奧馳亞 (MO) 2012 Q2 法說會逐字稿

Good day, and welcome to the Altria Group 2012 second-quarter earnings conference call.

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

(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 now like to turn the call over to Mr. Brendan McCormick, Vice President, Investor Relations for Altria Client Services.

Please go ahead, sir.

Good morning.

Thank you for joining our call.

I am joined this morning by Marty Barrington, Altria's Chairman and Chief Executive Officer; and Howard Willard, Altria's Chief Financial Officer.

This morning, we will only be discussing Altria's 2012 business results for the second quarter and first six months, and will not be discussing the status of tobacco litigation.

Our remarks contain forward-looking and cautionary statements and projections of future results.

And I direct your attention to the forward-looking and cautionary statements section at the end of our earnings release for the review of the various factors that could cause actual results to differ materially from projections.

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

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

Today's call will 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 and reconciliations are included in today's earnings press release and are available on our website.

In addition, comparisons discussed on this conference call are to the same prior-year period unless otherwise stated.

Now it gives me great pleasure to introduce Marty Barrington.

Thank you Brandon.

Good morning.

Altria delivered excellent financial results for the second quarter and first six months, reflecting the strength of our diverse business model.

Altria grew its adjusted diluted EPS by 9.3% for the second quarter and 10.2% for the first six months of 2012, while its tobacco companies pursued initiatives to grow their premium brands for the long-term.

These brand-building activities contributed to adjusted operating companies' income, and margin growth in both smokeable and smokeless product segments.

Exceptionally strong gains from our investment in SAB Miller and our Financial Services business complemented these results.

Innovation continues to contribute to the strong business results of our tobacco companies.

Products introduced in recent years have enhanced their product portfolios, supported adjusted operating companies' income growth, and contributed to retail share gains in cigarettes, cigars, and smokeless tobacco for the second quarter and first half of 2012.

Our companies continue to make progress on product development in the second quarter with activities related to Marlboro 83's, Copenhagen Southern Blend, and Black & Mild Summer Blend.

In June, Altria's subsidiary, NuMark, introduced Verve discs into a lead market to begin to understand adult tobacco consumer acceptance of this product.

In the smokable product segment, strong retail share performances benefited cigarette and cigar shipment volumes.

Phillip Morris USA continued to invest behind Marlboro's new brand architecture, with second-quarter activities across its four brand families, Red, Gold, Green, and Black.

In April, our sales force began updating retail pictures to reflect the new Marlboro architecture and highlight the four brand families.

In June, PM USA introduced Marlboro 83's box in modern updated packaging, and PM USA continued to support Marlboro Green and Marlboro Black with promotional offers intended to generate trial by adult competitive smokers.

These activities contributed to Marlboro's strong second-quarter retail share performance.

Marlboro's second-quarter retail share increased 3/10 of a share point to 42.9%.

Marlboro has a pipeline of brand-building programs planned for the rest of 2012 and into 2013 across its brand families.

Marlboro's retail share growth in the second quarter was complemented by gains for PM USA in the discount segment, where L&M has regained some of the retail share lost by Basic, as that brand has increased its price and margins.

Black & Mild delivered strong retail share gains in the second quarter behind the growth of untipped cigarillos introduced in 2011.

The brand also benefited from a new seasonal offering, Black & Mild Summer Blend, which Middleton introduced during the second quarter.

The smokeless product segment delivered strong adjusted operating companies' income growth for the second quarter and first half of 2012.

In the smokeless product segment, USSTC aims to maximize the combined performance of Copenhagen and Skoal.

These brands grew their combined retail share and volume for both periods.

Copenhagen drove this growth, as products introduced in recent years continued to gain share.

In May, USSTC expanded distribution of Copenhagen Southern Blend into select geographies.

Copenhagen Southern blend delivers a mellow taste in a manageable longcut form.

Skoal's retail share decreased for the second quarter and first half of 2012, primarily due to share losses from SKUs delisted in the second quarter of 2011.

In the wine segment, Ste.

Michelle continued to focus on expanding distribution of its premium wines.

Wine shipment volume grew for the second quarter and first six months.

Higher shipment volume improved premium mix, and higher pricing contributed to strong adjusted operating companies' income growth for the second quarter and first half.

Finally, Altria's 2012 first-half adjusted diluted EPS results exceeded our expectations.

We're pleased with the solid first-half performance of our tobacco businesses.

Altria's results also benefited from higher equity earnings from its investment in SAB Miller and gains from asset sales at PMCC.

As a result of this strong first-half performance, Altria revised its 2012 full-year guidance for adjusted diluted EPS from a range of $2.17 to $2.23 to a range of $2.19 to $2.23.

This represents a growth rate of 7% to 9% from an adjusted diluted EPS base of $2.05 per share in 2011.

We anticipate adjusted diluted EPS growth to moderate in the second half compared to the first half of 2012, with stronger adjusted diluted EPS growth expected in the fourth quarter compared to the third.

I'll now turn things over to Howard Willard, who will discuss Altria's business results in more detail.

Thank you, Marty.

Good morning, everyone.

In the smokable products segment, second quarter and first half reported operating companies' income grew by 3.6% and 4.3%, respectively, primarily due to higher list prices, effective cost management, and lower tobacco and health judgments.

These factors were partially offset by higher promotional investments to support Marlboro's new brand architecture, unfavorable mix due to L&M's volume growth, and higher net restructuring charges related to our current cost reduction program.

2012 first-half results were also negatively impacted by lower volume.

Excluding special items identified in our earnings press release, 2012 second-quarter and first-half adjusted operating companies' income for the smokable products segment increased by 2.8% to $1.7 billion, and 3.3% to $3.1 billion, respectively.

The smokable product segment delivered strong adjusted operating companies' income margin growth for both periods.

Adjusted operating companies' income margin grew 6/10 of a percentage point to 41.4% for the second quarter, and increased 1 percentage point to 41.2% for the first half.

PM USA's reported cigarette shipments were essentially unchanged for the second quarter.

The trade built more inventory during the second quarter of 2012 versus the prior-year period, benefiting comparisons of our reported shipments.

Following PM USA's list price increase on June 18, 2012, PM USA believes the trade depleted inventories through the end of last month and into July.

Reported shipments declined 1.2% for the first six months of 2012, as trade inventory dynamics impacted results.

In the first half of 2012, the trade built less inventory versus the prior-year period, which negatively impacted the comparisons of our reported shipments.

When adjusted for trade inventory dynamics and other factors, PM USA estimates that its adjusted cigarette shipment volume was down approximately 1.5% for the second quarter and 0.5% for the first half.

These results outperformed the total cigarette category.

PM USA estimates that the total cigarette category's adjusted volume declined approximately 3% for both the second quarter and first half, which is consistent with historical price elasticity and the secular rate of decline.

PM USA increased its retail share by 8/10 of a share point to 50.1% for the second quarter, and by 6/10 of a share point to 49.7% for the first six months of 2012.

Marlboro gained 3/10 of a share point to 42.9% for the second quarter, and was up 2/10 of a share point to 42.6% for the first half.

PM USA's discount share increased 8/10 of a share point to 3.8% for the second quarter, and grew 7/10 of a share point to 3.7% for the first half, driven by L&M.

Marlboro and L&M's second quarter and first half retail share gains were partially offset by share losses on other portfolio brands.

Cigar shipment volume was up 6/10 of a percent for the second quarter, primarily due to volume growth as a result of retail share gains, mostly offset by changes in trade inventories.

For the first half, cigar shipment volume increased 7.1%, driven primarily by retail share gains, changes in trade inventories, and one additional shipping day.

Black & Mild's retail share increased 1 share point to 29.8% for the second quarter, and was up 1.3 share points to 30.3% for the first half, primarily driven by the success of its Classic, Sweets, and Wine Untipped Cigarillos.

Turning to smokeless products, reported operating companies' income for this segment increased 8.1% to $240 million for the second quarter, and 4.1% to $432 million for the first half of 2012.

Second-quarter results were driven by higher volume and pricing, partially offset by unfavorable mix, due to growth in products introduced in recent years at a lower popular price and higher promotional investments.

First-half results benefited from higher pricing, effective cost management, and lower promotional investments, partially offset by growth in products introduced in recent years at a lower popular price and higher restructuring charges related to our current cost reduction program.

When adjusted for special items, primarily related to restructuring charges, operating companies' income increased 7.1% to $240 million for the second quarter, and 7.9% to $451 million for the first half of 2012.

Reported smokeless product shipment volume increased 7.6% for the second quarter, driven by Copenhagen's strong 12.6% volume growth, as well as Skoal's 6.6% volume gain.

Shipment volume for the first half of 2012 was essentially unchanged, as volume growth on Copenhagen was offset by volume declines on the balance of the portfolio.

Last year's introduction of Skoal Extra and the delisting of certain Skoal SKUs impacted Skoal's volume comparisons.

When adjusted for changes in trade inventories and other factors, USSTC and PM USA estimate that their combined 2012 second-quarter adjusted smokeless products volume grew approximately 5%.

USSTC and PM USA also estimate that the smokeless products category grew by approximately 5% over the 12 months ending June 2012.

USSTC and PM USA's retail share of the smokeless products category increased 1/10 of a share point to 55.2% for the second quarter, and 6/10 of a share point to 55.4% for the first half of 2012.

Copenhagen and Skoal delivered strong combined retail share growth of 1.4 share points for the second quarter and 1.8 share points for the first half of 2012.

Copenhagen grew its retail share by 2.1 share points for the second quarter and 2.4 share points for the first half.

Skoal's share declined 7/10 of a share point for the second quarter and 6/10 of a share point for the first half of 2012.

Ste.

Michelle's 2012 second-quarter reported and adjusted operating companies' income both increased 15.8% to $22 million.

For the first half of 2012, reported operating companies' income grew 19.4%, and adjusted operating companies' income increased 8.8%, excluding acquisition-related costs from last year.

Ste.

Michelle's shipment volume increased 2.1% for the second quarter and 4.2% for the first half.

The Financial Services segment's reported operating companies' income increased by more than 100% for both the second quarter and first half of 2012, primarily due to PMCC's leveraged lease charge of $490 million in the second quarter of last year.

Excluding leveraged lease charges, the Financial Services segment's operating companies' income grew by 55.6% to $42 million for the second quarter, and 95.8% to $94 million for the first half of 2012, driven by higher asset sales and a $10 million reduction in the allowance for losses.

This adjustment to the allowance for losses is largely due to the reduction in net finance receivables as a result of asset sales.

As a result of the closing agreement with the IRS related to certain PMCC leveraged lease transactions, Altria recorded a one-time net earnings benefit of $68 million during the second quarter of 2012, primarily due to lower-than-estimated interest expense on tax underpayments.

In addition, Altria paid $456 million in federal income tax and related estimated interest for available cash in June, and expects to pay an estimated $50 million in state taxes and associated interest later this year related to the closing agreement.

Earlier this month, UST paid off $600 million in debt.

These notes reached maturity and had a coupon rate of 6 5/8%.

Our current cost management program remains on track, and we have recorded net pre-tax charges of $253 million over the past three quarters.

We expect to incur approximately $47 million in pre-tax restructuring charges in the balance of 2012, related to this program.

These 2012 restructuring charges are reflected in our full-year diluted EPS guidance that we updated in today's press release.

Marty and I are now happy to take your questions.

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

Marlboro's price gap versus the lowest effective priced cigarette was 36% in the second quarter.

Marlboro's net pack price in the second quarter was $5.71, while the lowest effective priced cigarette was $4.20.

The cigarette discount category's retail share was 27.1% for the second quarter.

The estimated weighted average cigarette state excise tax as of July 1, 2012 was $1.41 per pack, an increase of $0.04 per pack versus the prior year.

This reflects the June 24 excise tax increase of $1.00 per pack in Illinois, and the July 1 increase of $0.04 per pack in Rhode Island.

Copenhagen's second-quarter retail price was $4.07, and its price gap versus the leading discount brand was approximately 40% in the quarter.

CapEx was $23 million for the second quarter and $39 million for the first half of 2012.

We revised our 2012 full-year CapEx forecast from $150 million to a range of $100 million to $125 million based on current plans.

Ongoing depreciation and amortization was $57 million for the second quarter.

We estimate that 2012 full-year ongoing depreciation and amortization will be approximately $230 million.

Operator, do we have any questions?

(Operator Instructions) Investors, analysts and media representatives are now invited to participate in the question-and-answer session.

We will take questions from the investment community first.

Our first question comes from the line of Bonnie Herzog with Wells Fargo.

I had a question on L&M -- growing quite rapidly, and you had talked about in your commentary, your mix has been deteriorating.

So I guess my first question is, are you comfortable with your current mix between premium and discount brands?

And then, if not, what strategies are you putting into place to stem this?

And could you talk a little bit more about some of the promotional activity behind the brand?

Because I know that that started to step up last year.

And just kind of walk us through that again, please.

Sure.

Thanks for your question.

The answer is, we are comfortable with the mix.

Remember, Bonnie, that more than 90% of PM USA's shipment are premium, and obviously, our strategy is to focus on the premium end of the business.

That said, there is a discount segment and we want to have an offering there.

Our retailers in particular like for PM USA to have an offering there, and there's some business there.

So, that's L&M's job.

L&M really grew its share basically by picking up share that Basic had shed as it increased its price and its margins.

So, there's no shift in strategy there.

I think L&M has done a nice job; certainly helped from a volume point of view.

I don't see any need to change the strategy with L&M at all.

With respect to L&M's promotional activity, that varies a bit over time.

It is a bit different in '12 than it is in '11; but again, that depends sort of on how it's performing in the marketplace and we adjust -- as we adjust most of our promotional allowances when the moment is right to do that.

Okay.

And then my next question is just in terms of your innovation pipeline.

Could you talk about your plans for innovation, is it going to step up in the second half and possibly next year?

And then can you talk a little bit about your plans to pursue next-generation products?

Especially since my understanding is you do have some of the rights to part of Phillip Morris's technology.

Sure.

We've spoken about this previously, and I think we've pointed out that innovation is one of the ways that one grows.

And particularly, we know that in the tobacco business now that there's a group of adult tobacco smokers in particular who are looking for and are open to innovative products.

You know, innovation comes across several sort of axes, if you will.

You saw that we rolled out Marlboro 83's and we've got a new Copenhagen blend.

Black & Mild rolled out another blend.

So on the conventional side, I think we've got good pipeline of products.

We stay close to the adult tobacco consumer.

We watch what their needs are, either articulated or unarticulated.

We do a lot of consumer research there.

We try to make sure that we're offering products that they want and that, for us, are premium, of course.

We also, as you know, rolled out -- we have an exciting development with respect to a different kind of product called Verve.

And Verve is a non-combustible product.

It has nicotine in a flavor system and it's a chewable disc.

And it's really a very different kind of product.

We put that product in about 60 stores in Virginia in June.

This is part of our journey as we explore how adult tobacco consumers may migrate to products of that sort.

That, I would say, is a learning experience.

We want to get it in the hands of consumers.

We've built robust consumer research around that product.

We want to learn whether they like it; they like its shape or its taste, for example.

And I -- the way to think about this, Bonnie, I think is, innovation is really an iterative process.

It is not a great big ah hah one day that we find the next thing.

It's about putting out experiments, putting out tests, developing products, asking consumers, getting that feedback, and then continuing to develop the next generation.

With respect to your question about next-generation products, you made reference to PMI.

I think it's probably worth pointing out that, as I think everyone knows, we do have an agreement with PMI as a result of the spin-off, in which certain intellectual property is jointly owned and separated by market, and that we have agreements in place with respect to the commercialization of technologies that may come out of that.

I would also point out, though, that in addition to PMI, PM USA has robust R&D, and we were able to marry that with the really terrific R&D resources of the smokeless company we acquired.

So we're very proud of our Research and Development team.

We believe we've got lots of opportunity to innovate there.

So innovation continues to be a focus area for us.

Okay, that's very helpful.

Thank you.

Thanks for calling in.

Nik Modi, UBS.

Just a quick question on the Marlboro architecture.

You know, you talk about making further investments; can you just kind of contextualize those investments?

Is it more point-of-sale?

Is it more support behind some of the SKUs that you've been launching?

That's the first question.

And the second question is, the -- I guess the Marlboro share incentive program ended in the June quarter.

So just curious if that has created some kind of inventory bloat at retail, as lots of retailers were probably aiming to make some of their targets.

Any thoughts on that would be very helpful.

Okay.

Thanks for your questions.

Look, the way to think of Marlboro architecture is, obviously, it's the way that we're going to continue to grow Marlboro over time as it has grown in the past.

And that allows us now, across these four brand families, to have a variety of initiatives, product, programmatic, retail executions.

And you see some of that playing out, obviously, in the second quarter, that the sales force in April, as we referenced, went out and reset at retail, so that when the consumer comes to point-of-sale, the four brand families are reinforced for the consumer there.

And it makes it easier, actually, from an SKU point of view to see them.

You saw Marlboro 83's box being rolled out to bring news to the Red franchise.

We have promotional plans in place to generate trial from adult competitive smokers on Marlboro Black.

So, those are but some examples, Nik, of the way I think that we think about putting the architecture together in a way that it comes alive for the Marlboro consumer, and it allows it to continue to grow as it would like.

With respect to the Marlboro share incentive, as you know, those are retail trade programs that evolve over time.

There is a share growth component there.

I don't think that we've noticed anything unusual at inventory as a result of the program.

Great.

Thanks, Marty.

Appreciate it.

You bet.

Thanks for calling.

Vivien Azer, Citi.

My first question has to do with inventory levels at wholesale.

You mentioned destocking in the back half of June and into July.

Is that largely done?

Are inventories kind of back to normal levels?

Or should we expect more destocking through the quarter?

Well, I think Howard made reference to this in his remarks.

Just to maybe to start one level up from that, for PM USA, it's true, of course, that there are changes in inventory levels quarter to quarter, or intra-quarter even; but for PM USA, that actually tends to kind of wash itself out over the course of a year.

I think that what Howard pointed out in his remarks is, the trade inventory increased in the second quarter of '12 compared to the second quarter of '11, which did benefit PM USA's volume performance a bit.

And then you had a build in second quarter.

And then those inventories were reduced after PM USA's announcement of its price increase on June 18.

We saw some of that reduction continue a bit into July.

I think that's a fair description of the situation at wholesale right now.

Okay, fair enough.

In terms of the consumer, I know it's early days since the pricing's been passed through, but I think there's kind of increasing concern about the health of the US consumer.

Have you seen anything in the trade in terms of a response to the price increases?

A little bit more trade-down?

Because I was actually surprised to see, over the last two quarters' discount, losing about 100 basis points a share.

No.

We haven't seen that.

Of course, the price increase just went in on June 18, right?

And then we price-protected in our MLP stores through June 30.

But no, we haven't observed that.

Fair enough.

My last question has to do with Skoal.

I recognize that the year-over-year compares are skewed a little bit because of the launch of Extra and the SKU discounting.

But can you give us a sense of how the underlying business is doing?

Sure.

Remember, the strategy is to grow Copenhagen and Skoal together.

So, if you look at the numbers really since the acquisition and over time, USSTC has done a great job with that.

Skoal has a tough challenge, doesn't it, because it has to compete not only with other competitive brands, but also with Copenhagen.

And Copenhagen has really been growing.

Copenhagen wants to grow a lot.

They've got some of the product offerings that it needed to compete more effectively.

And so, the combined share growth is spot-on target for our strategy.

And so we're pleased with that.

We've said, I think, previously, Vivien, that those brands will move at different speeds.

One will move faster at one time than another.

So as long as the combined retail share growth goes, that's our strategy, because we want to grow income by growing volume in this growing category.

But there's work to do on Skoal.

We've got its positioning, I think, better.

And now we're really seeing if we can get Skoal's growth accelerated.

But together, as long as they grow, we're pretty okay with that.

Fair enough.

Thank you very much.

Thanks for calling in.

David Adelman, Morgan Stanley.

It looks to me that the net price mix for PM USA this quarter was maybe 1% plus or minus.

Do you agree with the characterization that that business is going through a period of time where it's putting a greater relative emphasis on market share growth?

No.

I think that the strategy remains constant.

The strategy for PM USA is to maximize income while maintaining modest share momentum on Marlboro.

And I think that's exactly what you see playing out.

Look, here's what I would say about understanding kind of the pricing environment.

First of all, smokable adjusted operating company income grew, and its margin grew.

So, it's not as if it's gone the wrong direction.

One can argue about the relative growth, but it continues to grow and its margin grew.

I think the other thing to point out is, pricing, obviously, as you well know, occurs in a context.

And the economic context in which that business currently competes is, we're in the middle of a really anemic recovery from the greatest recession in decades.

And consumers are under pressure.

And pricing for most consumer packaged goods -- and this category is no exception -- have been more restrained than in previous periods of economic health.

Then the final thing I guess I might say, just on PM USA is, it's a time of investment in Marlboro.

And the reason we do that is, Marlboro is the long-term engine of PM USA's premium growth, and the way it grows its margin and the way it contributes to income.

So, I think if you put all those factors together -- and remembering, listen, pricing is obviously important in the cigarette segment.

Everybody recognizes that; but it's not the only way for PM USA to contribute to income growth.

It can moderate its promotional plans; it can reduce its cost structure; it could become more efficient about the way it delivers products to the marketplace.

And they've been very attentive to all of that.

And then, of course, at the Altria level, we have other income contributors.

So, we've got a growing smokeless business, and we've got a great line business and so forth.

So that's kind of how we think about it, David, which is putting all of those factors together.

You point out that pricing has slowed a bit on that one axis, but really, overall, I think we're pretty okay with how we're doing on income.

Okay.

And then, secondly, Marty, how much of an impact do you think this growth of roll-your-own volumes because of the -- what was going on with retail with these small manufacturing -- I mean, how much of that -- how much of an impact do you think, looking backwards, that may have had on total cigarette category volumes?

And how much of a benefit do you think from this legislation you may see going forward from that?

Yes.

It's a good question.

I think that it's hard to measure, is the honest answer.

You know, you have a secular decline rate that's made up of a number of factors, including people smoking fewer cigarettes per day or switching to smokeless products.

Actually, I think in that group are people who have gravitated to these kinds of products, whether it's roll-your-own or pipe-your-own.

So it's a bit hard to measure.

Obviously, for PM USA's business, which focuses on premium, I don't think there's a belief that it's going to be a significant contributing factor.

Some folks who are using those machines now will gravitate to other low-cost forms of using tobacco.

Some of it may be cigarettes, but some of it may be something else.

So, we'll see.

It's a good development, of course, that everybody who's manufacturing cigarettes is playing by the same rules.

I just don't think at this moment we see it having a significant impact on volume.

Okay, thanks a lot.

You bet.

Thanks for calling.

Thilo Wrede, Jefferies.

This is Margot Schacter in for Thilo.

I just had a kind of quick question off of David's price flowing question.

Is it fair -- can we expect price to accelerate any time soon?

Well, I guess I would just refer you back to PM USA's strategy, which is to maximize income while maintaining modest share momentum on Marlboro.

And we'll just have to see how that plays out over time.

Okay.

Thank you.

Thank you for calling.

Judy Hong, Goldman Sachs.

I guess, sort of following on kind of the Marlboro share and pricing dynamics, Marty, just maybe you can give us some perspective on how you get comfort around the fact that some of these price-driven investments are actually -- or where the investments that you're making behind Marlboro's building brand equity, particularly among kind of the legal age to under 30 smoking group, and that it's not coming solely because of, really, the price investments that you're making.

Sure.

Thanks for calling in.

There's a number of metrics that we follow around Marlboro, of course.

But when you put them all together, I think we feel quite confident that Marlboro's health is good and that the investments we're making are wise.

It has great brand equity.

It has high share.

It commands premium pricing.

Its price gaps have been stable throughout this terrible economic period.

In fact, if you look back from the period 2007 to 2011, it both grew share and it improved its margin.

And we know -- listen, this is how Marlboro has grown.

Right?

If you go back to Marlboro in 1954 with Red or when Menthol was launched in the '60s, or Gold in the '70s, we know that Marlboro has that kind of equity.

It's that kind of the big brand.

And when you invest in it, and it's got all these benefits, we know that consumers will choose Marlboro.

So we have a lot of experience about both investing in and measuring the power of those investments in Marlboro.

We have every reason to think that's the case today.

Okay.

And then, Marty or Howard, just in terms of your guidance, so just the commentary that the second half sort of moderates from the first half, just wondering, is it just really more a comparison issue?

Are there any other factors that we should consider, just in terms of a bit of a slowdown you're expecting for the back half?

And then, in terms of taking the low end of the guidance up today, I know you've had strong performance in the first half from the equity income from SAB Miller, and then the PMCC.

So I'm just wondering how much of that is those factors as opposed to the tobacco business?

Well, I think that you point out that the comparison is probably the principal reason for that.

Listen, the businesses are performing extremely well.

We're very pleased that the execution of our plans is going fine.

But, as we point out in the release, gosh, Capital Corp's adjusted OCI was up 56% for the quarter and 96% for the half.

As you know, Judy, those are transactional kinds of contributions from the leasing business.

But that's likely to moderate.

And SAB, which is a wonderful -- doing a wonderful job, was up nearly 25%.

And it does great, but it hasn't performed historically at that level.

So we just think that when you do that and compare it to the first half, it's likely to moderate a bit in the second.

I think that's the way to think about that.

Okay.

And then for the cigarette category, the industry's decline to 3% in the first half, is that sort of reflective of the underlying consumption decline number?

And do you think that that's kind of a reasonable rate of decline to think about for the full year?

Well, as you know, I mean, over time, the decline rate has been a function of both the secular decline rate and then some decline when prices go up, with historical elasticity of about minus 0.3.

Actually, that's been constant for some time.

I mean, we don't see much change in that in the current environment.

Okay.

Thank you.

Thank you for calling.

Michael Avery, CLSA.

Just back on smokeless, I wonder if you could give us a little more color there.

And I guess part of what I'm getting at is, I know there's some trade issues and comparisons that skew some of it, but it certainly looks like Skoal is accelerating and that some of the things that I think you're trying to do in that business look like they may be working.

Is there a corner you might be turning there?

I think it's probably as I described it just a couple of moments ago.

We focus on growing Copenhagen and Skoal together.

The brands have different places in the marketplace.

They have different propositions.

Copenhagen has really had very, very strong growth.

Skoal has to compete with that growth as well as compete against its competitors in the marketplace.

We're making progress on Skoal, I think.

And as long as the retail shares are growing together and we're participating in the industry volume growth, we're able to grow our income in accordance with our plans.

We have brand managers for Copenhagen and we have brand managers for Skoal, and they're both trying to out-compete the other as well as the competition.

And we think that's the right way to attack that category.

That's great, thanks.

Then on the cost side, obviously, you have the benefit of relatively benign input costs.

But has the drought this year put any pressure on leaf costs for this year or for next year?

Yes, I think -- there's nothing really out of the ordinary on our costs this year.

We are tracking the drought's impact on tobacco growers and there's -- I would say there's some modest impact today, although they've recently got some rains in some key areas.

So, while that's on our watch list, we don't see any unusual impact, at least to date.

That's great.

Thank you very much.

You're welcome.

Thomas Russo, Gardner, Russo & Gardner.

I'm curious as to whether you found any steps to take in the context of either mutually low interest rates?

Either regarding your pension fund in its funding status or work that you might be able to do on your capital structure.

Sure.

You know I think -- we've been in a low interest rate environment for some time now, although, as you accurately point out, they've continued to head further south.

And I think we're pursuing the strategy we have over the last couple of years, both in our pension plan and with our focus on seeking to reduce our effective interest rate.

And, as you know, we've done that by allowing some of our high interest debt to mature.

And then we've been going into the market periodically and getting quite advantageous rates.

And I think that the latest low rates just indicate that that opportunity is likely to be with us for some time.

Thank you.

Thanks, Tom.

Ann Gurkin, Davenport.

I wanted to return to the smokeless tobacco segment.

And I was just curious if that business, your business, is more in a position to grow in line with the overall industry now?

Have you gotten Copenhagen and Skoal kind of to a position where that growth rate could be more in line with the industry?

Well, I think, you know, on an adjusted basis, we think that it did grow in line with the industry.

Our strategy is to grow in line with the industry rate or a little bit better than that.

And you're correct to point out that if you take a big bigger piece of the share, that does help grow your volume there.

But we're, I think, well on the way to doing that and I think the numbers in the quarter reflect that.

That's great to see.

And then just returning to Marlboro and the discussion, if you back out the architecture and back out the innovation, and the stepped-up brand investment, like, the organic growth, is that meeting your target?

The underlying performance of that brand?

Well, as you know, we don't back out that way.

But I guess I'd just return to what I said before, which is Marlboro's health is really very good.

It's up 3/10 versus year-ago; up 2/10 for the half.

We have our new -- our Marlboro architecture that's being put in place.

We have some new products that are in the marketplace.

So I think we're really pleased with how Marlboro is performing, Ann.

That's great.

Thank you.

Yes, ma'am.

Thank you.

Chris Ferrara, Bank of America.

A couple of quick cash questions.

First, I understand you paid down debt this quarter, right?

But is that why the share repurchase slowed down to, I guess, its slowest rate since you guys started buying back again, maybe five quarters ago?

And then, on CapEx, can you just give a little color on why that outlook is changing down to 100 million?

Sure.

Yes, I think you're pointing out that we had $600 million in debt that matured not in the second quarter but early in July.

And we did pay that off.

I won't go into the details of how we calculate how much stock to repurchase, but I would point out that three quarters into that five-quarter share repurchase program, we've repurchased $700 million about worth of stock.

So we think we're on a decent run rate and expect to finish that by the end of the year.

Did you have a second question?

Yes, (multiple speakers) on the CapEx.

Yes, on CapEx, you know, I would say that there's nothing unusual going on there.

We forecast our capital expenditures at the beginning of each year.

But then as we put together more detailed plans, we scrutinize those capital expenditures more carefully.

And if there's an alternative way to achieve the results, or if we can drive some incremental efficiencies, we seek to do that.

And so, as we pointed out, we've now taken our capital expenditure forecast for the year from $150 million down to somewhere between $100 million and $125 million.

And we think that that's plenty in order to maintain the infrastructure we need in each of our businesses.

Great.

And then just one question on the guidance.

I know you guys said that EPS growth, I guess, would be easier in Q4 than Q3.

And consensus is kind of there but not quite.

Can you just remind us of the puts and takes and why Q4 growth will be better than Q3?

No, I think I'd just rely on the remarks we made before, Chris, that it's going to moderate a bit in the back half compared to the first half, for the reasons I articulated.

Okay.

Thanks.

Thanks for calling.

Andrew Kieley, Deutsche Bank.

Marty, just wanted to go back to -- in terms of your satisfaction with the promotional investments on Marlboro, particularly on Special Blends and Marlboro Black, could you talk a little bit about the decision to ease back on the promotions in May or June, and how that speaks to the traction you're getting on those SKUs?

Yes, well, look, the promotional levels on these SKUs obviously are very carefully monitored over time.

And you know, Special Blends, of course, have a different role to play than Black, so it's worth just taking a second to make sure that's clear.

Special Blends, obviously, their role is to offer SKUs at price points for some of the more promotion-sensitive smokers that are in the franchise.

I think we've spoken before about 90% of Marlboro smokers choose the brand 100% of the time, but that leaves you 10% or so, like in other competitive franchises that are more promotion-sensitive.

Special Blend is a way to keep them in the franchise.

All the while we manage our margin at the Marlboro level and they've been very effective in that regard.

But, of course, you don't want to offer more promotion than is needed, and so we are able to moderate those or to change those as circumstances warrant.

Marlboro Black, on the other hand, is a new product offering.

And so what we're trying to do is to generate trial among adult competitive smokers.

And given the marketing restrictions in the industry, you have to do that principally at point-of-sale.

And you do that with some promotional offers.

And that's been the role of promotions for Marlboro Black.

And as soon as we get some trial there, that meets our goals.

Obviously, it's the same issue, which is if you don't have to spend more promotional money there than needed, and you're able to back it off.

And I think that's been what we've observed, both with respect to Special Blend and Marlboro Black.

Okay, thanks.

And then just a second question.

If you could just talk broadly about the promotional and pricing environment of cigarettes, in terms of what you're seeing from the premium competitors and the price gaps in the discount tier?

You've got a little bit of reaction now to the pricing you took in July.

Just how that's sticking.

And maybe if lower gas prices are helping at all in terms of trade-down within the categories?

Well, I think you know it's fair to say that the industry has been competitive.

It is competitive.

It's likely to be competitive.

And we don't see a big significant change one way or the other in that.

And PM USA's plans take that into account.

Okay, thank you.

You bet.

Thanks.

Chris Burritt, Bloomberg News.

Thanks for your time.

I want to ask you first, did you disclose how much pricing helped revenue?

Is that something that you give?

Yes, I think you can certainly calculate that from what is included in our press release.

Okay.

And secondly, as you introduce new products, can you describe whether you're hitting a wall, so to speak, with the FDA?

I gather that they -- that the Agency simply is not considering -- or at least not considering promptly -- requests by the cigarette manufacturers for new and modified products.

Can you talk about that a bit and what impact that's having on the Company?

Yes, there's a couple of things in your question maybe we should separate out just to be clear.

There was a major filing of so-called substantial equivalence application some time ago, which was the principal filing.

And what we've observed is that FDA is pretty methodically working through those.

There were a lot of them that were filed at the Agency.

And it's worth remembering that the Agency, obviously, is in its first kind of couple, three years of staffing up and putting process and procedure in.

It's a pretty deliberate Agency anyway, and so they have some work to do in that regard.

So that's actually been, I think, pretty much what we expected, which was that they would work their way through that.

After that date, of course, to introduce regulated products into the marketplace, you do have to file applications for substantial equivalence.

And the products can't be launched -- cannot be launched -- until approval.

And you know, I think most majors have applications that are pending there.

I think that's just more of the same.

They're trying to work through their structure and process about approval.

I would distinguish that from the last part of your question, which was modified risk products as opposed to, for example, more conventional products.

There, the Agency is really just building out its science and policy base about how they're going to think about that.

And, as you know, they've conducted several hearings.

And if you're interested in what we have to say about that, we have them on our website.

But I would distinguish that situation, which is likely to take place over some period of time.

They have to get the science right before they're going to permit claims.

And that's what they're working through right now on that.

Well, thank you.

So on the first half of the question, you're not kind of tapping your fingers and urging the FDA to get moving on that.

You seem to have some patience.

Well, we planned for what was coming, I think.

And so, everyone would like their regulator to move promptly on matters.

But we have found, actually, FDA to be pretty okay about how it's going about its work.

And I'm sure that the speed will improve as they staff up over time.

Thank you.

Yes, sir.

Thank you.

Thilo Wrede, Jefferies.

Hello, Thilo?

Operator, we don't seem to have a question.

That question has been withdrawn.

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

Thanks, everyone, for joining our call today.

If you have any follow-up questions, we'd be happy to help you in Investor Relations.

That concludes today's call.

Thank you.

This does conclude today's conference call.

You may now disconnect.