奧馳亞 (MO) 2009 Q2 法說會逐字稿

Good day and welcome to the Altria Group second quarter 2009 earnings conference call.

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

All lines have been placed on mute to prevent any background noise.

(Operator Instructions).

Representatives of the investment community and media on the call will be able to ask questions following the conclusion of the prepared remarks.

I would like to turn the call over to Cliff Fleet, Vice President Investor Relations for Altria Services.

Good morning and thank you for joining our call.

This morning we will only be discussing Altria's 2009 second quarter and first half business results and will not be discussing the status of tobacco litigation.

Our remarks contain forward-looking statements and projections of future results and I direct you to the forward-looking statements cautionary statements at the end of our earnings release for the review of the various factors that could cause actual results to differ materially from projections.

As a result of the spin-off of Phillips International in the first quarter of 2008, our reported results for the six months ending June 30, 2008, reflect PMI's discontinued operations.

Revenues and operating company income for PMI are therefore excluded from Altria's continuing results.

Since Altria acquired UST and its smokeless tobacco and wine subsidiaries on January 6, 2009, US smokeless tobacco companies and St.

Michelle Wine Estates financial results from January 6 through June 30, 2009, are included in Altria's first half of 2009 consolidated and segment results.

For a detailed review of Altria's second quarter business results, please review the earnings release that is available on our web site www.altria.com.

Altria reports its financial results in accordance with Generally Accepted Accounting Principles.

Today's call may contain various operating results both on a reported and adjusted basis which excludes items that affect the comparability of reported results.

Descriptions of these measures as well as reconciliations are included in the earnings press release.

Now it gives me great pressure to introduce Mike Szymanczyk, Chairman and Chief Executive Officer of Altria Group, Inc.

Good morning, everyone.

As was the case with our first quarter, our second quarter results unfolded pretty much the way we expected.

Altria reported strong adjusted earnings per share growth of 8.7%.

Our tobacco businesses continued performing well in what I describe as a challenging environment.

Our cost savings programs remained on track.

Our cigarette business delivered exceptional financial results.

The UST integration continued to proceed smoothly.

I think we remain encouraged by the initial results coming from our actions to enhance the value equation of USSTC's premium portfolio in our smokeless business and Black & Mild had another quarter of strong retail share growth in the cigar business.

Volumes for the quarter were negatively impacted by a significant Federal Excise Tax increase on tobacco products that took effect on April 1, 2009.

Because the ramifications of these tax increases were different by tobacco segment, the business trends for the quarter are a bit difficult to decipher.

Dave will go into more detail on these impacts when he reviews business segment results and we'll try to provide further insight during the Q&A portion of the call.

However, three events negatively impacted our tobacco volumes in the quarter beyond industry performance that do not represent trends and need more explanation.

First, during the early phases of the FET induced period of pricing dislocation in the cigarette business, PMUSA experienced share losses as some competitors spent aggressively into the FET while we did not.

Once price caps normalized at the beginning of June, Marlboro experienced sequential retail share growth throughout the month.

Marlboro ended June with a share of 42.4%, which was the same share level as the first quarter.

We also allowed our nonsupport brands to adjust to lower post FET share loss.

Together, these two actions turned out to be a profitable strategy for our cigarette business.

Second, USSTC executed an every day low price strategy on Copenhagen and Skoal and eliminated duplicate inventories caused by large quantities of value packed promotions in the system.

This is a one time adjustment.

Finally, in our Cigar business, Middleton integrated our cigar distribution system into the one we use for cigarettes, thus reducing required wholesaler lead time.

We also moved to zero day payment terms.

These two steps have reduced Middleton trade inventory system-wide and should result in improved product freshness.

So far the impact of the FET increase on industry volumes is in line with our expectations.

In the cigarette category, the FET hike helped drive the average industry-wide price for a pack of cigarettes up approximately 25% versus a year ago.

To date, estimated cigarette industry volume adjusted for changes in trade inventories has decreased in line with historical price elasticity.

As I mentioned, PMUSA did not spend into the FET increase, but rather waited for the marketplace to sell.

Price gaps widened to about 50% early in the second quarter.

We saw the discount category grow in April and May.

The price gaps returned to below 40% by early June.

In June PMUSA changed its promotional programs to focus on single pack offers.

The results of this plan was retail share loss during April and May and rapid sequential retail share gains for Marlboro and sequential share losses for the discount category during June.

PMUSA's promotional spending on a per pack basis was essentially the same in the first and second quarters of 2009.

The UST integration is proceeding very well.

USSTC's sales force and one-to-one consumer engagement functions were combined with those of PMUSA to create two new support organization, Altria Sales and Distribution and Altria Consumer Engagement Services.

Creating these companies combined with other ongoing Altria cost savings initiatives has enabled the integration to proceed quickly.

Ninety-eight percent of the planned employee separations resulting from the UST integration have occurred.

We expect integration cost savings to begin enhancing profitability in the second half of 2009 and beyond.

USSTC's premium portfolio has responded well to the marketing changes implemented in the first half of 2009.

USSTC's premium share stabilized sequentially as USSTC transitioned from multi-can value pack promotions to an everyday low price strategy on single cans to reset the brand's value placement.

As a next step, in the third quarter USSTC will adjust the price gap of Copenhagen and Skoal in some states where price gaps remain too high and/or where particularly difficult economic conditions exist.

Also in the second half of 2009, USSTC will enhance its brand building equity programs to help return Copenhagen and Skoal to modest retail share growth.

Altria's cost saving programs continue to proceed as planned.

$25 million in cost savings were achieved across the Altria family of companies in the second quarter.

UST integration savings along with savings from ceasing cigarette production in Cabarrus which will occur by the end of this month as well as other SG&A cost savings programs should further enhance profitability.

We remain confident that we will complete the $1.5 billion in cost reductions off our 2006 cost base as planned by 2011.

On June 22, 2009, the President signed the Family Smoking Prevention and Tobacco Control Act into law.

The legislation provides the Food and Drug Administration regulatory authority over tobacco products.

While we did not agree with every element of this legislation ,including those that we believe cross Constitutional limits, we supported its enactment.

We believe this comprehensive national regulatory framework implemented thoughtfully can provide significant benefits to adult consumers by establishing a common set of high standards for all tobacco manufacturers and importers doing business in the United States, by providing a framework for evaluation of tobacco products that are potentially less harmful than conventional cigarettes and by creating clear principles for accurate and scientifically grounded communication about tobacco products to adult consumers.

We hope the FDA will implement this new regulatory framework consistent with these principles.

We will work constructively with the agency to supports its enactment.

This regulatory framework will bring change for our tobacco businesses, and we have been preparing for this change for the past several years.

Immediately after the President signed the legislation into law, Altria established a regulatory affairs group to oversee our future work in this area .

We remain very pleased with Altria and its operating companies 2009 performance to date.

Our cigarette business continues to grow income in a challenging environment.

The UST integration is proceeding very smoothly.

USSTC's premium MST portfolio is benefiting from our actions to enhance its value equation.

Black & Mild continues to generate strong retail share growth and our aggressive cost savings programs continue to enhance overall profitability.

Altria remains well-positioned to continue to deliver strong shareholder returns.

Given Altria's strong YTD EPS performance, we are raising our 2009 full year guidance for adjusted diluted EPS to a range of $1.72 to $1.77, representing a growth rate of 4% to 7%.

Now I'd like to turn the call over to David Beran, Altria's Executive Vice President and CFO who will discuss Altria's business

Thank you, Mike.

Let me begin with the cigarette segment which delivered strong operating companies income growth.

Reported cigarette operating companies income increased 6.7% versus the prior year period to $1.4 billion due to list price increases partially offset by lower volumes as well as charges primarily related to Cabarrus facility closure.

Excluding those charges, the cigarette segments operating companies income increased 7.4% to $1.5 billion.

Second quarter results were impacted by the April 1 increase in the Federal Excise Tax.

In the first quarter of 2009, trade inventories were substantially reduced to minimize floor tax payments, and in the second quarter the trade rebuilt inventories, though not back to their prior levels.

PMUSA's cigarette shipment volumes were down 6.8% in the second quarter, but are estimated to be down about 12% when adjusted for changes in trade inventories.

P MUSA estimates that total adjusted cigarette industry volume declined 8% in the second quarter.

Overall ,2009 cigarette industry volumes had performed in line with P MUSAs expectations.

For the first half of 2009, P MUSA estimates that adjusted total cigarette industry volumes declined 7%.

P MUSA estimates that its cigarette shipments were down 9% on a year-to-date basis when adjusted for changes in trade inventories and calendar differences.

When comparing P MUSA to the total industry, the difference in volume decline can be attributed to volume lost during the period of price gap dislocation and share losses on unsupported brands due to higher retail prices.

Initial adult consumer reaction to the FE T hike was consistent with our expectations.

There was some adult consumer down trading to competitive brands as some competitors chose to spend into the tax increase, driving a widening of the price gap between Marlboro and the lowest price brand.

This gap reached a peak of about 50% at the beginning of the second quarter.

However, as the quarter progressed, price gaps closed below 40%.

As price gaps closed, Marlboro's retail share began growing again and ended the month of June at a 42.4 share.

The trade down from premium to discount that occurred in the first part of the second quarter was most evident among non-menthol brands due to less competitive activity in the menthol segment.

Marlboro menthol grew 0.04 of a share point in the second quarter.

At the end of the quarter, PMUSA began shipping Marlboro blend number 54 to continue building on Marlboro's success in the menthol segment.

Retail acceptance and initial adult consumer trial of this new packing have been very strong.

Overall, we are pleased with the second quarter cigarette business results.

Profitability growth was very strong and Marlboro's retail share performance returned to growth in June after the initial period of dislocation following the Federal Excise Tax increase.

Now let's turn to the smokeless segment.

USST C's actions enhanced the value equation on Copenhagen and Skoal with a list price reduction of $0.62 per can that was effective at the end of the first quarter.

As we anticipated, national net price gaps versus the leading discount brand closed to below 60% at the end of the second quarter.

We are encouraged by USSTC's premium retail share performance as its share began and ended the second quarter of 2009 at the same level.

Importantly, USSTC's premium revenue share increased 6.6 share points versus the first quarter of 2009 as the Company eliminated multipack deals.

USSTC's domestic MST volume declined 3.4% in the second quarter, but is estimated to be essentially flat versus a year ago period when adjusted for changes in trade inventories, the discontinuation of multipack deals and the discontinuation of its Rooster brand.

The trade continued reducing inventory levels on USSTC's products as the company transitioned from multipack deals to everyday low pricing, which eliminates the need for promotional inventory.

USST C believes that the long-term growth rate for total MST industry volume remains at 6% to 7%.

Reported operating company's income for the smokeless segment was $177 million in the second quarter.

When adjusted for exit, integration and acquisition related charges, second quarter smokeless segment operating companies income was $213 million.

Now let's discuss our cigar business results.

Black & Mild reported another strong quarter of retail share growth.

Black & Milds retail share was 30.4%, up 2.7 share points versus the prior year period.

Black & Mild continued benefiting from the support of the Altria sales and distribution infrastructure at retail as well as the successful launch of Black & Mild original wood tip earlier this year.

New products continue to be an important component of Black & Mild's retail share performance.

Middleton recently announced two new line extensions that are expected to ship to wholesale in the third quarter of 2009.

Black & Mild wood tip line and new non-tip tip product, Black & Mild cigarillo which will be test marketed in the state of Georgia.

In the second quarter, cigar shipments were impacted by the FET increase on April 1.

There was no floor tax on cigar inventories, so the trade increased inventories in the first quarter in advance of the tax increase.

In the second quarter, the trade fully depleted this FE T inventory build.

Additionally, the trade further reduced cigar inventories in the second quarter as Middleton migrated to the Altria sales and distribution system.

Middleton does not expect to recover volume lost for this one time adjustment.

Second quarter cigar shipment volume was 270 million units, a decline of 23.8% versus the prior year period, but is estimated to have grown moderately when adjusted for changes in trade inventories and timing of promotional shipments.

Middleton believes that the long-term industry volume growth rate from machine made large cigars remains at 3% to 4%.

However, the growth rate may have slowed in the second quarter.

We will have a better understanding of the volume impact as the year unfolds.

Reported operating companies income for cigars decreased 28% versus the prior year period to $36 million, reflecting lower volumes.

Excluding integration costs, adjusted operating companies income was $40 million, a decline of 21.6% versus a year ago period.

The first half of 2009 adjusted cigar operating companies income increased 3.2% versus the prior year period to $97 million.

Let's now turn to the wine settle.

The wine segment's second quarter results continued to show strong underlying performance, but were negatively impacted by continuing wholesale inventory depletions and weakness in on-premise sales that includes restaurants and bars.

As a result, St.

Michelle second quarter wine shipments were down 1.5% versus a year ago period to 1.4 million cases.

St.

Michelle's volume from wholesale to retail increased approximately 5% in the second quarter and first half of 2009 due primarily to higher off-premise channel volume that includes supermarkets and liquor stores, partially offset by lower on-premise channel volume that includes restaurants and bars.

Retail volume as measured by the Nielsen total wine database for US Food and Drug increased approximately 12% in the second quarter of 2009 versus the prior year period.

Reported second quarter operating companies income for the wine segment was $9 million.

When adjusted for acquisition related charges of $6 million, adjusted second quarter operating companies income was $15 million.

Let's conclude with financial services.

Reported operating companies income in the second quarter increased $53 million to $83 million due to higher gains on asset sales, partially offset by an increase in the allowance for losses of $15 million.

On June 1, 2009, General Motors filed for Chapter 11 bankruptcy protection.

PMCC leases various types of automotive manufacturing equipment to GM under leases which expire from 2012 through 2023.

Automotive equipment under lease to GM represented approximately 4% of PMCC's portfolio of finance assets as of June 30, 2009.

As a result of the bankruptcy filing, PMCC has ceased recording income on these leases.

All other PMCC lessees are current on their lease obligations.

PMCC has assessed its allowance for losses for its entire portfolio excluding its exposure to GM, and believes that the allowance for losses of $315 million is adequate.

As you know, the jury in our LILO-SILO tax refund case in the Southern District of New York reached a verdict in the Government's favor.

In that case we were seeking a refund for taxes and interest we paid following disallowance by the IRS of tax benefits we claimed in the 1996 to 1997 years related to four LILO-SILO transactions.

There are critical legal issues involving these transactions that will be raised in post-verdict motions that will be filed by the end of July and that we expect will be resolved by September.

If necessary, depending on the resolution of these issues, we will pursue an appellate strategy.

We had previously paid approximately $150 million of Federal Income Tax and net interest related to disallowed tax benefits for LILOs and SILOs for the years 1996 through 1999, including the four transactions that were subject of the July verdict.

The IRS has indicated to us that it intends to disallow tax benefits we claimed in the years 2000 to 2003 with respect to the same four leases plus other lease transactions characterized by the IRS as LILOs and SILOs.

The total disallowance for the 2000 to 2003 time period for these leases and Federal Income Tax and related interest would be approximately $1 billion.

If the IRS in the future disallowed the tax benefits for these leases for the period from 2004 until December 31, 2009, the disallowance for that period in Federal Income Tax and related interest would be approximately $900 million, taking into account a Federal Income Tax paid or payable on gains associated with sales of leased assets during that period.

PMCC entered into no LILO or SILO transactions after 2003.

We intend to contest all these disallowances vigorously.

Whether and when we make payments of these amounts will depend on the timing and outcome of future IRS audits and any related administrative challenges and litigation.

LILO and SILO transactions represent approximately 36% of the net finance assets of PMCC's lease portfolio.

Although there will be some likely impact on our reported earnings in the event of an ultimate adverse outcome to these matters, management believes that the resolution of the LILO-SILO matter will have no adverse effect on our dividend policy or our ability to satisfy our financial obligations.

Mike and I will will now be happy to take your questions.

While the calls are compiled, let me cover a few housekeeping items.

Marlboro C- store price gap versus the lowest effective price cigarette averaged 42% in the second quarter.

Marlboro's net pack price was $5.22, and the lowest affected cigarette pack price was $3.68.

The cigarette discount categories second quarter retail share increased two share points versus the prior year period, to 27.3%.

The estimated average weighted cigarette state excise tax at the end of the second quarter of 2009 was $1.15 and is estimated to be $1.22 at the end of July.

Five states, including Florida, increased their SETs on July 1.

Through July 22, nine states and Puerto Rico have increased their cigarette excise taxes in [2009] with an average increase of $0.53 per pack in those nine states.

Our second quarter MSA and quota buy-out accruals were $1.4 billion or $0.67 per pack.

Of the $0.67, MSA represents $0.61 per pack and the quota buy-out represents $0.06 per pack.

Copenhagen's national retail price was $4.16 per can in the month of June.

In the second quarter, CapEx and ongoing depreciation and amortization were both $69 million.

And we anticipate that our 2009 full year effective tax rate on operations will be approximately 37.1%.

Operator, do we have any questions?

(Operator instructions.) our first question comes from Christine Farkas from Banc of America.

I have some questions on smokeless, if I could.

You talked about premium share stabilizing by the end of the quarter.

First, could you comment on category growth for the second quarter and/or first half.

And secondly, are you implying that the premium growth in June, for example, approached that of the first quarter?

Can you just clarify what the share was, for example, at the end of the quarter and if you were referring to premium?

Well, I think it's kind of hard to categorize category growth given some of the movement in inventories that took place the first half of the year.

Our best estimate coming from USSTC is that they believe it continues to be running at a modest 6% to 7% category growth rate.

But it's best, I think, to look at those things over an extended period of time because things like large FETs and inventory movements and some of the changes that we've made can kind of cloud the read.

We've got a number of moving items going on relative to the smokeless business which was our intention for the year.

We are making lots of adjustments in that business.

So we've adjusted the cost structure significantly.

A lot of that's been done.

We still have a little more to do in the second half.

We've adjusted our list prices as a first step toward getting our value equation right.

We said in the process of talking about this that we would take that a step at a time.

We would do what was necessary, we thought, on a broad basis and then we'd look at hot spots that developed around the country or places where that list price reduction was inadequate to get to the range of gap that was going to be necessary, and so we couldn't do that until after we had taken the first step.

That was just completed in the second quarter.

And so now in the third quarter we are moving on to look at discrete particular areas and we will take a more surgical approach to getting things right there.

And really that's just getting pricing right.

in the long run, we want to build those businesses using equity tools, and we will begin to do that as we move on through the second half.

Formulated strategies there, we've developed some programs and opportunities we think will benefit the brands on a longer term basis and certainly influence the outcome as we move into 2010.

I think you have to look at the smokeless category and our business, given the size of our business relative to the total category in 2009 as operating in a period of adjustment.

I wouldn't get too excited about trying to predict trends or read trends during that period of adjustment because it's hard to nail down numbers as trends when you've got so many things moving around.

It's tough for me to give you an answer to a question that I don't think is really answerable relative to trends right now.

Okay.

Thanks for that.

A follow up on smokeless, though.

You gave us the price gaps now at the second quarter.

Were any changes in weight based tax structures helpful in closing that gap in the quarter in the first half?

I'm not sure there were any that influenced that.

You will probably see some of that take place the second half of the year as Texas goes.

But you've got some offsets relative to Florida and I think Wisconsin, if I remember correctly, that worked the other way.

So, no, I wouldn't say that the gap has been driven by that.

I think it's been driven purely by the changes in the price structure that we put in place as well as whatever other competitors did.

I would say that that gap is still kind of moving because, as you know, the impact of the FE T on many of the competitive brands wasn't reflected until late in the quarter, so we really haven't seen that play out in the gaps at this point.

So that's still kind of moving, and I think we will likely see a bit more narrowing of that in the third quarter.

A final question for Dave on your SILO-LILO comments about potential impacts not disrupting your ability to pay dividend or meet financial commitments.

Do you have a comment on whether or not that would impact your plans for potentially resuming a share buy back in 2010?

As we said earlier in the year, the Board will take that decision by the first quarter of next year and look at the total business including the potential impact of LILO and SILOs when they make the determination on future share buybacks.

But just let me remind you that when we look at our companies and how we manage our cash flow, we are always looking to have a strong balance sheet and to make sure that we have a strong dividend policy.

But specifically on stock buy backs, we will make that call later on in the year.

Keep in mind the Board did not say that it would resume share buy backs in 2010.

It said it would readdress the subject in the first quarter of 2010.

I understand.

That was me.

Thanks.

The next question come from the line of Judy Hong of Goldman Sachs.

David, just to follow up on SILO-LILO here.

The $1 billion that the IRS intends to disallow between 2000 and 2003 ,my understanding is you have to pay for it before you can litigate.

Is that the case?

And if that's the case, when would the cash obligation be due?

Let me comment on it, then Dave can comment on it.

But I would say there are several different options relative to that, so your assumption could be right but not necessarily right.

So depends on which option you choose.

We also are still awaiting both the final outcome from the jury trial that we think will happen some time in September plus receiving the actual final revenue agent's report which we would expect for the time period 2000 to 2003, which we would expect to receive some time in the next six months.

Okay, so what are the other options that could you pursue here?

Well, I'm not going to get into legal strategies, but there are several different approaches.

Okay.

And then Mike, just in terms of on the cigarette side, the narrowing of the price gap in June that you saw and the subsequent share improvement that you saw in your brands, how much of that is driven by competitors that are backing off in their promotions as opposed to your increased promotions on Marlboro.

I'm just trying to get a sense of whether your promotional strategy has changed as the quarter progressed or just competitors kind of backed off in June.

As I mentioned, our spending rate per thousand for the second quarter was the same as it was the first quarter.

So I don't think you can attribute that to increased spending by us.

I think did you see some lagging of the reflection of the tax in the marketplace.

In a number of cases you even saw some spending into the tax increase, and then that moderated as you got on through the end of May.

And I would say that we would attribute it more to that than anything else.

We made some adjustment in our promotion plan on Marlboro.

We moved from where we do run on some packings or have run two pack deals, we moved to a one pack strategy because we felt like as pricing went up, particularly in this economic climate, that was a better approach for our consumers.

But at the same time we did that, we actually lowered the rate per pack that we were spending from the level we had when it was a two pack deal.

But broadened modestly the amount of activity that we had.

We adjusted our strategy, but I wouldn't say we made any dramatic changes in the amount of spending that were reflected in the quarter.

And then in terms of the menthol category, Mike, you talked about the category not facing as much price competition from the lower end, or the trading down being more limited in that category.

Can you maybe talk about the menthol category growth, and within it the new product that you introduced there.

What is the -- how is that different than other Marlboro menthol line extensions?

Marlboro blend 54 really did not impact market share in the second quarter because it really didn't hit the marketplace and start to have an impact until the third quarter.

So Marlboro's menthol strength for the quarter was driven by other packings in the brand.

It's a different taste profile and it seems to, among menthol smokers, seems to be very attractive to a pretty good segment of menthol smokers, and so kind of fills a bit of a void in the portfolio of Marlboro menthol SKUs.

That's why we decided to put it out in the marketplace, and so we will get a chance to get an early read on it in the third quarter as it kind of unfolds.

And at this juncture, we are just trying to give menthol consumers, adult consumers the opportunity to give it a try.

Representatives of the media are now invited to ask questions.

Your next question comes from the line of Chris Growe of Stifel Nicolaus.

Hi, I had a couple of questions for you.

if you look at the inventory rebuild, if you will, that occurred in the second quarter, I get somewhere around 2.2 billion stocks rebuilt of it, are we at a level that's a good sustainable level going forward for inventory or are we having any continuing out of stock problems, for example, like you had in Q1?

Our stocks on Marlboro are still a bit higher than they were pre-FET.

As I have spoken to people in the retail distribution, the retail part of the distribution system, I would say they're is still kind of finding their way and adjusting their inventory level.

I think they pretty much recognize that cost of inventory has gone up, but they tend to operate with the idea of wanting to satisfy demand in the category.

And so you'll see, I think, some continued adjustment in inventory as the actual category volume level begins to settle in in the third quarter.

Typically when we see one of these larger excise tax increases, we will see a dip in volume and then a return of volume, and that return is on a slower curve out over several months.

If you believe, as I do, that retail inventories tend to follow the actual outflow of volume from retail stores, you are likely going to see those inventory levels continue to adjust a bit on through the third quarter and maybe even into the fourth quarter.

So I would say that's not finished yet.

It's still moving around a little bit and that's reflected in some increased out of stock levels on Marlboro in the marketplace.

I have one more question related to smokeless and the US T business.

You talked about making some second half adjustments, it looks something like the Copenhagen price and some brand building programs as well.

When you look at the net cost savings from US T, are there other adjustments you are making to help pay for this, if you will, or is this kind of cutting into the cost savings as a fair way to look at it?

I'm sorry, ask me that again.

I'm not sure I understand.

I guess I'm looking at you have $300 million in cost savings from US T.

They are going to spend a portion of those back as you did with the $0.62 reduction in price in Q2.

And now you are going to make a few more adjustments in Q3, it sounds like, Copenhagen and some brand building adjustments?

Are those -- have you found more cost savings or a way to pay for those or will that cut into, I guess what I regard, as kind of a net cost savings from UST?

No, we've always anticipated that we would have to make -- as we do in the cigarette business, make some more localized adjustments in order to deal with particular circumstances.

You have some circumstances where the tax structure or the amount of tax in a particular statement has a bearing on whether or not the gap falls in the range we are talking about,.

You also have some circumstances in some states where you have high unemployment.

So the gap that you can sustain may a little bit less.

We had anticipated that that would be the case all along, so we factored a bunch of that into our calculations when we were determining what we thought we would have to spend back into the marketplace.

You just can't get there, though, until you do the first step, otherwise you're just wasting money.

So we had to make the list price adjustment, let that set in so that we could see where the gaps were and where the issues were.

And then now we can move on to the next step, which in some cases may only be on a particular brand, or in other cases may be on both brands, and in the majority of cases there's no more to be done.

So, no, it's not new news.

You shouldn't look at it that way.

I think I spoke to this and discussed it relative to strategies with UST that we use both list price, but also localized by state more surgical approaches to dealing with the price gap today because it's more efficient than simply doing it all with list price.

That makes sense.

One quick follow if I could for Dave, is could you give us an idea what the tax rate would be, say, in 2008 or 2009 excluding any LILO or SILO benefit?

Is that something you can answer?

No, but I do not believe our effective tax rate will change at all.

This is nothing more than the timing of tax payments.

This $1 billion charge represents an acceleration of tax payments and interest, not a change in the tax rate.

That makes sense.

Your next question comes from the line of David Adelman of Morgan Stanley.

Good morning.

Mike, I'm curious first on the cigarette business, and certainly in the second quarter arguably for the second half you prioritized profitability over share.

I'm curious, is that solely a reflection of sort of the tactical things that are happening in the marketplace or is there a more secular shift in how you are thinking about balancing profit versus share?

Well, I would go back to the objective that we've stated relative to the cigarette business which is to maximize earnings while maintaining modest share momentum on Marlboro.

And I would say what we did in the second quarter is very consistent with that.

We looked at a discrete event in the marketplace, and so we looked at it to say, well, what's the most efficient way to manage around that event relative to how we are going to spend our money.

And it seemed to us that the most efficient thing to do was to not try to deal with all of what was going on in a period of dislocation, but instead to let the dislocation pass, see where we were and then go back to the business of maintaining momentum on this key brand that we have, Marlboro, and we'd see where we adjusted to on the other other brands which we don't spend a lot of money on.

That's how we did it.

I wouldn't suggest the second quarter represents any fundamental change in our strategy.

It just says that that's strategy is a longer term strategy, it's not something you necessarily are going to do regardless of what's going on around you.

There may be points in time that it makes little sense to go ahead and let those more price sensitive shoppers shop and come back and then return them to the brand, which is precisely what happened.

If you saw the sequential share growth in June, what you see is it just stepped up every week once the gap was corrected.

And the Marlboro business was very strong as it went through the month of June.

Was some of the issue,Mike, in the early part of the quarter, actually the price promotion levels on competitive premium brands?

Because the 42% gap you called out for the quarter on average is fairly narrow in a historical context for Marlboro to have lost share.

So was some of the issue promotional spending on premium brands which isn't captured in that 42% number?

I think the 42% is basically irrelevant in terms of looking at the business, and that's because it ranged from over 50% to down below 40% by the end of the quarter.

So the average for the quarter doesn't mean much.

In April and May it was driven by a number of factors, largely discount.

So it was largely dragging your feet by some competitors in terms of reflecting the increase, and in some cases it was some big expenditures into the FET.

So it was not only not reflecting it, it was also spending into it pretty aggressively for a period of time, and there was share gain by those discount operators, and in particular, I think there was one brand that had very aggressive share growth behind very aggressive spending.

And then as the reflection of the tax played out and the gaps began to narrow, what you saw was equilibrium return and then ultimately the discount share began to decline and the premium share began to pick back up.

And Marlboro in particular which kind of rested during April and May, came back very strong.

Then on Copenhagen and Skoal ,are you surprised or a little disappointed that the $0.62 reduction in wholesale list prices wasn't alone sufficient to generate sequential share growth?

No, and I said this at the beginning of this proposition that to some degree, given my experience in the cigarette business and remember I date back before Marlboro Friday, so I think it's fair to say when you go back that far, and given the tools we had back then that the depth of the change in the business which resulted in some significant share growth over a short period of time for the cigarette business and the Marlboro business wasn't the most efficient approach to it.

And so we've looked at it and we said this before we did it, our objective was not to use price gap management to drive growth.

It was rather to stabilize the share in these businesses and then grow them, using brand enhancing approaches that really allow you to sustain a larger gap because you have a stronger brands equity.

So we've approached it differently, and it's a step by step process.

We are stepping our way through it because that's the most efficient and most profitable way to do it and that's what our objective is.

Two last things.

First on SILO-LILO.

Thank you for the increased disclosure.

Can you help us understand, if you were to approach the issue just how you have to date, which is the IRS challenges you, you pay the money, you litigate and you go through that cycle over time.

In that hypothetical, and then the government prevails throughout.

Under that hypothetical scenario, can you give us an assessment of this $1.9 billion you called out, what the phasings of those cash payments would be by year approximately?

I don't think so, at least not right now.

And then lastly as it relates to the FDA, what gives you confidence that they are not going to mandate product specifications or product modifications that are going to impair the consumer enjoyment of your tobacco products?

Well, it's going to be an extended process here, and I don't think that any of us can predict exactly what things the FDA will focus on.

I think they've opened up a web, communication page, so you can comment to the FDA.

We've begun to communicate with them and we put some structure in place to engage with the FDA.

But remember, they are building an organization.

They have to put that together.

They have to take comments.

They have to write a reg, and there are some things that they have to work toward implementing, and we were focused on the things that need to be implemented and engaging with them on how they want to have them implemented.

It's very early in the process.

I can't predict what areas they will land on.

What I can tell you is whatever it is, it will be a level playing field.

So we'll compete on that playing field to try to give our consumers products that they enjoy and, certainly I would hope decisions the FDA makes will be ones that are focused on allowing consumers to have choice, be informed and hopefully find ways to reduce harm through offering them products that help do that.

Okay.

Thank you.

Your next question comes from the line of Chris Burritt of Bloomberg News.

Thanks for your time.

On smokeless, now that you've had about six months to get a better idea of Skoal and Copenhagen, can you talk a bit on whether loyalty differs between snuff and cigarettes and loyalty for rival brands like Grizzly help explain some of the difficulty that you folks have had in taking share at this point?

Thanks for your answer.

Well, if you look at the loyalty factors on those brands, they are slightly below Marlboro, but they're certainly within a few percentage points, call that less than five of Marlboro.

Marlboro has very high brand loyalty level.

So I wouldn't say their loyalty factor is weak.

I would say the gap was pretty wide.

We saw this in the same kind of circumstances with Marlboro and so we've narrowed it.

But we didn't narrow it as much here as we did here when we narrowed it on Marlboro.

We think, as we've done research and evaluated this, that there are some opportunities relative to these brands and the way they're positioned and their offerings that we can take advantage of that will help them grow.

We are just taking a pretty methodical approach to it.

We are not trying to buy business here.

What we are trying to do is build brands, so that takes a little more time.

I would kind of hasten to point out when somebody says to me, well, it's been six months and the train is not going 100 miles an hour, yet I would say it's only been six months and we've absorbed the company taking on a massive amount of cost, reduced a sizeable amount of headcount and repositioned the pricing in the marketplace, and we are just getting started.

Are you able to explain how you might tap some of those opportunities for Skoal and Copenhagen?

No, I won't, because I think that would be competitively sensitive information.

Thank you for your answers.

Your next question comes from the line of Nik Modi of UBS.

Good morning, guys.

Just one quick question, Mike, as you think about having now owned UST for about six months and deep into your own cost cutting initiatives within the base PMUSA business, I'm just curious of any perspective on -- thoughts on potentially more opportunities to scale back costs as you have gone a couple of years into this program in your own business?

You mean overall or related to UST?

Both, both.

Well, the UST program kind of first goes through the initial approach which is taking out the identified cost opportunities to kind of restructure the business, insert it into the overall operation and take advantage of the synergies that exist.

That's what we've been focused on with UST.

As we move into 2010, they will kind of move into the normal mode we have in all of our companies, which we expect them to find new, better ways to operate and become more efficient.

Yes, I would expect to see that business become more efficient over time.

The same thing is true in the rest of our business and that's how we operate.

We've got a cost savings program that we put out through 2011.

We bumped it up a little bit this year in terms of what we expect to get.

We continue to look for better ways to do things, and as we uncover them we put them on the table.

So that's an ongoing part of the company's strategic planning process.

We look at ways to improve processes, to allow us to be more effective and more efficient, and nothing will be different about UST in that regard.

Thanks for the perspective.

Your next question comes from the line of Thilo Wrede of Credit Suisse.

The 8% industry volume decline on an adjusted basis that you pointed out for the second quarter, is that the rate of decline that you expect for the rest of the year as well?

That rate of decline represents the price elasticity on the price changes that took place in the second quarter.

We would expect to see that historical price elasticity would hold in the third and fourth quarter.

So translated, that means unless more major price increases, that 8% of volume declines should be what we should expect for the rest of the year?

We don't give forward-looking forecasts on projected cigarette volumes going forward, especially in this year of dislocation.

Let me reiterate that what we've seen in the first six months is reflective of historical price elasticities.

I don't think we've seen any unusual relative to historical price elasticities.

Now what happens in the second half of the year, your guess is as good as mine.

We'll watch and see what happens in the marketplace.

But so far, the way it's behaved is pretty much with what the numbers would have said from other instances of tax increase or price increase in the marketplace that should have happened.

That's what's occurred.

So whether it recovers more than that or less than that as we go on through the next three to six months, I think remains to be seen.

So far so good.

Have you seen any changes in cross elasticity between cigarettes and [inaudible]?

No, we have not at this point.

But still, we are talking about an FET hike that took place at the beginning of April and we are only three months into it.

It's a little soon to be evaluating that, I think.

Fair enough.

Okay.

One more question, the UST integration, with the cost savings, the response from the brands to your price cuts, the overall progress of the integration, would you say everything right now is on track and it is exactly where you thought it would be at this point?

Pretty much.

If we progress on track and everything runs as smoothly as it has so far, when would you think to be able to tell us whether or not it's going to be accretive or not?

Do we have to wait until the end of the fourth quarter?

Probably in January I'll be able to tell you that.

All right.

No further questions.

Thank you.

At this time, I would like to turn the floor back over to Mr.

Cliff Fleet for closing remarks.

Thank you for joining us today.

If you have any follow up questions, please call us at the Investor Relations Group of Altria.

Thank you, this does conclude today's Altria Group second quarter 2009 earnings conference call.

You may now disconnect.