奧馳亞 (MO) 2009 Q3 法說會逐字稿

Good day and welcome to the Altria Group third quarter earnings call.

(Operator Instructions).

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

I would now like to turn the call over to Mr.

Cliff Fleet, Vice President, Investor Relations for Altria Client Services.

Please go ahead, sir.

Good morning and thank you for joining our call.

This morning we will only be discussing Altria Group, Inc.'s 2009 third quarter and year-to-date through September 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'd direct you to the forward-looking and 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 Philip Morris International in the first quarter of 2008, our reported results for the nine months ending September 30, 2008, reflects PMI as a discontinued operation.

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

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

Michelle Wine Estates financial results from January 6 through September 30, 2009 are included in Altria's consolidated and segment results for the nine months ending September 30.

Unless otherwise noted, all financial data and the remarks refer to comparable year-over-year periods.

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

Altria reports its financial results in accordance with generally accepted accounting principles.

Today's call may contain various operating results on both a reported and on an 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 pleasure to introduce Mike Szymanczyk, Chairman and Chief Executive Officer of Altria.

Thank you, Cliff, and good morning, everyone.

In a year which I think can only be characterized as challenging, Altria and its operating companies continued to deliver excellent results in the third quarter.

Altria reported solid adjusted earnings per share growth of 4.3%.

Our cigarette segment delivered solid financial results, growing its adjusted operating company's income by 2.1%.

Marlboro continued to show strong underlying dynamics, growing its retail share both sequentially and on a year-over-year basis.

Our smokeless product segment's premium retail share remains stable versus the second quarter of this year, positioning Copenhagen and Skoal for future growth with equity building programs and new products such as Copenhagen Wintergreen.

And finally, adjusted operating company's income for the cigar segment increased 6.5% behind the strength of Black & Mild.

The four strong premium brands of Altria's tobacco operating companies performed very well in an environment characterized by high unemployment and low consumer confidence.

Marlboro continued to display strong fundamentals and return to retail share growth on the third quarter.

Marlboro's retail share for the third quarter of 2009 was 41.9%, an increase of 0.7 of a share point from the second quarter of 2009 as the brand responded well after the initial period of dislocation caused by the federal excise tax increase and by differing market pricing around the event.

Marlboro was the only leading premium brand to grow third quarter cigarette retail share as measured by IRI Capstone, either sequentially or on a comparable year-over-year basis.

We are particularly pleased with Marlboro's balanced retail share growth between menthol and non-menthol from the second quarter to the third, as the brand grew its non-menthol retail share by 0.4 of a share point and its menthol retail share by 0.3 of a share point.

The successful introduction of Marlboro Blend 54 was an important contributor to Marlboro's strong menthol share growth.

Marlboro achieved these retail share results in the third quarter while expanding its margins on a per pack basis both sequentially and on a comparable year-over-year basis.

We are similarly pleased with the results of Copenhagen and Skoal in the marketplace as premium retail share of the smokeless products category, which we now define as MST and spit-less tobacco products, remain the same as the second quarter of 2009.

If we had continued reporting retail share against only the MST category, USSTC's third quarter premium retail share would also have been unchanged versus the second quarter of 2009.

We are particularly pleased with Copenhagen's retail share performance.

Copenhagen grew its retail share of the smokeless category by 0.3 of a share point from the second quarter of 2009 to the third quarter, and its September monthly retail share was 0.8 of a share point higher than its retail share in April, the month immediately following the list price reduction.

We expect the launch of Copenhagen Wintergreen Longcut in the fourth quarter of this year to continue enhancing Copenhagen's ability grow retail share of the smokeless category.

Skoal has also responded well to the actions enhancing its value equation.

Since July, Skoal has demonstrated retail share stability with a consistent monthly market share of approximately 23.6%.

USSTC has a number of initiatives planned for Skoal that should continue strengthening its position in the smokeless category in 2010.

Black & Mild continued it's impressive performance, growing its third quarter retail share of the machine-made large cigar category by 0.7 of a share point versus the year-ago period to 30.9%.

Share growth was driven by a recent successful launch of Black & Mild Wood Tip and Black & Mild Wood Tip Wine, as well as the equity building campaign, Enjoy Black & Mild.

Black & Mild's growth within the machine-made large cigar category should be further enhanced by expanding its portfolio of products into new segments, such as Untipped Cigarillos.

While the retail share performance of our tobacco company's leading premium brands in this environment is impressive, shipment volumes of our tobacco operating companies are noticeably lower, principally as a result of two factors.

The first factor was the large federal excise tax increase on tobacco products that took effect on April 1.

PM USA estimates that adjusted cigarette industry volumes declined 10% in the third quarter of 2009 versus the same year-ago period, at about 8% on a year-to-date basis, which we view as a decline rate in line with historical price elasticity.

In the smokeless category, USSTC and PM USA estimate that the long-term category growth rate remains stable at 7%.

Middleton estimates that the machine made large cigar category's long-term growth rate also remained relatively stable, at about 3%, though the category growth rate has slowed after the federal excise tax increase on cigars.

The second factor was a decline in trade inventories across all of our tobacco businesses.

In the third quarter of 2008, the trade increased cigarette inventories, while in the third quarter of this year the trade substantially reduced them.

PM USA estimates that trade inventory levels on its cigarettes were reduced by an estimated 20% at the end of the third quarter of 2009 versus the end of the third quarter of last year.

In addition to not replicating the inventory build that occurred in the third quarter of 2008, P M USA believes the trade also reduced inventories due to ongoing cigarette category volume declines as well as higher costs associated with maintaining cigarette inventories.

USSTC's actions positioning the Company for future volume and share growth contributed to trade inventory reductions on its smokeless products at the end of the third quarter versus the comparable year-ago period.

Earlier this year, the Company eliminated value pack promotions, and in the third quarter USSTC changed the shipping unit from 10 cans to five can logs for a number of Copenhagen and Skoal's packings.

This shipping unit change should allow USSTC to increase distribution of its products while improving product freshness, but caused a reduction in trade inventories.

Middleton estimates the trade inventories on its cigars were also significantly lower at the end of the third quarter 2009 versus the end of the third quarter of 2008.

This decline can be largely attributed to the integration earlier this year of Middleton into the Altria sales and distribution system, which reduced wholesale delivery lead times.

Although the federal excise tax increase and trade inventory reductions have had an impact on the reported shipments for our tobacco businesses, we are pleased that these businesses continue to report solid income performance.

On a year-to-date basis, the adjusted operating company's income growth for the cigarette segment was a strong 6.4% and the cigar segment delivered solid adjusted operating company's income growth of 4.3%.

Additionally, the smokeless product segment contributed $495 million in adjusted operating company's income.

Altria's cost reduction programs are a key contributor to this strong income performance.

And they remain on schedule.

In the third quarter of 2009, $76 million in cost savings were achieved across the Altria family of companies.

We have now achieved $881 million of savings against the plan of $1.5 billion cost reduction program off the 2006 cost base, and are confident that we will complete the program by 2011.

We remain very pleased with the 2009 performance of Altria and the top rated companies.

The four premium brands of Altria's tobacco operating companies continue to display great strength in a challenging operating environment.

The cost savings programs across the Altria family of companies continued to create shareholder value.

Adjusted earnings per share continue to grow.

And the Company continues to maintain its focus on returning cash to shareholders in the form of dividends, as evidenced by the third quarter dividend increase of 6.3% to an annualized rate of $1.36 per common share, which reflects the underlying financial strength of our business.

Given Altria's strong year-to-date performance, we are narrowing our guidance range.

We expect full-year adjusted diluted earnings per share from continuing operations in the range of $1.74 to $1.77, representing a growth rate of 5% to 7% from an adjusted base of $1.65 per share in 2008.

Now I would like to turn the call over to Dave Beran, Altria's Executive Vice President and CFO, who will discuss Altria's business segment results

Thank you, Mike.

Let me begin with the cigarette segment.

Marlboro had good retail share performance in the third quarter, and it has also performed well on a year-to-date basis.

Marlboro has grown 0.1 of a share point to 41.9% through the first nine months of this year versus the same year-ago period.

Careful management of the price gap as well as Marlboro's strong brand equity has enabled the brand to continue growing share while also supporting strong income growth for the cigarette segment.

Marlboro's price gap versus the lowest effective priced cigarette continued to close after the initial dislocation caused by the federal excise tax increase to the mid 30% range for the third quarter of 2009.

The cigarette segment continued delivering solid adjusted operating company's income growth.

Reported operating company's income for the cigarette segment decreased 2.6% in the third quarter of 2009 versus the prior year period, to $1.3 billion due primarily to lower volumes as well as restructuring charges related primarily to the Cabarrus facility closure, partially offset by list price increases and cost savings.

Excluding the restructuring charges, the cigarette segment's adjusted operating company's income in the third quarter of 2009 increased 2.1% to $1.4 billion.

PM USA's cigarette shipment volumes were down 16.4% in the third quarter but are estimated to be down about 12% when adjusted for changes in trade inventories.

PM USA estimates that its cigarettes shipments were down an estimated 10% on a year-to-date basis when adjusted for changes in trade inventories and calendar differences.

Marlboro's cigarette shipment volume was down 15% in the third quarter of 2009, but was estimated to be down about 10% when adjusted for trade inventory changes which disproportionately impacted the brand.

As Mike previously mentioned, overall 2009 cigarette industry volumes have performed in line with historical price elasticity.

When comparing PM USA's shipment decline to the overall cigarette industry decline rates, the difference can be attributed to higher trade inventory declines on PM USA's products versus competitive offerings, as well as PM USA's pricing strategy on portfolio brands which led to share and volume declines but higher operating company's income.

We are very pleased with PM USA's third quarter and year-to-date cigarette business results.

Profitability growth is strong, and Marlboro continues to perform well.

The UST integration is proceeding very well and is substantially complete.

USSTC has moved its headquarters to Richmond, Virginia.

Virtually all the planned employee separations have occurred, and we are on track to realize the previously announced $300 million in integration cost savings by 2011.

Importantly, Copenhagen's and Skoal's combined retail share of the smokeless segment was unchanged from the second quarter of 2009 to the third quarter, positioning USSTC to begin moderately growing premium retail share.

Reported operating company's income for the smokeless product segment was $127 million in the third quarter.

When adjusted for exit integration and acquisition related charges, third quarter operating company's income for the smokeless product segments was $156 million.

USSTC's and PM USA's combined domestic smokeless volume decreased 4.5% in the third quarter versus the prior year period.

When adjusted for changes in trade inventories, the timing of returns from retail, the discontinuation of multipack deals and the discontinuation of its Rooster brand, we estimate that the smokeless tobacco shipments were essentially flat versus the third quarter of 2008.

As Mike previously highlighted, Black & Mild had another strong quarter of retail share growth in the machine-made large cigar category.

This quarter is the latest in an impressive retail share performance since Altria acquired Middleton at the end of 2007.

From the first quarter of 2008, Black & Mild's retail share has grown an impressive 3.9 share points to 30.9%, and has increased its retail share of the tipped cigarillo segments from 79.8% to 83.1%.

Operating company's income performance for cigars was strong in the third quarter.

Reported operating company's income for cigars increased 32.4% versus the prior-year period.

Excluding integration cost, adjusted operating company's income for cigars increased 6.5% versus the year-ago period to $49 million.

Middleton's third quarter cigar shipment volume increased 3.9% from the prior-year period and on a year-to-date basis, Middleton's cigar shipment volume was down 3.9%.

Volume results for both periods were estimated to be relatively stable when adjusted for changes in trade inventories and Middleton's migration to the Altria sales and distribution system as well as the timing of promotional shipments.

Now I would like to discuss our wine business.

US wine business continues to be impacted by the economic environment which has caused adult consumer down trading to less expensive wines and declines in on-premise sales.

Despite these challenges Ste.

Michelle is performing well at retail with its high quality and affordable wines.

Ste.

Michelle's third quarter retail volume as measured by the Nielsen Total Wine Database for US Food and Drug increased 9% compared to an overall industry increase of 2%.

Ste.

Michelle's third quarter wine shipments were up 2% versus a year-ago period to 1.5 million cases.

Reported third quarter operating company's income for the wine segment was $12 million, but when adjusted for acquisition related charges of $7 million, third quarter operating company's income was $19 million.

Let me conclude with financial services.

Reported operating companies' in the third quarter of 2009 increased $64 million due to higher gains on asset sales as well as a 2008 increase in the allowance for losses.

The allowance for losses at the end of the third quarter of 2009 was $266 million, which reflect a decrease of $49 million from the second quarter of 2009, due to the write-off of a lease related to Motors Liquidation Company, formerly known as General Motors Corporation.

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

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

Marlboro's net pack price was $5.29 in the third quarter, and the lowest effective price cigarette pack was $3.91.

The cigarette discount category third quarter retail share was 27.4%.

The estimated weighted average cigarette state excise tax at the end of the third quarter was $1.24 per pack.

Through October 1, 13 states, the District of Columbia, and Puerto Rico have increased their cigarette excise taxes in 2009 with an average increase of $0.54 per pack in those 13 states and DC.

Our third quarter master settlement agreement and quota buyout accruals were $1.2 billion or $0.67 per pack.

Of the $0.67, the MSA represents $0.61 per pack, and the quota buyout represents $0.06 per pack.

The FDA user fee payments for cigarettes through September 30 were $11 million or $0.01 per pack.

Copenhagen's national retail price in the third quarter was $4.21, and its net price gap versus the leading discount brand was 51% in the third quarter.

In the third quarter, capital expenditures were $60 million, and ongoing depreciation and amortization was $71 million.

The third quarter tax rate included a benefit from the reversal of tax reserves following the resolution of certain Kraft matters related to 2000 to 2003 IRS audit.

This benefit was offset by a reduction in a corresponding receivable from Kraft that arose in connection with potential tax liabilities, for which Kraft was responsible under a tax sharing agreement executed as part of the 2007 spin-off transaction.

As a result, there was no impact on Altria's net earnings.

And we anticipate their 2009 full-year effective tax rate on operations will be approximately 36.6%.

Our reported tax rate for the third quarter is 28.5% due primarily to lower state taxes and, as previously mentioned, the reversal of tax reserves related to Kraft are no longer required.

Operator, do we have any questions?

Thank you.

(Operator Instructions).

Our first question comes from Judy Hong with Goldman Sachs.

Good morning.

Good morning, Judy.

Mike, I guess first I wanted to get a better understanding of just the inventory movement situation here as it relates to the impact on your business versus the industry as a whole.

What is the difference between how much you're impacted versus the industry generally and why is there a difference, if there is a meaningful difference?

Are the trade is just trying to carry lower levels of your inventory, or is this a catch-up to have all of the products at the -- at more equalized levels?

Well, there's a couple of different factors here to consider in the third quarter.

Inventory is kind of a complex item in the third quarter.

You have to go back to 2008.

What you see in 2008, third quarter, about the middle of August, wholesale trade began building inventory.

It is not uncommon for inventory changes to be skewed toward Marlboro simply because it sells through faster.

So if inventory builds take place they often start earlier on Marlboro because inventory depletions happen faster on Marlboro simply because of size.

So there is a difference relative to that brand versus our other brands and I believe versus other competitive brands.

But that's the first thing.

So you have a base that had inventory inflation in it last year.

This year, you have a base that is reduced due to the federal excise tax increase.

Trade decreased its inventory following the excise tax increase, and they have maintained that reduction, and you didn't have a corresponding inventory build at wholesale a year -- versus the situation you had a year ago.

So you have a doubling situation.

You have the impact of the volume decline related to the excise tax, and you have the impact in the base of an inventory build a year ago that did not occur this year.

The best example I can give you is if you take Marlboro in the third quarter, and you adjust its volume for the inventory changes, the inventory change at wholesale versus a year ago, and then you adjust it for its market share improvement, and then you apply historical price elasticity to it, you will come out with a volume level that is almost identical to the volume level that it achieved in the third quarter.

So when we look at the Marlboro brand it is tracking just exactly the way it should track from a shipment point of view once you modify the shipment numbers based on these inventory changes that have nothing to do with the brand's ongoing performance.

It's also a bit encouraging to see that because it also indicates that we haven't had any fundamental change in counterfeit activity, at least to this point that has influenced the volume of the brand.

So it's kind of complex.

It traces back to year-ago activities, inventory last year.

The build in wholesale began in the middle of August.

It continued all the way through the middle of December a year ago.

So there are base issues when you start to make comparisons, and so I wouldn't get too exercised about the volume, actual volume versus a year ago, because it is influenced heavily by what happened a year ago relative to inventories.

Okay.

So just to be clear from a base perspective, you probably have up until December of last year that you have to lap over.

And then as far as the inventory movement post the FET-driven increases, are we now at sort of the tail end of what we're seeing from that perspective?

Relative to trade inventory adjustments that we would attribute to the volume decline and the business based on price elasticity, we saw that step down at wholesale, and that seems to be reasonably stable.

However, wholesale inventories do move around from quarter to quarter so you can't look at that as a constant just as I described the situation a year ago.

Wholesalers make other decisions about their inventory that are not just based on outflow.

So you have to keep that in mind.

But we would say that the wholesale adjustment related to the federal excise tax appears to have occurred and appears to now have stabilized to the best we're able to figure that out.

Retail, I think there's still some movement.

I wouldn't call it decline, I just think there's movement at retail as retailers settle in on a different volume structure and how they're going to allocate space in their stores relative to that volume structure.

But I wouldn't say that there's some meaningful trend there that's going on right now.

then just in terms of the menthol segment, Mike, you had the new line extension that sounds like you're promoting in the quarter.

Just get a sense of what you're seeing there both from a competitive perspective and as the menthol segment as a whole.

We're talking about Blend 54?

Yes.

Is that what you're talking about?

Yes.

It seems to be off to a good start.

It's grown some market share.

We did an initial promotion on it.

Now it's kind of fallen into kind of a normal promotion situation for us, and it is adding some share to our overall menthol business, which continues to grow.

Okay.

And then Dave, if I can just ask a question about this tax benefit and the Kraft receivable issue, here.

It sounds like it's just basically a one quarter issue.

First of all, is that correct?

Secondly, can you quantify the impact both at the corporate expense line as well as at the tax rate line so that we have a better understanding of what the underlying corporate expense is for your businesses, and then as it relates to tax rate?

Yes, it increased our corporate expense by $88 million, and decreased our tax by $88 million.

So it was a zero total impact for the Company.

So zero impact for the Company in the third quarter.

There were just line item differences between corporate expense and tax.

So it had zero impact on the Company for the third quarter and for the year to date.

Okay.

Thank you.

Your next question comes from Chris Growe of Stifel Nicolaus.

Hi, Chris.

Good morning, guys.

I just had two questions for you.

The first one is if you could -- and I don't think I heard this yet from you, Mike, but if you could talk about the promotional levels in 3Q versus 2Q.

I guess for your business maybe you could talk about the overall category.

It looks like it got a lot better maybe evidenced by price gaps.

But I was just curious if you could add a little more clarity to that.

Our margin grew.

So that's always a good thing.

And I wouldn't characterize anything in the third quarter as being acceptable.

It continues to be a very competitive marketplace.

We do have some competitors focused on growing discount brands, but we are focused on maintaining some modest share momentum on Marlboro while maximizing our income.

I think it's worthwhile to point out, we lost a little bit of overall share, but I think it's useful to understand that what's basically happened, these are on our brand portfolio that we don't invest in heavily.

And it's stepped down in the third quarter, or in the second quarter, after the federal excise tax increase, and then it stabilized.

So what we're seeing now is actually a pretty stable group of very profitable brands on that side of the business, but did it take a notch down after the federal excise tax increase.

But it hasn't changed trend there, It just simply took a step down.

That was my other question.

All in all, it's a competitive market.

The cigarette business is always a competitive business because it's a declining business.

So I don't expect that to change.

But I didn't see anything in the third quarter that was, I guess, outside of what we should expect in terms of competition.

Okay.

And then if I could ask a question on -- there was a comment about accretion from UST in 2010.

If I might, just back of the envelope calculations, it does suggest a pretty meaningful increase in profitability.

I guess I want to be clear on what you're assuming for volumes or share.

Or is it more about the cost savings that is driving to you make that assumption?

Well, I've said this before, and I'll repeat it again.

This is -- 2009 is a year of transition for the Company.

So we've restructured the whole Company.

We bought UST.

We've restructured that entire business enterprise as a part of a larger restructuring at Altria.

I wouldn't try to read anything in quarter-to-quarter movements in that business at this point in time.

We have absorbed all of the smokeless costs now together into one smokeless unit.

We have smokeless costs over in the PM USA business, so that's been absorbed over on the smokeless side.

I just wouldn't try to draw any conclusions at this point.

The cost line on that business is progressing the way we expected it to progress.

And we're achieving the savings we expected to achieve.

Share stability has been achieved in that business.

A little share growth on the Copenhagen side, based on just the pricing activity that we put in place that we said we would put in place at the beginning.

And we've begun the equity building process that will make these brands grow.

We've announced a major initiative that will start to ship in a couple of weeks.

And so all of that is on track, and I just wouldn't try and read trends there.

We'll read trends next year.

It was a close call as to whether or not it would be accretive this year or next year, all along the way.

And based on some decisions we made, we decided to go ahead and do some things this year that absorb costs and get them behind us, be done with them so that pushes accretion into 2010.

But we expected that to occur in 2010.

So that business is on track.

I know that if you're trying to read it as an ongoing business right now, it's hard, but we're restructuring all of this and that's working fine.

It's happening the way it is supposed to happen.

So I think we feel pretty good about it.

Fair point.

Just to follow up would be, in relation to Judy's question about menthol, what was your Marlboro menthol share?

How did it perform in the quarter?

And then how was your overall menthol share in the quarter?

I can't tell what you our overall menthol share was.

Our menthol share for Marlboro was up, and I think I mentioned that.

I think it was up 0.3 quarter over quarter.

Quarter versus a year ago.

But your overall share, you don't have that figure, you're saying?

For overall menthol share for the whole Company?

Yes.

I don't have that off the top of my head.

Okay.

Thank you.

Your next question comes from Erik Bloomquist of JPMorgan.

Hi.

Good morning.

Good morning.

I was wondering if you could talk a little bit more about Copenhagen and Skoal.

I mean, take the point that this is a transition year, but you're just preparing then to launch this first new major initiative in Copenhagen with the long-cut Wintergreen.

How does that -- can you talk about how you're thinking about the evolution then of Skoal as well?

Because that struck me as a brand that perhaps was more suited to that kind of innovation.

Should we expect line extensions or innovation in Skoal next year as well as you start to work toward maintaining share in both these brands with the long-term category growth rate to about 7%?

Thank you.

Yes, we have actually some initiatives for Skoal that are planned.

We haven't announced them yet because we're not quite ready to do that.

But I would point out to you that relative to Copenhagen Wintergreen, about 40% of the MST segment is Wintergreen.

It's a growing segment.

Copenhagen has no business in the Wintergreen segment.

So it's a very appropriate expansion for Copenhagen.

It should participate in that segment, and we believe we have an excellent product to put forth to the consumer, and we believe it's going to stimulate growth on Copenhagen and create a lot of interest for the brand among adult MST users.

But we also have some interesting initiatives for Skoal, and so we'll kind of play all that out as we get into 2010.

We like to focus efforts, make sure that we make the most of them.

And so we'll take advantage of that brand a little further into the year.

Thank you.

And then secondly, just a quick question on the FDA tobacco products scientific committee.

Should we still be expecting that report around this time next year, or is that still further delayed?

I think it's still around this time next year, if I remember right.

August, I think, next year if I remember right.

Frankly, I'm not aware of the changing on timing of that.

There have been some push-backs where FDA has moved back the date for some submissions, but not long periods of time, 30 days, those kind of things.

I am not aware of one related to menthol at this point in time.

Great, thank you.

Your next question comes from David Adelman of Morgan Stanley.

Good morning.

Mike, can you explain how you're going generate a double-digit return on UST?

You'll have spent, with the restructuring cost, about $13 billion.

You need about $1.9 billion then in smokeless tobacco operating income.

Year-to-date it's about $500 million.

And I know there's a lot of transitional costs, but, big picture, how do you get there and how long do you think it's going to take?

Well, the answer to your question is yes, I can explain it.

And the answer to your question is also that yes, we have an estimated timeline on that.

But it's also that we're not going to disclose that because it gets into some pretty sensitive strategic information and would be forward looking.

But I appreciate your question.

You should understand we are very aware of those things, and they're important to us.

Can you quantify how much your promotional spending went up on premium brands from the second quarter to the third quarter?

In the second quarter to the third quarter?

In other words, did you additional --

You mean first quarter to the second quarter?

Going into the second quarter, you reduced wholesale prices.

Then my understanding is in about 13 or 14 states during the third quarter you increased your promotional spending levels -- incrementally.

Okay.

You're talking about relative to MST.

Right.

I'll tell you, there were several movements in the third quarter.

One of them was, and I explained this in our last earnings call that we moved our list price down, and we moved it down a particular amount.

We didn't want to go too deep with it.

We wanted to set it at a level where then we could go into particular spots where we knew there would be a necessity for a bit more in order to get the gaps the way we wanted them.

And that we would do that in the third quarter once we were able to see what the impact was of the reduction that we took in the second quarter.

So, yes, we did do that in the third quarter, and that is reflected in the business.

There are a number of other items that are reflected in the cost line of that business in the third quarter.

But as I mentioned a little bit earlier, I wouldn't get too caught up in that, because we're doing a number of things this year to structure that business and set it up the way we want it to be, so we can go forward and grow it next year.

Okay.

Lastly, do you have any early read about that tact, the regulatory tact that the FDA is likely to take?

And if not, when do you think you will be able to form a view about the potential range of outcomes of -- particularly as it relates to sort of the product and product standards and how involved the FDA may get in mandating changes?

Well, what I would say is, it's very early.

They're building their organization.

There is some communication that's going on.

It's constructive communication.

But I think it's too early to have a read on the approach that the FDA is going to take, how they're going to interpret certain areas of the legislation.

They don't have all their staffing in place, and I don't think really formulated those things yet to the degree that those questions could be answered.

So it's going to take some time.

It's going to continue to move on into 2010.

I think all along we've said it would probably take a few years actually for the FDA to really get fully up to speed and get their regulations written following legislation being passed.

So it's pretty early in the game right now, and I think they're moving rapidly.

They have a leader in place, and so -- and there is communication, but it's pretty early to expect that they would be operating at a level that would answer those kinds of questions.

Okay.

Thank you.

Your next question comes from Thilo Wrede of Credit Suisse.

Good morning gentlemen.

Good morning.

Mike, you mentioned at then of end of the second that the UST acquisition still may be accretive this year.

Now that's not the case anymore.

What has changed since then, given that you just told us that the cost line for UST is progressing as expected, savings are as expected?

What's the big difference?

Three more months passed, and we made some decisions relative to how we were going to implement certain things related to that business.

And we hadn't made those decisions yet at the point in time that we reported at the end of the second quarter, and now we've made them.

So that's why we're saying, well, it's going to push that into 2010.

Okay.

And then on the cigarette side, relative to the second quarter, the average price gap declined.

What was the driver for that?

Was it an increase in the discount prices?

Reduction of the premium prices?

What's behind that?

I'm not sure I understand that question.

Say that again.

So the average price gap in cigarettes in the second quarter was 42%, I think, and I think David just told us a minute ago that it's now in the mid 30% range.

What's the driver in that reduction of the price gap?

Is it that the bottom end of the prices have come up or has the top end come down?

Well, that's the gap for the quarter.

So if you think about the third quarter, what was happening in the third quarter, you recall there was quite a bit of price dislocation as people moved around their prices.

Some took the FET earlier, some took it later, some spent into the FET.

So the average gap for the quarter was higher, but by the end of the quarter, by the end of the second quarter, it was pretty close to where it is now, okay.

So remember, those are average -- these are average gaps we're looking at quarter to quarter.

And in the second quarter, you had the movement as people adjusted their prices.

So that gap started up in the 40s, it went up to the 50s, and then it came back down.

So is the mid-30% range the new target range for you?

And does that mean as Pall Mall is going through another cycle of their fall promotions that you'll maintain that 35% gap this quarter?

Well, that's where it is right now.

The competitive marketplace kind of tells you where you can be.

We've seen times where you can expand the gap some, and we've seen times where you can't.

Some of that is dependent upon economic conditions an unemployment, and some of it is dependent upon competitive activity.

So we kind of monitor that.

I would also say today, it's a much more complex model than simply looking at it on a national basis.

We look at it state by state.

So we're talking about generalities here.

But we are moving that all the time.

And we're moving it in various locations, based on what that business trends are and what the opportunities are, because remember, our goal is to maximize income in the cigarette business.

So we do that -- part of the way we do that is the way we manage the gap.

Okay.

In other words, 35% is not the new target?

Well, 35% is about where it is right now.

I haven't described a new target.

Alright.

And then just one quick question for Dave.

Did you buy back any debt during the quarter already?

In the third quarter -- no, I think we extinguished some debt in the second quarter.

Okay, thank you.

Your next question comes from Ann Gurkin with Davenport.

Good morning.

Hi, Ann.

Wondering if you would comment at all on market response to the changes in pricing on MST, and do you anticipate making any other price changes in these select markets?

Well, I'm not going to comment on future pricing activity.

What I would say is that the market has kind of settled out.

There's been some pricing changes in states relative to tax changes that we've seen.

The gap has kind of gotten down to the lower end of the 50s range, and we have some variability in states, and so we've addressed some of that variability by state to get those in line.

I can't tell that you there's any particular trend that's developed beyond that.

That's what's going on.

Okay.

Then if you look long term, would you comment on how you would define solid OCI performance for the cigarette business on a long-term basis?

No, that would be a projection.

Okay, thank you.

Your next question comes from Christine Farkas of Banc of America.

Thank you very much.

Good morning.

Hi Christine.

A couple of quick questions if I could, Mike.

Firstly, just to confirm, were there any shipments ahead of fourth quarter launch of the Copenhagen Wintergreen long-cut in the third quarter?

No, we have not shipped any Copenhagen Wintergreen at this point.

Okay, great.

And then secondly, just to follow up on cigarette inventory levels.

Just by nature of the trade taking down inventories given lower volumes and higher costs, won't we have this adjustment, or this year-over-year adjustment, carry through right to the first quarter or even second quarter of 2010?

Well, again, there two are different factors, okay.

One factor, which is the elasticity factor on the whole industry, which will -- I think, has flowed through to wholesale inventories and retail inventories.

And I would say that that's probably going to be sustained that way.

Then the other factor is, a year ago inventory build at wholesale, which we saw begin about the middle of August and continue all the way through about the middle of December.

That did not occur in the third quarter of this year.

I cannot tell you what will occur in the fourth quarter.

Okay.

Because I don't know.

Right.

Okay.

I think I'm just thinking of it in one bucket when really there's two, the elasticity and then the year-over-year build.

My next question has to do with the cigarette leverage or the margin improvement in cigarettes in the third quarter.

Given your decline in volumes, certainly there were cost savings, strong pricing.

Was there anything else in the quarter, timing-wise, on SG&A or something else that might have been shifted out of one quarter into another?

No, I don't think so, nothing of significance.

Okay.

And final question, Dave.

Just to confirm, it looks like your underlying tax rate was 34%.

Is that right?

No, as I said in our remarks, underlying tax rate is expected to be 36.6%.

For the year.

For the year.

And in the third quarter, was it 34%?

Just looking at your schedule, that's what I gather, but I just want to confirm I'm doing that right.

Yes, that's about right.

Okay, terrific, that's it for me.

Thank you.

Your next question comes from Adam Spielman of Citigroup.

Hi.

I think most of my questions have been answered.

But there are a couple of detailed ones.

You mentioned a couple of times that the way you're defining smokeless has changed slightly.

And you said also that there were some costs that were previously in PM USA that have now moved to the smokeless category.

I was just wondering whether you could quantify how much cost in dollar terms have moved.

What we basically did was we moved anything associated with Marlboro Snus or Marlboro MST into our smokeless cost base because it is all smokeless.

That's what we meant.

But It's not a huge amount, it's a nominal amount.

But we've done that for the year.

So that's the way to think about it.

And the second question is, is it fair to say now that all the dislocations that were caused by the April 1 tax increase are basically through the system, and that looking forward where -- what is the state, if you like?

Well, yes, I think the dislocation related to the change in tax rate has occurred, is behind us.

And I would say that the historical price elasticity curve showed up the way we would have expected it to show up.

I think the industry is kind of returning to what will be its base level.

I don't know that we'll see much more movement than that in the fourth quarter.

Perhaps a little bit.

It would more likely than not be up rather than down at this point.

But it seems to be pretty stable now.

Now it's just a function of competitive activity that occurs episodically in the marketplace.

Thank you very much.

Your next question comes from Nik Modi of UBS.

Hi Nik.

Hi guys.

Good morning.

One quick question.

With Reynolds likely to go back on pulse promotion on Pall Mall in the fourth quarter, just wanted to get your perspective on how you're thinking about the promotional strategies, obviously without giving too much detail, just how philosophically you're thinking about extending your positions in the fourth quarter.

Thanks.

Well, that's not a question I would typically answer.

We'll compete.

That's what we always do.

But I don't think beyond that there's much I can add.

I guess the question that I'm trying to get around is, with Pall Mall obviously having an impact on Marlboro and with your focus on L&M coming back to the fore, do you think of using L&M as more of a fighter brand within your portfolio as you've started to focus on just Marlboro and maybe one discount brand versus looking at Parliament, Basic and the rest?

Any thoughts on L&M specifically?

Well, we have -- we have a strategy for how we use L&M.

It's not a primary focus for us.

Our primary focus is the Marlboro brand, and that's where we'll continue to focus our effort.

But relative to some differences between where Basic has a nice franchise and where it doesn't, we have some activity with L&M.

And we have some activity planned with a product called L&M Bold, which is a full flavor menthol product where we're underdeveloped in the full flavor menthol arena.

So that's really how we've focused on L&M, but it's not our primary strategy.

Our primary strategy is Marlboro.

Mike, last question.

When it comes to the sales force, clearly you have -- your current sales force selling all three different categories with cigar, smokeless and cigarettes.

How long do you think it's going too take for that group to really get up to the learning curve across all of the categories?

Well, I think they're doing a great job.

They're picking all that up.

They have a lot of work to do because we're -- and have launched some new programs relative to these new categories, so those have to be sold in.

We have [fixturing] activity before us that they'll be dealing with, so they have a lot of activity.

They're launching Copenhagen Wintergreen right now and doing a terrific job with that.

So I wouldn't suggest to you that they're not up to speed.

I would just say, hey, we have lots of initiatives for them, and they seem to be knocking them off in extraordinarily high-quality fashion.

So I'm very pleased with what our sales organization is doing.

We're still making some adjustments in that organization relative to the addition of these two businesses to get it deployed properly.

So that's some movement that eventually will be finished, but we're still doing it.

That's a little bit disruptive.

But otherwise they're really doing very well.

Great, thanks for taking my questions.

Thank you.

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

Cliff Fleet for closing comments.

Thank you for joining our call today.

If you have have any follow-up questions, please feel free to give us a call at Altria's Investor Relations.

Thank you.

Thank you ladies and gentlemen.This does conclude today's Altria Group's third quarter 2009 earnings conference call.

You may now disconnect.