dinny?

Thanks, Nick. Good morning, everyone. As mentioned earlier, my remarks today will focus on our quarterly results. I will not be addressing specific actions Altria may take going forward to further enhance shareholder value, except to repeat what I said last quarter.

We remain as committed as ever to meaningfully enhance long-term shareholder value. We continue to carefully and diligently examine the benefits of a spin-off of Phillip Morris International and other possible value-enhancing options to decide the optimal long-term strategic course to follow. And once a decision has been made, we'll promptly communicate it.

Turning to Altria's second quarter results, diluted earnings per share from continuing operations were up 5% to $1.05 including charges of $0.12 per share for asset impairment and exit costs primarily related to the closing of Phillip Morris USA's facility in Cabarrus, North Carolina, as well as other items detailed on Schedule 7 versus $1.00 per share in the year ago quarter.

Adjusted diluted earnings per share from continuing operations were up 9.5% to $1.15 versus $1.05 in 2006. For the full year 2007 diluted earnings per share from continuing operations were revised to a range of $4.05 to $4.10 versus a previous projection of $4.20 to $4.25. This reflects $0.15 per share of new charges for asset impairment and exit costs, an additional $0.12 related to PM USA and an additional $0.03 related to PMI. The change in guidance reflects the recent announcement by PMI and PM USA to optimize their worldwide cigarette production, and underscores the Company's steadfast commitment to reducing costs.

Earlier this morning, PMI announced that it has reached an agreement in principle to acquire an additional 30% stake in its Mexican tobacco business. PMI currently holds 50% of this business and this transaction would bring PMI's stake to 80% with Grupo Carso retaining 20%. The transaction has a value of approximately $1.1 billion and is expected to be completed later this year. When completed, the transaction is expected to increase Altria's annualized net earnings by approximately $0.03 per share. We are very pleased with our tobacco business in Mexico and today's announcement further reinforces PMI's commitment to this profitable market.

Turning to our domestic and international tobacco company results, I'll start with Phillip Morris USA. In the second quarter, Phillip Morris USA's operating company's income declined 22.8% to a billion dollars largely as a result of the $318 million charge related to the closure of Cabarrus, as well as lower volume and increased resolution expenses. This income decline was partially offset by lower wholesale promotional allowance rates and lower expenses for marketing, administration, and research costs.

Adjusted for the $318 million charge, Phillip Morris USA's operating income would have increased 1.6% to $1.3 billion. PM USA's shipment volume of 45.6 billion units was down 3.3%, or 1.6 billion units versus the prior year. In the first half of this year, Phillip Morris USA estimates that total cigarette industry volume declined between 4% and 5% and it is maintaining its prior estimate of accretive 4% decline in total industry volume for the full year 2007.

Although Phillip Morris USA's retail share was unchanged at 50.5 %, Marlboro continued to grow gaining 0.4 points. Parliament is performing well in a competitive market and its share this quarter remained unchanged, while Virginia Slims and Basic declined by 0.1 and 0.2 share points respectively versus the same period last year.

Marlboro Smooth was launched nationally in March 2007 and the brand is off to a strong start. Today, Phillip Morris USA announces that it will introduce Marlboro Smooth 100 box and a new Marlboro line extension with a single-leaf blend called Marlboro Virginia blend in September. In June, Phillip Morris USA announced that it will test market Marlboro Snus in the Dallas/Fort Worth area, Texas area. Marlboro Snus is a spit-free tobacco pouch product that utilizes a unique flavor strip, doesn't require refrigeration and will be available at retail in August.

For 2007, Phillip Morris USA forecasts moderate growth in retail share and operating companies income in the 1% to 2% range excluding the manufacturing consolidation charge related to closing the Cabarrus facility. This projection reflects planned investments in the second half of 2007 to support numerous new product initiatives and takes into account the slower than expected recovery of volume.

Finally, Phillip Morris USA believes the federal excise tax increase on cigarettes under discussion in the U.S. Senate Finance Committee to fund health insurance is unfair and could result in multiple, unintended consequences. In addition to placing an unreasonable burden on adult smokers, an increase in the federal cigarette excise tax could encourage smuggling and illegal cigarette purchases which can deprive states of much needed funding for important public programs, as well as rob local businesses of much needed revenue. Phillip Morris USA will continue to actively voice its opposition to increasing the federal cigarette excise tax. I would further remind you, there is a lengthy process requiring action by members of the Senate and the House, as well as signature by the President before any proposal becomes law.

Turning to our international tobacco business. In the second quarter, PMI's operating companies income increased 4.7% to $2.2 billion due primarily to higher pricing and favorable currency of $87 million, partially offset by higher asset impairment and exit costs of $76 million. PMI's cigarette shipment volume increased 3.3%, or 7.1 billion to 221 billion units due primarily to the acquisition volume from Lakson Tobacco in Pakistan.

Volume gains in several markets, including Argentina, Egypt, Indonesia, Korea, the Philippines and Ukraine, as well the favorable timing of shipments in certain markets were partially offset by shipment declines in Germany, the Czech Republic and Russia, as well as Japan, where comparisons to the second quarter of 2006 were distorted by heavy trade purchases in anticipation of the July 2006 excise tax increase. Excluding the impact of acquisitions, PMI's cigarette shipment volume was down 0.5%.

As described in our earnings release, starting with the second quarter of 2007, we are presenting volume and financial information for PMI's reportable segments of the European Union, Europe, Middle East and Africa, Asia, and Latin America. We expect that this will provide investors with an increasingly transparent view of PMI's business, as well as the breadth and scope of its opportunities. Since the earnings release presents a fairly detailed overview of PMI's business in its various segments, I will contain my remarks to a few specific subjects and markets.

Volume trends in the European Union have stabilized, particularly compared to the volatility experienced in the past few years. Based on end market sales, as opposed to shipment data, industry volume in the second quarter, at 167.3 billion units was down 0.6% compared to the same period last year. PMI's end market sales, at 66.4 billion units, were up slightly resulting in market share increasing 0.4 points to 39.7%. The increased predictability in the EU [presages] well for PMI's overall results.

PMI's share is growing in all the key EU markets with the exception of Germany. In Germany, the cigarette industry declined 2.5% in the second quarter, reflecting the impact of higher pricing. PMI's end market sales declined 4% and market share was down 0.6 points to 37% due largely to a 38% volume decline in the vending channel.

Vending accounted for 15% of industry volume in the second quarter of 2007 versus 23.7% in the comparative period a year ago. PMI's share of the vending channel at 51% is over-indexed relative to its overall market share and consequently the decline in vending throughput has adversely affected PMI's overall market share. The vending universe has declined due to the reduction in machines resulting from new regulations that require electronic age verification. Marlboro felt the brunt of the vending universe shrinkage more than other brands and its share in Germany declined 2.8 points to 26.1%.

L& M performed strongly in the second quarter with share up 2.5 points to 4.7%. PMI expects the trend in the vending channel to gradually improve. In the second quarter of 2007, the vending channel accounted for 15% of industry volume compared to 14.2% in the first quarter. In EMA, PMI has leading shares in the key markets of Russia, Ukraine and Turkey. It is also very well positioned in the Middle East and Egypt. In Russia, shipments were down 2.6%, but PMI's end market sales were up and share rose 0.2 points to 26.7% due mainly to market share increases for PMI's higher margin international brands, Marlboro, Parliament, Virginia Slims, and Chesterfield, partially offset by losses for L&M.

PMI is strengthening its brand portfolio in Russia by introducing many new innovative products. For L&M, it has developed new packaging and a new blend, flavor system, and filter that will deliver a smoother taste. The new lineup for L&M will be launched in Russia during the third quarter. Other new initiatives in Russia are the recent launch of Marlboro Filter Plus, an innovative new Ultra Light product which has been introduced at a premium price to Marlboro, as well as line extensions for Parliament, Virginia Slims and Muratti. Driven by improved pricing and favorable mix, PMI income in Russia is up significantly in the second quarter.

In Asia, PMI's volume and profitability were affected by declines in Japan. Volume progressed well in Korea, Indonesia, the Philippines and Thailand and was further buttressed by the acquisition in Pakistan. In Japan, the industry faced a difficult comparison with the second quarter of 2006 as last year's total market was distorted by heavy trade purchases prior to the July 2006 excise tax increase. As a result, in the second quarter the industry was down 20.3% versus last year. However, PMI estimates that the underlying industry decline after the July 2006 price increase has been approximately 6%. PMI anticipates that the distorted comparison against last year will continue into the third quarter of this year. By the fourth quarter, the market contraction will return to a more normalized 2.5% to 3% decline.

PMI shipments into Japan were down 8.7%, but this was flatted by favorable distributor inventory movements. Market share for PMI at 24.3% was down slightly, although Marlboro's share was stable at 9.8%. PMI has recently introduced a number of new products including Marlboro Wides and Marlboro Ice Mint, a new innovative menthol product to strengthen its position in the highly competitive menthol segment. PMI estimates that its in-market sales in Japan will be up in the mid single-digit range, but that shipments will be down in the second half of this year compared to last year.

In Indonesia, PMI shipments rose 1.3% in the second quarter. Market share was essentially unchanged at 28%. A resilient performance given the tax driven price increase that took effect in May. A Hijau's share rose 0.8 points to 6.0%, but A mild and Dji Sam Soe lost 0.6 share points and 0.3 share points respectively due to low-price competition and temporarily widened price gaps with competitive brands.

Marlboro's share grew 0.1 points to 4.1%. Just a few weeks ago, PMI launched a kretek version of Marlboro to meet consumer taste preferences and build on the brand's fame in Indonesia.

In Latin America, volume was down 2.6% as a result of declines in Mexico and the Dominican Republic, partially offset by continued growth in Argentina. Market share grew an impressive 1.7 points in Argentina to a record 68% due to Marlboro and the continued growth of the Phillip Morris brand. In Mexico, the total industry declined 8.6% in the second quarter due to the impact of the excise driven price increase in January of this year, as well as the timing of shipments. However, PMI's market share reached a record 64.2%, up 1.4 points on the strength of Marlboro which grew one share point to 47.8% aided by the national introduction of Marlboro Wides in May 2007. Benson & Hedges and the local brand, Delicados, are also growing strongly.

For 2007, PMI's volume is forecast to grow between 2% and 3% including all Lakson volume in Pakistan. Absent Pakistan, volume is expected to be essentially flat. Operating companies income is forecast to increase, to increase 5% to 7% in 2007 excluding currency, restructuring charges, and the 2006 Dominican Republic gain. This concludes my introductory remarks, and now I will be happy to take your questions.

Thank you. We will now conduct the question-and-answer portion of the conference. (operator instructions) Our first question is from Filippe Goossens of Credit Suisse.

Yes, sir, good morning, Dinny. Two questions, if I may today.

Yes. Good morning.

Good morning, Dinny. My first question, we have seen you make, or we seen you increase your stakes in a number of companies in the Dominican Republic, Pakistan, and now Mexico. Is this the type of transactions that we may expect from you going forward, and if so, what shall we look for in terms of companies where you can increase your current stake?

Well, I will not answer the second part of your question, but regarding the first part, that's what we've traditionally done a lot of at Phillip Morris International, i.e., increasing our stake in many of our businesses and what you've seen, the markets you just referred to, are again examples of that and I, I can fully well see us in the future doing the same thing.

Okay, and then my second question, Dinny, relates to the adjacency strategies. I would expect that given that this new category today, doesn't really exist, it will take some time before Marlboro Snus will really have a meaningful impact on your EPS.

So would it be fair to say that over the near term we may hear from Phillip Morris, more news in terms of the adjacency strategies that will make a more meaningful impact on the EPS and also, would some of these adjacency strategies be suitable to be exported to other markets, let's say Eastern Europe, sorry, Western Europe which demonstrate today many of the same trends as what we're seeing in the U.S. market?

Well, we have announced, or PM USA, rather, has announced that it is going to go into the, going to progress with its adjacency strategy and go further into the smokeless category. You can expect further news from Phillip Morris USA. As far as the prospects for Snus, you're right, this is a new category.

That's why we're going to go about it carefully, cautiously, that's why we're doing the test market -- we did the test market with [Taboca], we learned a lot. We're using many of those lessons in the introduction of Marlboro Snus. We will gradually step this up. You can hear, you can expect more news from us in the future. I can't be more specific than that. As far as Western Europe is concerned, well actually there is a ban on Snus in the EU. But certainly there could be opportunities for smokeless products in the European Union as well as in the United States.

Just as a concluding follow-up, if I may, Dinny, as it relates to the adjacency strategy, would it be your objective to accomplish that strategy purely organically, or would you also be willing to look at acquisition opportunities if they were to make sense in order to execute that adjacency strategy?

Filippe, as we've always said, all options are on the table.

Wonderful. Thanks so much, Dinny.

Thank you

Our next question is from Chris Growe of A.G. Edwards.

Hello?

Chris Growe, you have the floor.

Hello

We'll proceed with the next question.

Yes.

Are your next question is from Bonnie Herzog of Citigroup.

Good morning, Dinny, how are you?

Hi, Bonnie, fine, thank you, how are you?

Fine, thanks. Just a few questions, just to start off with international business. You know, listening to your remarks, am I correct in my perception that you sound maybe much more aggressive, your business does, in terms of innovation, and therefore, as a company, are you getting closer to becoming more transparent? Because I do believe, this is certainly my opinion, that that is an important aspect once the two businesses are separated.

So, should I read you correctly in sort of assuming that a lot of the, the new products -- innovation that you discussed, is a positive signal and that you're getting closer to the eventual breakup of your two businesses?

Well, I don't think the actions that Phillip Morris International has taken and continues to take has got anything to do with our restructuring strategy. Those are two different issues. And, yes, I think Phillip Morris International is taking a number of innovative initiatives, that's going to continue.

You're right about the transparency. As you've seen, we presented our reportable segments at PMI, four segments, that will give investors a lot more information about PMI's business, but again, that has got nothing to do with any specific actions that we would take or not take in the future with regard to the corporation. The fact that we are now purely basically a tobacco company, we would be required anyway to present these various segments. I just wanted to clarify that.

No, this is just my perception, I'm getting a sense from listening to you and hearing some of the initiatives that your Company's undertaking that it's a positive signal that you're becoming much more aggressive. Bottom line.

Yes.

And that's a good thing.

Good.

And now, secondly, do you have any comments that you'd like to share with us regarding the most recent announcement, I guess, this morning, our time, the U.S., regarding Imperial and Altadis and how that may affect the global landscape?

I really don't have any specific comments, Bonnie. I don't think, consolidation in the tobacco industry has been taking place for some time now, and PMI and PM USA have experienced this before and we'll continue to compete as aggressively as they have in the past. I don't think this really changes things much as far as we're concerned.

You're not that concerned?

No.

Okay. And then--

I mean, we respect, we respect Imperial Tobacco, but we're not concerned.

Okay, turning to the U.S. and Washington, obviously, there's a lot going on. Things are incredibly fluid. I've been tracking it very closely and there is, the latest I've heard is there's a mark-up today regarding the [inaudible], the children's legislation, which would include potentially a tax increase. Could you talk about that and sort of your Company's philosophy and how you will deal with a potential federal excise tax increase? And your thoughts in terms of the passing or whatever it may be. Whatever you can share with us would be incredibly helpful.

First of all, we are against any increase in the federal excise tax. As I said earlier, we believe it would be unfair to adult smokers and have many unintended consequences. The bill is in discussion, I think it's, in fact, been postponed, the discussion has been postponed to tomorrow or later on today. Sorry, later on today.

I think so.

So we just have to wait and see what happens, but I want to repeat that we are against any increase in the federal excise tax. We really think it would be unfair to adult smokers.

Okay, just in terms of Marlboro and the line extensions, certainly Marlboro Smooth is doing well. You did mention you're launching an additional line extension off of that brand. So I would assume that that product, or that line extension is taking share. I don't know if you can quantify that for us in any particular way, but we actually did conduct a survey, we heard positive results, it doesn't surprise me that you're doing what you stated. Is there anything more you can say on that, on Marlboro Smooth?

Well, thank you for your survey by the way, but the fact is that the brand is still not in retail and as it gets to retail in early August, we'll only find out at that time--

No, I meant Marlboro Smooth, not Snus. Sorry.

You're talking about Marlboro Smooth?

Yes, and the line extensions to that --

Marlboro Smooth is off to a strong start. And that's why we're extending it into a 100-millimeter version. We feel very good about it, but I'm not going to give you any specific numbers at this stage.

Okay, another question, speaking of Snus and smokeless, certainly there's a shift and depending on what happens with the federal excise tax increase, which certainly will also include other tobacco products, it's going to depend on the gap, it's going to depend on how all the manufacturers handle it if it occurs, where do you see your portfolio makeup in terms of, as you look out the next five to 10 years, I'm thinking specifically PM USA? Is Snus just the first step into smokeless? Would you expand, like you said, into other tobacco products? Do you feel that that will become a larger and larger stake of your overall portfolio? We can talk top line.

Yes, as Phillip Morris USA has announced and said many times in the past they are committed to their adjacency strategy. That covers a wide range of non-cigarette products and if these are successful, which we hope they will be, then obviously these products will make up a larger part of the business than they do today. The question remains which are going to be successful, which are not going to be successful. It's impossible to predict. But I would venture to say that five years from now, certainly non-cigarette products will make up a bigger proportion, a meaningful proportion of Phillip Morris USA's product mix.

Do you have the capacity and supply to go national by the end of this year if it is successful? This is Marlboro Snus?

Well, we, our planning has taken capacity and tobacco supply situation into account and that's all part of the test market process and the plan we have for expanding the brand.

So you're ready to go?

We will be ready to go at the appropriate time.

Done. Thank you, I appreciate your time.

Okay, thank you, Bonnie.

Our next question comes from Judy Hong of Goldman Sachs.

Hi, Dinny.

Hi, Judy. How are you?

First, for PM USA, can you just reconcile your comment about industry volume being down about 4% to 5% versus kind of the data we've been seeing from IRI where April, May numbers have actually gotten better? So I'm just wondering if June was really bad from an industry perspective, or if there was any sort of an inventory movement that may be impacting the shipment number versus what we're seeing at the consumption level?

I think we, as I said, the number I gave you for the, was for the first half and I spoke about 4% to 5%. And we give this range because, frankly, it's impossible to nail down an accurate number so quickly after the end of the quarter. And IRI themselves is just one source. There are many other sources we look at in coming to our market estimates for the U.S. tobacco industry.

I will say that in the second quarter, the market declined at a lower rate than the first quarter, but when you combine the second quarter and the first quarter, i.e., you look at the year-to-date, we think the decline is very clearly in the 4% to 5% range. We think the decline in the second half of the year is going to be lower, in the 3% to 4% range and that for the full year, the market's going to be down, again, in the 3% to 4% range.

Okay, and then how concerned are that you if you look at PM USA overall market share, it's flattish even though Marlboro is growing. So in other words, can you do something to really grow the overall share of PM USA through either Marlboro or other focus brands you have in your portfolio?

Yes, I think Phillip Morris USA will be able to grow its market share. They'll grow their market share moderately because they want to balance OCI growth and market share growth. You'll have quarters from time to time, like this quarter where the market share was flat, although sequentially it was up. But it was flat compared to the second quarter last year, and you're going have periods like that. We're not too concerned about that. I think the, you've got to look at the long-term trend and the long-term trend is clearly upwards.

Okay, and then turning to PMI, if we look at PMI's operating income growth in the second quarter, excluding currency and acquisition, it looks like it was up about 4% which is a deceleration from first quarter where it was up about 5%, so I recognize that Japan is still weak, but the volume decline in Japan actually moderated in the second quarter versus first quarter. I'm just wondering from an operating income growth perspective what really drove that, a slight deceleration kind of from what we saw in the first quarter?

Yes, well first of all, let me say that you're right that the apples-to-apples growth in the second quarter was slightly lower at about 4.1% compared to more like 4.5% or 4.6% in the first quarter. There were a variety of markets and factors that contributed to that. But I think the important thing is that PMI is going to come in this year with apples-to-apples growth in the 5% to 7% range.

That means PMI's going to have a strong second half and this growth rate by the way is much better than the apples-to-apples or underlying growth rate we've had in the last few years. For example, last year I think our growth rate on an apples-to-apples basis was like 2.5%. So we're more than doubling our growth rate in 2007.

Can you just talk about some of the factors in the second half that would drive the improvement? I guess Japan would be key, but--

Yes, Japan will help a bit, volume will still be down, ship and volume will still be down, but the decline will moderate. Russia will be in better shape. Indonesia will do better and the EU will do slightly better.

Okay, thank you, Dinny.

Thank you.

Our next question comes from David Adelman of Morgan Stanley. Beep - beep - beep - beep. One moment, please. Please stay on the line. The conference will resume momentarily.

Ladies and gentlemen, this is the operator. I apologize, there will be a slight delay in today's conference. Please resume and hold for the conference. Thank you for your patience.

Welcome back to the call. We apologize. There was a technical difficulty with the phone line. David, if you're listening please call in. Operator, could you take the next question please?

Thank you. Our next question is from Erik Bloomquist of JPMorgan.

Hi, good morning, Dinny.

Hi, Erik.

Hi. Two questions, one, with respect to the strong growth in the European Union, I was wondering if you could comment on the potential for the industry to drive growth in government tax revenues in that area and then, hopefully, therefore forestall further excise tax increases. Is that something that seems reasonable over the next few years?

Mmmm, look each budget has its own budgetary requirements. I guess, obviously, if the industry does well the revenue take from tobacco is good and to that extent it helps the government with their tobacco revenues, but I don't know whether in the long-term that makes much of a difference or not. I hope it would. But I can't give you assurance on that, in that direction.

So it wouldn't be fair to think that price increases could be a way to offset further excise tax increases, particularly in high ad valorem countries?

That's the way we've been operating in the past and that's the way we'll operate in the future.

Okay, thanks. Then with respect to the U.S. and the federal excise tax, is it likely that the industry will work together given that the interests seem to be aligned on this in a similar fashion to the way the industry defeated the California proposition to increase taxes?

Yes. That's a fair assumption.

Can you give us more color on that?

I can't really give you any more color except to say that I think we're all on the same page on this one. We're all against the excise tax increase and, yes, we're working together.

Okay, sorry, last question then on PM USA. The growth this year looks relatively modest at the operating company level. Is it fair to assume that's building a base where we could see growth get back with a relatively normal volume decline level and excluding an excise tax or FDA regulation in the neighborhood of 3% to 4%. Is that a reasonable range to think longer term?

You know we started off this year by saying 2% to 4% was the growth rate for Philip Morris USA, and I think that's the kind of range you should be looking at.

Okay. Thank you

Our next question comes from Ann Gurkin of Davenport.

Good morning.

Hi, Ann.

I wonder if we could start with the FDA -- Kennedy's proposed FDA bill. I guess the one change I heard with respect to the user fees and the language has changed, giving maybe the FDA some more latitude in raising user fees, not just based on a volume or market share basis. Can we talk about that? Do you see user fees moving in the direction of what pharmaceutical companies pay to the FDA to support the approval process?

I'm not going to get into the specifics of that Ann, because quite frankly I'm not an expert on it. Maybe, it's probable that you know more about the FDA bill than I do, but I know one of the issues is the user fee, but that is under discussion. We'll just have to see what the marked up version of the bill looks like.

Okay, but do you think it'll likely be a scenario where we'll have user fees more like pharmaceutical companies?

I'm not sure.

Okay, and then switching to PM USA, I'm hearing that there's a lot of discussion, and, I guess, research into looking at the components of core brands, say a Marlboro, and you may even consider changing the paper type on a key large brand. Is that going on? Are you willing to change the mix or component of a large scale brand?

I can't comment on that, Ann.

Okay, great and, third, how about the EU, I think issued a tentative report potentially lifting the ban on smokeless tobacco and their comment is due in August, is that correct? Is there any update there?

Yes, that's correct. I think there's been a study published regarding smokeless tobacco, and I think a discussion period is going to start, but other than that, I don't have any details.

And just one more thing, if I might. The timing of shifting production of cigarettes from U.S. to overseas, I guess we would have thought that would occur in a couple years from now, so why now, shifting all of that production overseas? Can you help me understand that?

Well, frankly, if we look at the fact that we want, we're sort of very committed, very committed to doing everything possible to get costs down, to be as productive, Ann, and as efficient as possible. And, of course, the main area that, in this regard is optimizing the allocation of production between various plants around the world. And we came up with this plan because we believe it is the best way of moving forward.

It also prepares Phillip Morris USA for the situation where you have a declining industry here. At the same time, PMI had some spare capacity in their European plants and with a minimal amount of expenditure could take on this extra volume. So it all worked out very well from that point of view. And as you know that, we're making this investment in shutting down Cabarrus, but the returns are terrific.

Okay, great, thanks Dinny.

Thank you, Ann

Our next question is from David Adelman of Morgan Stanley.

Good morning, Dinny.

Hi, David, sorry you got cut off earlier.

It's okay. I want to ask you a few things, Dinny. First, in terms of the consumption decline in the U.S. cigarette market is there something more afoot than simply higher pricing and lower levels of manufacturer promotional spending?

Difficult to say. But I would say most of it is just higher pricing.

Okay, secondly, Dinny, if you take the hypothetical that there will be, either this year or in the future, a substantial FET increase, let's just work under that hypothetical for a second, it goes without saying you'll pass that onto consumers, what are the prospects, or how aspirational do you think it is to believe the industry would be able to get sufficient incremental pricing above and beyond that to offset the adverse effect of unprofitability of lower unit volumes?

Well, first of all let me again underline, use your own words, that's a hypothetical situation you're outlining. There are a couple of factors we'll have to look at. First of all, whether the extent of the increase, if there is any increase. And then, whether it's phased in, or whether it's all front-loaded. And the fact of the matter is that the price elasticity is around 0.3, so you'll have to factor that in with any price increase.

But I think if you look at markets around the world and you look at the experience in the United States itself, after the MSA, I think one can work around increases, although, obviously, the kinds of increases they're talking about which we are very, very much against and which we sincerely hope that nothing near that will come to pass, but at those levels, obviously, there is going to be a hit on industry volume.

Sure. Dinny, on costs, if you look out four or five years, and you were to define the total cost reduction opportunity for the two tobacco subsidiaries, how much of that is captured by the announced manufacturing restructuring effort? Versus how much is still available in terms of SG&A expense?

I think that target is a moving target as to how much we've covered already. But I think we've got room to to get cost savings for both the tobacco companies well above the numbers just announced for the Cabarrus restructuring.

Okay, and, Dinny, I know it's very early days on Imperial/Altadis, but what's your position on your willingness to rely on [Lohista] as your distributor in France and Spain, Italy and Morocco if it's owned by Imperial, or controlled by Imperial?

At this stage, no change in strategy or philosophy.

Okay, and then as it relates to Japan, Dinny, in the third quarter, shouldn't shipments be up for you in Q3? Wasn't that a period of time that now you'll be comparing against a year ago when the trade was deloading the product it had bought in advance of the excise tax increase or am I mistaken?

I think the in-market sales are going to be up, but last year we had, well, our in-market sales are going to be up, but in fact our inventories this year are going to be drawn down in the second half of the year. And that's what's going to cause a reduction in shipments in both the third and fourth quarter.

Okay. And then lastly, Dinny, in the quarter, at PMI going back to Judy's question about the Q1 versus Q2 comparison, on a net basis, were trade inventory movements negative to PMI's operating income in Q2? It appears to be the case with what happened in Japan, Italy and France.

Well, actually, the trade inventory movements were helpful -- benefited us in the second quarter in Japan.

In Japan this quarter? Okay.

Yes, in this quarter.

Okay, all right, thank you very much.

Okay, David.

Thank you, at this time the floor is now open for questions from media representatives. (operator instructions) While we're waiting, our next question comes from Christine Farkas of Merrill Lynch.

Thank you very much. Good morning, Dinny.

Hi, Christine, good morning.

A couple of housekeeping questions, if I could. Firstly, your minority interest or equity income line was up nicely year-over-year, I'm wondering if you could give a little bit of color on that? Is that SABMiller, is that something to do with the Pakistani change? And how will Mexico or the change in the Mexico ownership impact that line going forward?

Well, first of all, SABMiller is doing well. And so most of that improvement is SABMiller.

Okay.

As far as Mexico is concerned, going forward what you're going to see actually is lower minority interest expense, and that's where you're going to see, in that part of the geography that you're going to see the improvement in our income from the Mexican business.

And currently with your 50% ownership of Mexico, are those volumes fully accounted for in PMI, or just prorated for your ownership?

No, the volume we include for Mexico is the brands we own. There's another, approximately 5 billion units that were Grupo Carso brands which we'll include in our volume going forward.

Okay, great, and then second question, would you have a number for your total PMI OTP volumes in the quarter?

OTP volumes for PMI, yes, I think we referred to it in our press release. Most of it is in Germany. I'll give it to you right now. Just give me a minute. The total OTP volume was 2 billion units.

Okay, great, and then last question, I guess just broadly, certainly there's a lot of moving parts in many international markets and higher taxes and pricing impacts volumes, but are there any particular markets where there are other more pronounced factors, for example, accelerated down trading where the price gap may or may not be too wide or growing smoking bans hurting the overall industry? Aside from the taxes and pricing, are there some particular markets that are more concerning based on some of these other factors?

No, in fact, I think we're sort of seeing, well, as I said in the EU, the situation looks quite good. It's become stable and predictable. If you go across the rest of the geographies, Russia looks good, consumers are trading up. It's becoming more of a premium market.

Japan, we've described the problem in terms of the market declining. It's important in Japan for Phillip Morris International to grow it's market share. It has plans to do that. Indonesia looks fine and most of Latin America also looks okay. So I can't see any sort of difficult issues there on the horizon like we were experiencing in the past few years.

Okay, great. Thanks, Dinny.

Thank you

Our next question is from Chris Burritt of Bloomberg News.

Hey. Good morning.

Good morning.

Could you provide some color on pricing, perhaps the average price on Marlboro in the U.S. in the quarter versus a year earlier quarter?

Yes, in the second quarter, we were at an average price on Marlboro of $4.17 a pack compared to $3.92 a pack in the second quarter of '06. So that's an increase of about $0.25 a pack in that period.

And--

But the gap with the lowest end of the market continues to remain in that mid-40% range.

Okay, and if I may ask a follow, did you step up promotions in the quarter to deal with the falling volume in the U.S.? I think you mentioned that that was the plan when you spoke in April.

Actually, promotion volumes in the second quarter were slightly down for us compared to the first quarter and, but, and for the industry in total, it was about the same between the first quarter and the second quarter. Some of our competitors increased their promoted volumes in the second quarter.

Thanks, very much.

Thank you

Our next question comes from Chris Growe of A.G. Edwards.

Hello, Chris?

Chris Growe of A.G. Edwards your line is live. We'll proceed to the next question. Our next question comes from Thomas Russo of Gardner, Russo & Gardner.

Hi, Dinny. I have a question, I was a bit late. You may have covered these two topics. One is the question as to whether or not, to what extent you've been receiving back from jurisdictions that held funds relating to litigation and the timing of the release and the receipt of those funds? And the second question would have to do with share repurchase and if/when you would turn to having the ability and appetite for share repurchase?

Well, as far as receipt of funds is concerned, the big one, of course, is Engle and there are no major hurdles to getting that back. There are some procedural issues that are ongoing and we expect to receive those funds before the end of this year.

Yes.

And there's about $200 million of other funds which we are expecting the money to come back, $200 million, and that's sort of going to come back partly in 2007 and partly in 2008.

Okay.

And your other question was regarding stock buy backs, I'm not really in a position to preempt the board on the timing or the amount of the stock buy back program. I'll only say that it's been Altria's policy in the past to reward shareholders through dividends and buybacks, and at the appropriate point in the future I'm sure we'll return to such a policy.

Okay, thank you.

Thank you.

Our next question comes from [Brian D'Ambrosio of Sutton Brooke.]

Hi, you know the market is looking, (inaudible) the last major deal out there, I guess, could you comment on that, and the second is to follow-up on the logistical question, is that something that you guys could or would look at given Imperial will probably be reviewing options for the business?

We actually never comment on specific acquisition issues such as the one you referred to. So I really have nothing to say on that. What was the first part of your question?

Just that Altadis is probably the last major deal out there. What are other areas for M&A, even geography, or any comment you would have on that?

There are always going to M&A opportunities out there, and there are opportunities out there today, but there are many business development opportunities out there today, and we just showed you one with our acquisition of 30% of our Mexican business. There are many opportunities like that. There are also free standing M&A opportunities. Besides that, I really cannot be more specific.

Okay, thank you very much.

Thank you

Our next question comes from Rafael Urquia of Citigroup. (pause in audio) We'll proceed with the next question. Our next question comes from Eric Bloomquist of JPMorgan.

Hi, Dinny, just wanted to confirm a detail. In terms of the tobacco businesses balance sheets, are we still on track to have roughly $2 billion net cash at the end of 2007?

No, we're going to be probably neutral no, no net debt.

Okay, so no net debt, no net cash, and that's due to the--

We'll have cash and we'll have debt roughly equivalent to each other.

Okay, very good. Thank you.

Thank you. There appear to be no further questions at this time.

Okay. Well, thank you very much for joining us on the quarterly call. Again, we apologize for the minor interruption we had in the technical difficulty, but if you do have additional questions, feel free to call Mike Kenney or Anthony Sanchez, or me, Nick Rolli. Thank you, again, for joining us and have a great day

Thank you. This concludes today's Altria Group conference call. You may now disconnect and have a pleasant day.