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Altria Group, Inc. (NYSE:MO)

Q1 2010 Earnings Call Transcript

April 21, 2010 9:00 am ET

Executives

Cliff Fleet – VP, IR

Mike Szymanczyk – Chairman and CEO

Dave Beran – EVP and CFO

Analysts

Christine Farkas – Bank of America-Merrill Lynch

Chris Growe – Stifel Nicolaus

David Adelman – Morgan Stanley

Judy Hong – Goldman Sachs

Thilo Wrede – Credit Suisse

Nik Modi – UBS

Adam Spielman – Citigroup

Chris Burritt – Bloomberg News

Michael Felberbaum – Associated Press

Ann Gurkin – Davenport

Thomas Russo – Gardner Russo & Gardner

Operator

Good day and welcome to the Altria Group 2010 first 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. 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. Cliff Fleet, Vice President of Investor Relations for Altria Client Services. Please go ahead, sir.

Cliff Fleet

Good morning and thank you for joining our call. This morning we will only be discussing Altria's 2010 first quarter business results and will not be discussing the status of litigation.

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

Since Altria acquired UST and its smokeless tobacco and wine subsidiaries on January 6, 2009, US Smokeless Tobacco Company and Ste. Michelle Wine Estates financial results from January 6, 2009 are included in the 2009 first quarter consolidated and segment results.

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

Altria reports its financial results in accordance with Generally Accepted Accounting Principles. Today's call may contain various operating results 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 Group.

Mike Szymanczyk

Thanks, Cliff, and good morning to everyone. We are pleased with the performance of Altria and its operating companies in the first quarter of 2010. Altria delivered strong adjusted earnings per share growth of 7.7%. In addition, we increased our dividend by 2.9% on an annualized rate of $1.40 per share. Reflecting our new dividend payout ratio target of approximately 80% of adjusted earnings per share.

Despite the continuing challenges of high unemployment and low consumer confidence as well as intensely competitive environment Altria’s operating companies continue to perform well.

Cigarettes segment’s adjusted operating companies income increased by 6.4% over the comparable year ago period to $1.3 billion. Marlboro achieved record retail share results as the brand grew its quarterly retail share both sequentially and on a year-over-year basis.

We are particularly pleased with the Cigarettes segment results considering that the prior year comparison period included cigarette segment’s adjusted operating companies’ income growth of 10.7% and a previous Marlboro retail share record high of 42.4%.

The smokeless products segment reported very strong adjusted operating companies’ income growth of 49.2% to $188 million. Copenhagen and Skoal’s combined retail share increased both on a sequential and comparable year-over-year basis and the brands combined shipment volume grew faster than the smokeless categories growth rate for the second straight quarter. Importantly, Copenhagen reestablished itself as the largest smokeless brand as measured by retail share in the quarter.

The Cigar segment’s adjusted operating companies’ income declined by 15.8% to $48 million. Middleton have very difficult income comparison against the first quarter of 2009 when its adjusted operating companies’ income grew by a very strong 32.6% due to the timing of trade purchases around the 2009 FET increase.

Wine segment’s adjusted operating companies’ income grew 33.3% to $12 million. Ste. Michelle reported strong volume growth versus the prior year period led by the 44.9% shipment growth of a Chateau Ste. Michelle wines.

Ste. Michelle continues to be recognized as a producer of a broad portfolio of high quality wines as wine industry publications had given over 30 of its wines ratings of 90 or better already this year.

The four premium brands of Altria’s tobacco operating companies perform well in a challenging environment. Marlboro had a particularly strong performance as I mentioned. The brand launched two Special Blend non-Menthol products in the quarter which contributed to the brand strong retail share performance.

The strength of these two new products help Marlboro grow its retail share one share point from the fourth quarter of 2009 to the first quarter of this year, despite continued heavy competitive spending on non-Menthol discount products.

PM USA plans to broaden the availability of two more variances. Special Blend in a hundreds length in the second quarter of 2010 to build on this success.

Marlboro also launched Marlboro’s Snus nationally, is a spitless, smokeless tobacco alternative. Since the products did not shift nationally to wholesale until late in the first quarter of 2010 it is premature to talk about retail share and adult consumer feedback. However, based on our test markets we believe Marlboro Snus has a good opportunity for future growth.

Copenhagen continued its strong retail share performance behind long cut Wintergreen which was successfully launched in the fourth quarter of 2009. USSTC began shipping Copenhagen Long Cut straight and extra Long Cut natural at the end of the first quarter of 2010. We anticipate that these products will contribute to Copenhagen’s growth this year and beyond.

Skoal showed solid momentum as it grew retail share each month throughout the first quarter behind a slim can pouch initiative. The brand will begin its Skoal up the summer campaign later this quarter which is an integrated program of enhanced products and marketing activities to strengthen the brand’s position in the marketplace.

Black & Mild continued growing its retail share versus the first quarter of last year despite a challenging environment due to an increase in competitive promotional activities. Middletown is monitoring the competitive environment and plans to respond appropriately to defend Black & Mild’s marketplace position.

New products will play in an important role in the brand strong retail share growth. And in the second quarter Middleton plans to introduce Black & Mild Royale to continue building its strong position in the machine-made large cigar category.

As expected, trade inventory changes last year caused by the April 1, 2009 FET increase impacted shipment comparisons across all the tobacco segments for the first quarter of 2010 versus the comparable year ago period.

Last year, the trade significantly reduced cigarette inventories in advance of the FET increase. And in the second quarter they rebuild these inventories. In the first quarter of this year the trade increased their inventory levels from the beginning to the end of the quarter.

Due to these inventory dynamics PM USA’s reported 2010 first quarter cigarette shipment volume was down only 0.7% when compared to the first quarter of 2009. However, when adjusted for these inventory changes PM USA estimates that its shipments declined approximately 11% versus the year ago period and that the cigarette category declined approximately 10% in line with historical price elasticity.

Smokeless product shipment comparisons were also impacted by trade inventory completions in the first quarter of 2009 in advance of the FET increase, as well as the timing of PM USA and USSTC’s new smokeless product launched in the first quarter of this year.

Reported first quarter smokeless shipments were up 21.9% versus the comparable year ago period. But when adjusted for the timing of new product launches trade inventory movements, the discontinuation of Rooster and other factors smokeless shipments were often estimated 5%.

Copenhagen and Skoal’s combined first quarter adjusted shipment volume increase and estimated 11% when adjusted for the new product pipeline volume and trade inventory changes as well as other factors. The company’s estimate that the smokeless category continue to grow at a rate of about 7% in the first quarter of 2010.

Cigar shipment comparisons were also impacted by advance in the first quarter of 2009. The trade increase cigar inventories and advance of the FET increase since there was no floor tax on machine-made cigars. And the initial shipments of Black & Mild Wood Tip also occurred in the first quarter of last year.

For the balance of 2009 and into the first quarter of 2010 the trade reduced inventories of Middleton’s machine-made large cigars. The combination of all of these year-over-year dynamics had a substantial impact on Middleton’s first quarter reported shipments.

Middleton’s reported shipments were down 18% versus the first quarter of last year. But when adjusted for trade inventory changes were estimated to be essentially flat. Middleton believes that when adjusted for FET related impacts the machine-made large cigar category was essentially flat.

The Altria family of companies continues to make excellent progress on its $1.5 billion cost reduction program. $43 million of cost savings were achieved across the enterprise on the first quarter of 2010 for 1.1 billion in total savings since the program inception of the 2006 cost base. We remain confident that we will realize the $419 million an additional cost savings by the end of 2011.

We continue to believe that the UST acquisition will be accretive to Altria’s adjusted diluted earnings per share in 2010. First quarter financial results for the smokeless product segment are in line with our year-to-date expectations. These segment results are not comparable to U.S. SEC’s reported results prior to Altria’s acquisition as they now include smokeless product results for PM USA.

In addition, we remain on track to realize the $300 million in cost savings resulting from the acquisition. The impact of these cost savings is reflected partially in the smokeless product segment operating companies’ income performance. With the balance reflected in other business areas across the Altria family of companies due to our new more efficient corporate structure.

We expect the second quarter of this year to be particularly challenging for income growth comparison purposes. Due to different trade inventory dynamics in 2009 versus 2010 we continue to expect adjusted diluted earnings per share growth to build in the second half of this year.

For the full year, Altria reaffirms that its guidance for 2010 adjusted diluted earnings per share is expected to be in a range of $1.85 to $1.89, which represents a 6% to 8% growth rate from an adjusted base of $1.75 per share in 2009.

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

Dave Beran

Thank you Mike. I'll begin by discussing our cigarette segment results. During the quarter PM USA successfully executed its objective of maximizing income while maintaining Marlboro's strong position in the cigarette segment.

For the first quarter of 2010, reported operating companies’ income for the cigarette segment increased by 7.6% to $1.2 billion, due primarily to higher list prices and lower pretax charges related to the previously announced closure of its Cabarrus manufacturing facility, partially offset by lower volume.

When adjusted for restructuring charges, first quarter adjusted cigarette segment's operating companies’ income grew by a strong 6.7% to $1.3 billion versus the same year ago period.

Trade inventory increases in the first quarter of 2010 help cigarette segment volume and income results for the period. We expect that the trade will return inventories to more normal levels which will have a corresponding impact on PM USA's business results when it occurs.

After adjusting for trade inventory changes PM USA’s first quarter cigarette shipment volume declined by approximately 11% which is greater than the estimated industry decline rate of approximately 10%, primarily due to retail share losses when its portfolio brands of 1 share point.

PM USA possibly reset the retail share positions of these brands after the FET increase last year. And we therefore expect that PM USA’s comparable year-over-year retail share results will improve over subsequent quarters as we begin to lap these resets retail share positions.

Marlboro had a record retail share of 42.7% in the first quarter of 2010. Marlboro achieved this result with sequential retail share growth on both the Menthol and non-Menthol components of the brand.

While launch support for the Marlboro’s Special Blend products played a role in the strong retail share results the share growth did not come at the expense of profits as Marlboro grew its margins in the first quarter of 2010 versus the first quarter of 2009.

We are also pleased that Marlboro Menthol achieved a record retail share results in the first quarter of 2010 with a six share. Overall, we are very pleased with a performance of the cigarette segment. Income growth was strong ad Marlboro displayed great strength in a challenging environment.

We are similarly pleased with a smokeless products segment results in the first quarter. Reported operating companies income was $178 million, an increase of $180 million from the comparable year ago period.

When adjusted for exit and integration costs and acquisition-related charges adjusted first quarter operating companies’ income was $188 million, an increase of 49.2% from the prior year. This strong income performance occurred despite costs associated with three national new product introductions in the first quarter of 2010.

Smokeless product shipment volume in the first quarter increased 21.9% versus a prior year period, driven primarily by Copenhagen and Skoal. And the national expansion of Marlboro Snus.

Both Copenhagen and Skoal has solid underlying shipment performances. After adjusting for the timing of new product launches wholesale inventory changes and other factors both Copenhagen and Skoal grew their first quarter shipment volumes versus the prior year period.

Copenhagen and Skoal’s combined retail share performance was also very strong as it grew both sequentially and on a year-over-year basis by 8/10th and one share point respectively.

Copenhagen’s first quarter retail share of 25.6% was particularly impressive as it brand share grew one share point on a sequential basis and 1.9 share points on a year-over-year basis. Now that Copenhagen and Skoal’s combined retail share has been growing sequentially for the past couple of quarters we expect that total smokeless products retail share will also return to growth on a year-over-year basis as the year progresses.

The Cigar segment reported first quarter operating companies’ income of $47 million, down 13% from the prior year period. When adjusted for integration costs adjusted operating companies income declined 15.8% to $48 million.

As Mike noted Middleton’s first quarter income and volume comparisons were particularly challenging due to the trade inventory build, a machine-made cigars in the first quarter of 2009 prior to the FET increase.

Black & Mild increased its first quarter retail share of the machine-made large cigar category by 3/10th of a share point versus the first quarter of last year to 28.2% behind the continuing momentum of last year’s new product launches.

Middleton has a strong pipeline of new products for 2010 including Black & Mild Royale and plans to respond as appropriate to the competitive dynamics in the marketplace.

Ste. Michael also reported solid business results in the first quarter of 2010. Overall, reported operating companies’ income for the wine segment increased $6 million versus the prior year period to $7 million.

When adjusted for exit, integration and acquisition-related costs, adjusted operating companies income increased 33.3% versus a prior year period to $12 million.

The wine segment shipment volume in the first quarter increased 22% to 1.4 million cases versus the year ago period. Overall, the wine industry’s retail unit volume has measured by Nielsen Total Wine Database for US Food, Drug and Liquor, increased 3.9% in the first quarter of 2010 and Ste. Michael’s retail unit volume grew faster than the industry at 6.1%.

Reported operating companies income for the financial services segment, in the first quarter of 2010, increased $99 million versus the prior year period to $21 million, due primarily to lower gains on asset sales.

At the end of the first quarter the allowance for losses was $202 million reflecting a net increase of $64 million due primarily to write-offs on leases with General Motors.

Mike and I will now be happy to take your questions. While the calls are compiled, let me cover a few housekeeping numbers. Marlboro's price gap versus the lowest effective priced cigarette was 33% in the quarter. Marlboro's net pack price was $5.42 and the lowest effective price cigarette pack price was $4.08.

The cigarette discount category's first quarter retail share was 27.5%. The estimated weighted average cigarette state excise tax at the end of the first quarter was $1.26 per pack. There were no state excise tax increases in the first quarter of 2010. However, New Mexico and Utah enacted legislation to increase their cigarette excise taxes on July 1.

Additionally, legislatures in Washington State, NY sent bills to respective governors that include cigarette excise tax increases.

Copenhagen's retail price was $4.15, and its net price gap versus the leading discount brand was approximately 45% in the first quarter. At the end of the first quarter the District of Columbia and 18 states used a weight based exercise tax system representing 27% of a smokeless categories volume.

Our 2010 reported first quarter tax rate was 36.5%. We anticipate that Altria's 2010 full year effective tax rate on operations will be approximately 35.5%. On April 15, 2010, PM USA made its full 2009 MSA payment of approximately $3.6 billion. The MSA payment included approximately $209 million that PM USA disputes it owes as a result of 2007 non-participating manufacturer adjustment.

In the first quarter, Altria recognized a one-time $12 million non-cash charge due to the elimination of tax deductions for retiree prescription drug subsidies under the 2010 healthcare legislation. And CapEx was $38 million in the first quarter and ongoing depreciation and amortization was $69 million.

Operator, do we have any questions?

Question-and-Answer Session

Operator

Thank you. (Operator instructions). Our first question comes from Christine Farkas of Bank of America-Merrill Lynch.

Christine Farkas – Bank of America-Merrill Lynch

Thank you very much. Firstly, a clarification, Dave, if I could. The profitability on Marlboro was set to be higher year-over-year but I am wondering about the pricing for Marlboro. You did have cost savings in the quarter. Was the pricing up similar to other brands or was it more moderate or was it in fact down year-over-year with added promotion?

Dave Beran

The overall profitability of Marlboro as well as our other brands increases this quarter over the last quarter and it represents the strategy that we use in the marketplace that includes our promotions and our new product launches. So I hate to split out individual components of the brand marketing plans. But it was the totality of both the new product launches and our promotional activity in the quarter that enhance Marlboro’s margin.

Christine Farkas – Bank of America-Merrill Lynch

That’s helpful. And then just a broad question on smokeless. If you can look at the regions around the U.S. that were troubling given some high unemployment, if you look at where price gaps are now and Cope’s performance can you talk about how that performance might have changed in the quarter or are there some regions that are surprising you? Thank you.

Mike Szymanczyk

Hi, Christine, it’s Mike. I would say that in general Copenhagen doing very well and that pretty much across the board. As you know we look at price gaps pretty much by state and I would say that there is any particular areas right now where we would describe it as a trouble significant trouble spot and on an average it’s the gaps remain about where we thought they would be which is in the kind of mid-to-high 40s. So there is nothing unusual going on. Copenhagen’s business is really being driven by getting the gap right, pretty average across the board and by new province, particularly, the Winnipeg province. At this juncture, the other ones are Cheverly in the marketplace building on how many bases on which (inaudible).

Christine Farkas – Bank of America-Merrill Lynch

Okay, great, that’s helpful. Thanks Mike.

Operator

Your next question comes from Chris Growe of Stifel Nicolaus.

Chris Growe – Stifel Nicolaus

Hi, good morning.

Dave Beran

Good morning.

Mike Szymanczyk

Good morning.

Chris Growe – Stifel Nicolaus

Hi. I had two questions for you. The first off to you that following on a bit to the question about price gaps here in cigarettes, it’s been at a pretty comfortable level Marlboro versus the lowest effective price of around 33%, it’s a good percentage relative to the history. Do you foresee upward pressure on the discount packs as whether it’s FDA cost or state tax increase, would that gap actually could narrow but this year was at, would that be reasonable assumption for the year?

Mike Szymanczyk

I don’t know I can’t predict the future on that. We kind of respond to what’s out there in the marketplace. As I said before we’ve had periods of time where the gaps wider than it is right now when the economy is healthier the primary factors there are unemployment rates and consumer confidence and so I think as unemployment rates come down and confidence goes up then there maybe some opportunity there, but I think the way we look at it is we watch the market and then we take advantage of opportunities in the market as they unfold. We don’t try to guess what’s going, we wait till it gets there and then we respond to it.

Chris Growe – Stifel Nicolaus

Okay. And then I had a question for you on Marlboro overall, could you say within your market share for Marlboro this quarter how much new products like Special Blend would have benefited the market share overall?

Mike Szymanczyk

Well, I just say here that Marlboro actually exhibited strength in both the Menthol and non-Menthol side and so we got some positive benefit on both those sides. And certainly, the new products were part of that contribution, but Marlboro was pretty healthy overall and kind of across the board.

Chris Growe – Stifel Nicolaus

Okay. And then just one final one for you. You suggested that inventory levels are maybe coming down from where they are today overall. Is that just an expectation for the rest of the year, do you foresee that happening in 2Q for example or is that just an expectation given the levels are at today that they do come down?

Mike Szymanczyk

Well, I think that our view of it is that inventories, particularly, the wholesale level won’t stay where they are. I’m not going to speculate on when they come down. I think that will be based on what wholesalers do, but when you look at them compared to the prior year activity where you had an unusual circumstance on the prior year where inventories really went to exceptionally low levels where we knew they were going to come back up. It’s a comparison that I try to explain because it’s a bit artificially overstates I think with the real volume. I can’t tell you exactly what’s going to happen because I don’t know, but I would expect that will see some of that inventory depleted as the year unfolds.

Chris Growe – Stifel Nicolaus

Okay, thank you.

Operator

Your next question comes from David Adelman of Morgan Stanley.

David Adelman – Morgan Stanley

Hi, good morning.

Mike Szymanczyk

Hi, David.

David Adelman – Morgan Stanley

Hi Mike and Dave. First on this inventory dynamic in the first quarter in cigarette. How much would your shipments have been down in Q1 if trade inventory levels did not increase during the quarter approximately?

Mike Szymanczyk

Well, I think I gave you an adjusted number in the earnings release which was 11%.

David Adelman – Morgan Stanley

But that’s taking into account both the anomaly last year and this year. If you told us how much the first quarter benefited from trade loading this quarter, I think it would help us understand how much of a negative variance there would be later in the year, saying the reverted to where they were entering the year?

Mike Szymanczyk

I don’t know that it’s necessary. I think you have a comparison that suggested. So that’s the best. I think I’m going to be able to give you after some time.

David Adelman – Morgan Stanley

Okay. And then in April, Mike, now that you’ve lapped the exercise tax increase what’s your sense of the year-on-year consumption decline that the categories reverting to?

Mike Szymanczyk

I’m not sure I know what you mean.

David Adelman – Morgan Stanley

In other words it’s been an unusual period for –

Mike Szymanczyk

As I mentioned in the earnings release and then my remarks we have a quarter where when we adjust out the factors what we see is shipments, our estimate is the shipments in the industry of about 10% when you adjust and that’s consistent with normal price elasticity. I don’t know how to translate that into assumption.

David Adelman – Morgan Stanley

No, all I am saying now, now in April, you have lapped the impact of the Federal exercise tax increase. So second quarter to-date do you have an initial read, it appears that underlying consumption declines are reverting to.

Mike Szymanczyk

We’ll look at the second quarter when we get to July. We don’t start talking about the quarter until June.

David Adelman – Morgan Stanley

Okay. And then with the pending substantial potential increase in dividend taxation is that going to cause the board to reconsider at all or reevaluate the relative preference of dividends versus share repurchases as we’re returning cash?

Mike Szymanczyk

Both of those remain speculative issues. We don’t know what’s going to happen exactly until we get the relative to tax rates and the board makes those decision when it thinks it has appropriate information on which to make it. So I would say it’s probably premature for us to be discussing here.

David Adelman – Morgan Stanley

Okay. And then last thing, Mike, historically, Marlboro could grow share presumably with a price gap of in the mid-40s. Do you think as the economy improves and unemployment rates get back to maybe where they had then two years, three years ago, is that still a realistic benchmark or do you think with significantly higher pricing in the category that sort of more on a secular basis the brand wouldn’t be able to gain share with that magnitude of pricing gap?

Mike Szymanczyk

Well, I can’t predict the future, but I can tell you a history which says that in a stronger economic environment where we have much lower unemployment we have higher consumer confidence that we’ve seen the brand able to withstand broader gaps. That’s true, pretty much across varying state tax levels. So there’s significant difference between state tax levels and therefore retail pricing. So that’s history and I can’t predict future for you, but I would say history would indicate that in those kinds of environments gaps have been wider and the brand has been able to grow.

David Adelman – Morgan Stanley

Okay, thank you.

Operator

Your next question comes from Judy Hong of Goldman Sachs.

Judy Hong – Goldman Sachs

Thanks, good morning.

Dave Beran

Good morning.

Mike Szymanczyk

Good morning.

Judy Hong – Goldman Sachs

Mike, just going back to David’s question about the trade inventory movement, last year, you did quantify that your shipments were negatively impacted by about 800 basis points, so if we take the gap between your reported shipments in the quarter down 1% and then your underlying shipments of 11%, and assume that 800 basis points of inventory got rebuilt in the year I mean is it really sort of 2 points of boot that you got from the quarter as the trade built from beginning of the quarter to the end of the quarter. Is that how we should think about it?

Mike Szymanczyk

I don’t know. I’m not sure I understood exactly your equation there. I think the basic thing to understand here is that we saw inventories in the first quarter of this year build through the quarter and last year, what we saw is as we got in the March was a significant depletion of inventory and so that’s up. A favorable comparison this year in volumes, but then ultimately, we would expect there will be some depletion of net inventory. The trade won’t carry that inventory forever. So, that’s what I think is important for people to know. We can’t predict exactly when that’s going to occur. But I think it’s important for people to know what’s there. Beyond there trying to quantify precisely is not something I’m not going to do.

Judy Hong – Goldman Sachs

And Mike was that of a category life phenomenon or was it more specific to your brands, why would the trade kind of rebuild inventory when the carrying costs are lot higher this year compared to history because of the tax issue. And is it any indication that they feel pretty comfortable with the underlying trends maybe going back to the historical trend line as we are lapping the tax increases?

Mike Szymanczyk

I’m not going to comment on that. I think that’s for wholesalers and for competitors to answer rather than for us to answer.

Judy Hong – Goldman Sachs

Okay. And then on the smokeless side, again, as we think about the shipment number outpacing the underlying number is there any way to quantify how much of that was specific to new product launches?

Mike Szymanczyk

I can’t tell you that off of the top of my head, but what I would say to you is that what we saw on our two premium brands was pretty strong shipment performance throughout the quarter so that wasn’t driven by tail end shipments which driven by pretty strong performance on those brands. Share performance throughout the quarter and some of that was driven by Copenhagen Wintergreen. So I wouldn’t attribute it simply to our pipeline on two SKUs of the launch on Copenhagen at all. It was pretty good shipment performance, supported by share performance and with good margins as well. So I would say that those two brands are doing a nice job right now.

Judy Hong – Goldman Sachs

Okay. And then just broadly speaking on the smokeless side I think clearly, you’ve set up the goal of achieving share gains on the premium brands and sequentially it’s gotten better year-over-year, the shipments are outpacing the broader categories. So it seems like from a share perspective you’ve achieved the goal of really gaining the share momentum back behind the brand. As you think about your spending level behind the brands and your investments that has gone against the two premium brands, are you comfortable now just in terms of the overall the pricing promotional levels and at what point you sort of start to think about maybe focusing a shift a little bit back towards profitability and price rose on these brands?

Mike Szymanczyk

Well, first of all, brands are highly profitable, so I don’t think there’s a question of focusing on profitability, they are highly profitable and the way we run them today. And I think that it’s a growing category and so it’s appropriate when you have brands that look like they want to grow and you’re in a growing category that, of course, you want to have healthy margins, but you also want to take advantage of the growth potential, which we have in front of us. So we balance those two things and I think we’re doing a pretty good job of that.

Judy Hong – Goldman Sachs

Okay, thanks.

Operator

Thank you. Your next question comes from Thilo Wrede of Credit Suisse

Thilo Wrede – Credit Suisse

Good morning, gentlemen

Dave Beran

Good morning.

Mike Szymanczyk

Good morning.

Thilo Wrede – Credit Suisse

What’s your expectation for the MST category growth for this year, now that we are one quarter beyond this?

Mike Szymanczyk

Well, I can report it what looks to be the our estimate of what the growth rate is in the category I am not going to speculate on what are we doing going forward, but it seems to be running around 7%.

Thilo Wrede – Credit Suisse

And so if you are expecting to grow share for the full year does that mean that the adjusted OCI growth that you have for this smokeless products, is that sustainable for the full year?

Mike Szymanczyk

Well, once again, I am not going to speculate what’s going to happen for the remainder of the year. We give guidance for the total business and we reaffirm that, but we don’t do it by segment. And so I think you’re going to have to wait three other quarters on hold, just like we do.

Thilo Wrede – Credit Suisse

Okay. The Marlboro Special Blend, where is that the smokers for those line extensions coming from?

Mike Szymanczyk

It’s got kind of a pretty broad appeal, so some of it comes from some of the Marlboro franchise but some of it comes from outside of the Marlboro franchise, some of it comes from some of the more branded oriented discount smokers and it also comes from other competitive premium brands. So its inflow is pretty broad.

Thilo Wrede – Credit Suisse

Were the Special Blends were they let’s say accretive during the quarter given the discount of price that you offer them at?

Mike Szymanczyk

Well, we haven’t put an aggressive pricing structure on it. So it’s been promoted, but not at a level that exceeds, what would be the level we use on other promotional SKUs. So Special Blend is doing its job, it's nice addition to the portfolio and I note for you that Marlboro’s margin improves during the first quarter as we launch that product, so it hasn’t had a negative impact on the overall brands profit performance.

Thilo Wrede – Credit Suisse

So not only the PM USA margin improve but the Marlboro margin as well?

Mike Szymanczyk

Yes, Marlboro margin was improved as well.

Thilo Wrede – Credit Suisse

Okay, thank you.

Operator

Thank you. Your next question comes from Nik Modi of UBS.

Nik Modi – UBS

Good morning, everyone.

Dave Beran

Good morning.

Mike Szymanczyk

Good morning.

Nik Modi – UBS

So just quickly want to clarify so on the Special Blend promotional, is it a fair characterization to say that we allocated some money from perhaps Marlboro mediums on to the Special Blend for this so launch –?

Mike Szymanczyk

I am not going to discuss our spending expense that we have.

Nik Modi – UBS

Okay, second question, Dave, can you just talk about the raw material environment, are you still seeing pressure or has that abated somewhat from a lead cost prospective?

Dave Beran

I would say that it’s moderate that when you look at the overall marketplace with unemployment recession, there’ve been a number of raw materials where price have gone up a number where they have stayed somewhat steady, so, overall, I would say that it’s been pretty moderate.

Nik Modi – UBS

Moderate inflation, you’re saying?

Dave Beran

Yes.

Nik Modi – UBS

Okay. And then the last question for you, Mike, is just with a year now behind you with the UST integration and some new leadership at the UST division, just looking back on integration and your plans and the strategy, is there anything you see different going forward in terms of what you originally expected in terms of the plan, any changes you are making and from a cost savings perspective, are you searching, do you have any comfortably with perhaps finding some excess upside in terms of the synergy number?

Mike Szymanczyk

Well, I would say that we adjusted that number up a bit after we bought UST and we got a lot of success in implementing the changes we wanted to make and getting a different structure that was more efficient in place, not only is related to USSTC but also relative to our other tobacco businesses. And I think we’re pretty comfortable with how that’s working, we’re always looking for ways to continue to refine these things and see if we can do them better and doing more efficiently, so I wouldn’t take that off the table. That’s just part of how we operate.

Overall, I think that transition was handled about as well as you could expect something like that to be handled. It was done quickly, it’s been fully integrated in the places like our sales force and our consumer engagement activities and we’re collecting the savings that have been accrued from that process. So I think we feel very good about that platform. And we also feel very good about the brand opportunities that we’ve been able to identify to use to grow these businesses going forward into the future. So we see plenty of opportunity there. This is not an acquisition where the games where simply short-term opportunities, this is one where there is an opportunity to build and grow and continue to get momentum out of this business going forward for an extended period of time and that’s what we expect to happen and we’re on the way to do it.

Nik Modi – UBS

Great, thank you very much.

Operator

You next question comes from Adam Spielman of Citigroup.

Adam Spielman – Citigroup

A lot of questions I have been asked but this is one of the questions that I hope you can answer. You mentioned a couple of times you’ve seen increased promotional activity in the machine-made cigar category. And I was wondering if you could say you could be a little bit more specific about which brands have been competing in this fray?

Mike Szymanczyk

I rather not be specific, it’s been a competitive marketplace and I think it will continue to be competitive. But I rather not –

Adam Spielman – Citigroup

Okay, okay. Can I ask question about smokeless in a slightly different way than before? As always your balancing market share progression and profitability, as all companies do, is it fair to say now that you are pretty comfortable with the trajectory of your market share and it’s time to start focusing more about on the profitability side of that particular balance?

Mike Szymanczyk

Well, again, I would point out that these brands in this business is already highly profitable business and so we haven’t, well, we have to go through a transition of getting it reconfigured as you can see by the first quarter, it makes a lot of profit, and it makes a lot of profit the way we’re running it now with the adjustments that we’ve made. So I don’t think we ever not have focused on profit, we’ve had focus on getting the system in place in order to be able to maximize the potential of business and we’re going to continue now that we got the system build to run the brand both to make money for our shareholders and to sustain the ability to do that over the long-term by building the brand equity still we have so both of those things after remain important.

Operator

Thank you. At this time we will now take questions from the media. Your next question comes from Chris Burritt of Bloomberg News.

Chris Burritt – Bloomberg News

Hi. Good morning. Actually, you folks have run through the answers to my questions, so thanks for the time, though.

Mike Szymanczyk

Good, you bet.

Operator

Your next question comes from Michael Felberbaum of Associated Press.

Michael Felberbaum – Associated Press

Good morning. My question was whether you are seeing that consumers are more comfortable paying for premium brand like Marlboro considering its strength this quarter? And also how much you can quantify or get some detail as to how important the Marlboro menthol and the Special Blends were to Marlboro success this quarter?

Mike Szymanczyk

Well, I would say just it’s kind of difficult for me to give an answer to your first question I would say probably the fact that gaps are being sustained at the level of their app, which is a good indication of what people are willing to pay for in a cigarette business and that the share is growing on a premium brand like Marlboro, we will say that the status of things right now, seems to be acceptable to consumers that are looking for the Marlboro brand. Whether that’s changing or not it’s hard for me to speculate on. Beyond that I would think we really would make to comment understanding your question.

Michael Felberbaum – Associated Press

Thank you.

Operator

Your next question comes from Ann Gurkin of Davenport

Ann Gurkin – Davenport

Good morning

Mike Szymanczyk

Hi, Ann.

Ann Gurkin – Davenport:

Hi, with gap prices increasing, are you seeing any change in consumer purchase pattern that coming in forth?

Mike Szymanczyk

What do you mean by gap prices?

Ann Gurkin – Davenport:

At the pump, gas price is going up

Mike Szymanczyk

Oh, gas prices, I thought you said gap, I am sorry, gas prices. Now there has been this high before and frankly, we try to do a correlation between gas prices and cigarette purchase behavior once before and we couldn’t find a correlation. So I don’t suspect it would be one this time either but we haven’t seen it at this point.

Ann Gurkin – Davenport:

Okay, and then second, regarding lease purchases or contracting volume with farmers are you reducing that contracted volume with farmers for lease this year and if so, are you reducing your duration levels of your leased inventory?

Mike Szymanczyk

Well, we pretty much manage our duration levels based on our blends and then also based on volume. So we make appropriate adjustments and what our lead inventory is kind of as we go and then that has implications on, the quantity that we contract or to purchase so. As cigarette volumes have come down we have adjusted where our purchases are and we also make appropriate adjustments in our inventory going forward. That’s kind of an ongoing process.

Ann Gurkin – Davenport:

Right, thank you.

Operator

Your final question is coming from Thomas Russo of Gardner Russo & Gardner

Mike Szymanczyk

Hi, Tom

Thomas Russo – Gardner Russo & Gardner

Good morning, Mike and Dave. I have a question first for Dave on the equity income from Altria’s investment in SABMiller and the recent increase in the quarter, seem to relate to a issuance of common stock class I’m curious how that worked out?

Dave Beran

They issued stock note treasury, we assume it’s going to be used for employee grants and options going out in the future. There’s an accounting rule that so you have to treat that as a sale, which we did, which result in a profit for this quarter.

Thomas Russo – Gardner Russo & Gardner

I see. And Mike, can you just take a look at the extent of the benefit from the efforts to rein back counter fit and the contraband trade, you are active around the country and lead by the launches to go after certainly tell us and broadly speaking, what direction has that resulted in improving condition?

Mike Szymanczyk

Well, I would say that there was a time where you have the kind of price changes that we saw in the market last year and then you’d see this stuff pop up in a lot of different places since we put a stronger infrastructure in place, worked closely with law enforcement on the subject, it seems that while it’s still will pop up it gets identified more quickly and gets tamp back down against or doesn’t have as much of an impact on the overall businesses it did a number of years ago.

So it’s one of those things where you have to invest and do due diligence on it on an ongoing basis in order to have some impact on the system that keeps it from occurring more broadly and that’s why we do it, we have the infrastructure and we sustain it and that’s why I think we didn’t see as much of it in this last quarter around.

Thomas Russo – Gardner Russo & Gardner

Sounds like money well spent. The last question from me has to do with the lessons learned, if you look across the category, across the markets, for the roll out of Snus, either your early lessons or just looking across to your competitors experience in terms of as a category, any early lessons you can share with us that we still can see in Marlboro the roll out?

Mike Szymanczyk

Well it’s very early. So we’re just in the stage of gaining distribution and getting it positioned on the shelf property. We do have some learnings from our test markets relative to engaging cigarette smokers on this subject that we will be putting in place as a part of this expansion of Snus, as I said in my comments, we feel pretty good about the potential for Snus, we set for a long time, we think this will be a kind of a methodical development of a business rather than something that happens rapidly.

And so based on the fact that I think we have a better understanding of that now than we did within the test markets we should see some more positive results from this as it kind of unfolds over the next few years, but it’s very early for us to be able to read anything on this. Frankly, again, I think by the end of the year we can probably compare it at least somewhat kind of a similar duration of time in the test markets and see what’s different and we will be looking back and try to understand that.

Thomas Russo – Gardner Russo & Gardner

Thanks Mike.

Mike Szymanczyk

Okay.

Operator

Thank you. At this time I would like to turn the floor back over to Mr. Cliff Fleet for closing comments.

Cliff Fleet

I want to thank everyone for joining us today. If you have any follow-up questions please give us a call at Altria’s Investor Relations Group

Operator

Thank you. This does conclude today’s conference call. You may now disconnect.

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Source: Altria Group, Inc. Q1 2010 Earnings Call Transcript
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