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Altria Group Inc. (NYSE:MO)

Q2 2007 Earnings Call

July 18, 2007 9:00 am ET

Executives

Nick Rolli - VP IR & Financial Communications.

Dinny Devitre - SVP and CFO

Analysts

Filippe Goossens - Credit Suisse

Bonnie Herzog - Citigroup

Judy Hong - Goldman Sachs

Erik Bloomquist - JP Morgan

Ann Gurkin - Davenport

David Adelman - Morgan Stanley

Christine Farkas - Merrill Lynch

Chris Burritt - Bloomberg News

Thomas Russo - Gardner Russo & Gardner

Brian D'Ambrosio - SuttonBrook

Presentation

Operator

Good day, and welcome to Altria Groups Second Quarter 2007 Earnings Call. Today's call is schedule to last about one hour including remarks by Altria Management and the question and answer session. (Operator Instructions) Media representatives on the call will also be able to ask questions following the conclusion of questions from the investment community. I will now turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communications for Altria. Please go ahead, sir.

Nick Rolli

Good morning and thank you for joining us on the call today. For those of you listening via the audio webcast, we are providing summary slides of the second quarter results. Today's call is limited to a discussion of our business results.

Our remarks today contain forward-looking statements and projections of future results, and I direct your attention to the Safe Harbor Statement at the end of our news release for a review of the various factors that could cause actual results to differ materially from projections. For detailed review of our second quarter results, I direct your attention to the news release we issued earlier this morning which is available on our website at altria.com.

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

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

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Dinny Devitre

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

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

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

Adjusted diluted earnings per share from continuing operations, were up 9.5% to a $1.15 versus a $1.05 in 2006. For the full year, 2007 diluted earnings per share from continuing operations were revised to a range of $4.05 to $4.10, versus previous projections of $4.20 to $4.25. This reflects $0.15 per share of new charges for asset impairment and exit costs, and an additional $0.12 related to PMUSA and an additional $0.3 related to PMI.

The change in guidance reflects the recent announcement by PMI and PMUSA to optimize there worldwide cigarette production and under scores the company’s steadfast commitment to reducing costs. Earlier this morning, PMI announced that it has reached an agreement in principle to acquire an additional 30% stake in its Mexican tobacco business.

PMI currently holds 50% of this business and this transaction would bring the PMI stake to 80% with Grupo Carso retaining 20%. The transaction has a value of approximately $1.1 billion and is expected to be completed later this year. When completed the transaction is expected to increase Altria’s annualized net earnings by approximately $0.3 per share. We are very pleased with our tobacco business in Mexico and today’s announcement further reinforces PMI’s commitment to this profitable market.

Turning to our domestic and international tobacco company results, I’ll start with Philip Morris USA.

In the second quarter Philip Morris USA’s operating company’s income, declined 22.8% to $1 billion. Largely as a result of the $318 million charge related to the closure of Cabarrus, as well as lower volume and increased resolution expenses.

This income decline was partially offset by lower wholesale promotional allowance rates and lower expenses for marketing, administration and research costs. Adjusted for the $318 million charge, Philip Morris USA’s operation income would have increased 1.6% to $1.3 billion.

PM USA’s shipment volume of 45.6 billion units was down 3.3% or 1.6 billion units versus the prior year. In the first half of this year Philip Morris USA estimates that total cigarette industry volume declined between 4% and 5%, and it is maintaining its prior estimate of a 3% to 4% decline in total industry volume for the full year 2007.

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

Marlboro Smooth was launched nationally in March 2007 and the brand is off to a strong start. Today Philip Morris USA announced that it will introduce Marlboro Smooth 100's Box and a new Marlboro line extension, with a single-leaf blend called Marlboro Virginia Blend in September.

In June, Philip Morris USA announced that it will test market Marlboro Snus in the Dallas/Fort Worth, Texas area. Marlboro Snus is a spit-free tobacco pouch product that utilizes a unique flavor strip, does not require refrigeration, and will be available at retail in August.

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

Finally, Philip Morris USA believes the federal excise tax increase on cigarettes under discussion in the US Senate Finance Committee to fund health insurance is unfair and could result in multiple unintended consequences.

In addition to placing an unreasonable burden on adult smokers, an increase in the federal cigarette excise tax could encourage smuggling and illegal cigarette purchases, which can deprive states of much needed funding for important public programs, as well as rob local businesses of much needed revenue.

Philip Morris USA will continue to actively voice its opposition to increasing the federal cigarette excise tax, and I would further remind you that there is a lengthy process requiring action by members of the Senate and the House, as well as signature by the President before any proposal becomes law.

Turning to our international tobacco business; in the second quarter PMI's operating companies income increased 4.7% to $2.2 billion, due primarily to higher pricing and favorable currency of $87 million, partially offset by higher asset impairment and exit costs of $76 million.

PMI's cigarette shipment volume increased 3.3% or 7.1 billion units to 221 billion units, due primarily to the acquisition volume from Lakson Tobacco in Pakistan. Volume gains in several markets, including Argentina, Egypt, Indonesia, Korea, the Philippines and Ukraine, as well as the favorable timing of shipments in certain markets, were partially offset by shipment declines in Germany, the Czech Republic and Russia, as well as Japan, where comparisons to the second quarter of 2006 were distorted by heavy trade purchases in anticipation of the July 2006 excise tax increase.

Excluding the impact of acquisitions, PMI's cigarette shipment volume was down 0.5%.

As described in our earnings release, starting with the second quarter of 2007, we are presenting volume and financial information for PMI's reportable segments of the European Union, Europe, Middle East and Africa, Asia and Latin America. We expect that this would provide investors with an increasingly transparent view of PMI's business, as well as the breadth and scope of its opportunities.

Since the earnings release presents a fairly detailed overview of PMI’s business in its various segments, I will contain my remarks to a few specific subjects and markets.

Volume trends in European Union have stabilized particularly compared to the volatility experienced in the past few years, based on in-market sales as oppose to shipment data, industry volume in the second quarter at 167.3 billion units was down 0.6% compared to the same period last year.

PMI’s in-market sales at 66.4 billion units were up slightly resulting in market share increasing 0.4 points to 39.7%. The increased predictability in the EU presages well for PMI’s overall results.

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

Vending accounted for 15% of industry volume in the second quarter of 2007 versus 23.7% in the comparative period a year ago.

PMI’s share of the vending channel at 51% is over-indexed relative to its overall market share and consequently the decline in vending through-put has adversely affected PMI’s overall market share. The vending universe has declined due to the reduction in machines resulting from new regulations that require electronic age verification.

Marlboro felt the brunt of the vending universe shrinkage more than other brands and its share in Germany declined 2.8 points to 26.1%. L&M performed strongly in the second quarter with share up 2.5 points to 4.7%.

PMI expects the trend in the vending channel to gradually improve. In the second quarter of 2007, the vending channel accounted for 15% of industry volume compared to 14.2% in the first quarter.

In EEMA, PMI has leading shares in the key markets of Russia, Ukraine and Turkey. It is also very well positioned in the Middle East and Egypt.

In Russia, shipments were down 2.6% but PMI's in-market sales were up and share rose 0.2 points to 26.7%, due mainly to market share increases for PMI's high margin international brands Marlboro, Parliament, Virginia Slims and Chesterfield, partially offset by losses for L&M.

PMI is strengthening its brand portfolio in Russia by introducing many new innovative products. For L&M, it has developed new packaging and a new blend flavor system and filter that will deliver a smoother taste. The new line-up for L&M will be launched in Russia during the third quarter.

Other new initiatives in Russia are the recent launch of Marlboro Filter Plus, an innovative new ultra light product, which has been introduced at a premium price to Marlboro, as well as, line extensions for Parliament, Virginia Slims and Muratti.

Driven by improved pricing and favorable mix, PMI's income in Russia is up significantly in the second quarter. In Asia PMI’s volume and profitability were affected by declines in Japan. Volume progressed well in Korea, Indonesia, the Philippines and Thailand and was further buttressed by the acquisition in Pakistan.

In Japan, the industry faced a difficult comparison with the second quarter of 2006, as last years total market was distorted by heavy trade purchases prior to the July 2006 excise tax increase.

As a result in the second quarter, the industry was down 20.3% versus last year. However PMI estimates that the underlying industry decline after the July 2006 price increase has been approximately 6%. PMI anticipates that the distorted comparison against last year will continue into the third quarter of this year, but that by the fourth quarter, the market contraction will return to a more normalized 2.5% to 3% decline.

PMI shipments into Japan were down 8.7%, but this was flattered by favorable distributor inventory movements. Market share for PMI at 24.3% was down slightly although Marlboro share was stable at 9.8%. PMI has recently introduced a number of new products including Marlboro Lights and Marlboro Ice Mint, a new innovative menthol product to strengthen its positions in the highly competitive menthol segment.

PMI estimates that its market sales in Japan will be up in the mid single-digit range, but that shipments will be down in the second half of this year compared to last year. In Indonesia, PMI’s shipments rose 1.3% in the second quarter. Market share was essentially unchanged at 28%, a resilient performance given the tax driven price increase that took effect in May. A Hijau's share rose 0.8 points to 6%, but A Mild and Dji Sam Soe lost 0.6 share points and 0.3 share points respectively, due to low price competition and temporarily widened price gaps with competitive brands.

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

In Latin America, volume was down 2.6% as a result of declines in Mexico and the Dominican Republic, partially offset by continued growth in Argentina. Market share grew an impressive 1.7 points in Argentina to a record 68% due to Marlboro and the continued growth for Philip Morris' brand.

In Mexico the total industry declined 8.6% in the second quarter due to the impact of the excise driven price increase in January of this year, as well as timing of shipments. However PMI’s market share reached a record 64.2%, up 1.4 points on the strength of Marlboro which grew one share point to 47.8% aided by the national introduction of Marlboro Lights in May 2007. Benson and Hedges and the local brand Delicados are also growing strongly.

For 2007, PMI’s volume is forecast to grow between 2% and 3%, including all Lakson volume in Pakistan. Absent Pakistan, volume is expected to be essentially flat. Operating company's income is forecast to increase 5% to 7% in 2007, excluding currency, restructuring charges and the 2006 Dominican Republic gain.

This concludes my introductory remarks, and now I will be happy to take your questions.

Question-and-Answer Session

Operator

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

Filippe Goossens - Credit Suisse

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

Dinny Devitre

Good morning.

Filippe Goossens - Credit Suisse

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

Dinny Devitre

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

Filippe Goossens - Credit Suisse

Okay. And then my second question Dinny, relates to the adjacency strategies, I would expect that given that the Snus category today does not really exist. It will take some time before Marlboro Snus will really have a meaningful impact on your EPS. So, would it be fair to say that over the near term, we may hear from Philip Morris more news in terms of the adjacency strategies that will make a more meaningful impact on the EPS and also would some of these adjacency strategies be suitable to be exported to other markets, let’s say Western Europe which demonstrates today many of the same trends as we are seeing in the US market.

Dinny Devitre

Well, we have announced or PM USA rather has announced that it is going to progress with its adjacency strategy and going to go further into the smokeless category. So I think, you can expect further news from Philip Morris USA. As far as the prospects for Snus you're right, this is a new category and that's why we are going to go about it very carefully and cautiously and that's why we are doing this test -- we did the test market with Taboka. We learned a lot. We are using many of those lessons in the introduction of Marlboro Snus. And now we will gradually step this up and you can expect more news from us in the future. I can't be more specific within that. As far as Western Europe is concerned, well, actually there is a ban on Snus in the EU. But certainly, there could be opportunities for smokeless products in the European Union as well as in the United States.

Filippe Goossens - Credit Suisse

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

Dinny Devitre

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

Filippe Goossens - Credit Suisse

Okay thanks very much, Dinny.

Dinny Devitre

Thank you.

Operator

Our next question is from Chris Growe of AG Edwards.

Dinny Devitre

Hello?

Operator

Chris Growe, you have the floor.

Operator

We’ll proceed with the next question.

Dinny Devitre

Yeah.

Operator

Our next question is from Bonnie Herzog of Citigroup.

Bonnie Herzog - Citigroup

Good morning Dinny, How are you?

Dinny Devitre

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

Bonnie Herzog - Citigroup

Fine, thanks. Just a few questions, just to start-off with international business, listening to your remarks and I correct and sort of my perceptions that you sound may be much more aggressive, your business does in terms of innovation, and therefore as a company, are you getting closer to becoming more transparent, because I do believe this is certainly my opinion that, that is an important aspect, once the two businesses are separated? So, should I read you correctly and sort of assuming that a lot of the new products innovation that you discussed is a positive signal and then you can closure to the eventual breakup of your two businesses?

Dinny Devitre

Well I don’t think the actions that Philip Morris International has taken and continues to take has got anything to do with our restructuring strategy. Those are two different issues. And yes, I think Philip Morris International is taking a number of innovative initiatives and that's going to continue. You are right about the transparency. As you've seen, we presented our reportable segments at PMI for segments that would give investors a lot more information about PMI's business. But again that has got nothing to do with any specific actions that we would take or not take in the future, with regard to the corporation. The fact that we are now purely basically a tobacco company, we would be required anyway to present these various segments. So, I just wanted to clarify that.

Bonnie Herzog - Citigroup

No, it's just my perception and given a sense from listening to you and hearing from the initiatives that your company is undertaking, that it's a positive signal that you are becoming much more aggressive bottom line. That's a good thing.

Dinny Devitre

Good.

Bonnie Herzog - Citigroup

Now secondly, do you have any comments that you would like to share with us regarding the most recent announcement, I guess this morning our time US regarding Imperial and Altadis and how that may affect the global landscape.

Dinny Devitre

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

Bonnie Herzog - Citigroup

Do you know that concerns?

Dinny Devitre

No.

Bonnie Herzog - Citigroup

Okay. And then…

Dinny Devitre

I mean, we respect Imperial Tobacco.

Bonnie Herzog - Citigroup

Certainly.

Dinny Devitre

But, we are not concerned.

Bonnie Herzog - Citigroup

Okay. Turning to the US and Washington, obviously there is a lot going on. Things are incredibly fluid and I have been tracking that very closely and the latest that I have heard is there is a markup today regarding the children's legislation, which would include potentially a tax increase. Could you talk about that and your company's philosophy, and how you will deal with a potential federal excise tax increase and your balance in terms of it passing, or whatever may be, whatever you can share with us would be incredibly helpful?

Dinny Devitre

Yeah. Well, first of all, we are against any increase in the federal excise tax. And as I said earlier, we believe it would be unfair to adult smokers and may have many unintended consequences. The bill is in discussion. I think it has in fact been postponed; the discussion has been postponed to tomorrow or later on today. And so, we just have to wait and see what happens. But, I want to repeat that we are against any increase in the federal excise tax. We really think it would be unfair to adult smokers.

Bonnie Herzog - Citigroup

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

Dinny Devitre

Well, thank you for your survey by the way. But the fact is that the brand is still not in retail and I think it gets to retail in early August and we will only find out at that time.

Bonnie Herzog - Citigroup

No, I mean Marlboro Smooth, not Snus, sorry.

Dinny Devitre

Are you talking about Marlboro Smooth?

Nick Rolli

We have the line extensions to that.

Bonnie Herzog - Citigroup

Yes.

Dinny Devitre

Marlboro Smooth is off to a strong start. And that's why we are extending it into a 100-mm version and we feel very good about it. But I am not going to give you any specific numbers at this stage.

Bonnie Herzog - Citigroup

Okay. Final question. Speaking of Snus and smokeless, certainly there is a shift, and depending on what happens with the federal excise tax increase, which certainly will also include other tobacco products. It's going to depend on the gap. It’s going to depend on how all the manufacturers handle it. If it occurs, where do you see your portfolio makeup in terms of, as you look out the next 5-10 years and I am thinking specifically PM USA? If you use just the first sort of step into smokeless, would you expand like you said into other tobacco products? Do you feel that will become a larger and larger stake of your overall portfolio into a less (inaudible) top-line.

Dinny Devitre

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

Bonnie Herzog - Citigroup

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

Dinny Devitre

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

Bonnie Herzog - Citigroup

Are you ready to go?

Dinny Devitre

We will be ready to go at the appropriate time.

Bonnie Herzog - Citigroup

Done. Thank you. I appreciate your time.

Dinny Devitre

Okay. Thank you, Bonnie.

Operator

Our next question comes from Judy Hong of Goldman Sachs.

Judy Hong - Goldman Sachs

Hi Dinny.

Dinny Devitre

Hi, Judy, how are you?

Judy Hong - Goldman Sachs

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

Dinny Devitre

I think, as I said, the number I gave you was for the first half and I spoke about 4% to 5%. And we give this range because frankly, it's impossible to nail down an accurate number so quickly after the end of the quarter. And IRI themselves, is just one source there are many other sources we look at and coming to our market estimates for the US tobacco industry. I will say that, in the second quarter, the market declined at a lower rate than the first quarter. But, when you combine the second quarter and the first quarter, you look at the year-to-date? We think the decline is very clearly in the 4% to 5% range. We think the decline in the second half of the year is going to be lower in the 3% to 4% range and that's for the full year, the market is going to be down again in the 3% to 4% range.

Judy Hong - Goldman Sachs

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

Dinny Devitre

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

Judy Hong - Goldman Sachs

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

Dinny Devitre

Yeah. Well, first of all let me say that, you are right that the apples-to-apples growth in the second quarter was slightly lower at about 4.1% compared to more like 4.5% or 4.6% in the first quarter and in other word a variety of markets, and fact of that contributed to that, but I think the important thing, is that PMI is going to come in this year with apples-to-apples growth in the 5% to 7% range. That means, PMI is going to have a strong second half and this growth rate by the way is much better than the apples-to-apples or underlying growth rate we've had in the last few years. For example last year, I think our growth rate on an apples-to-apples basis was like 2.5% and so we are more than doubling our growth rate in 2007.

Judy Hong - Goldman Sachs

Then can you just talk about some other factors in the second half that would drive the improvements. I mean, I guess Japan will be key, but?

Dinny Devitre

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

Judy Hong - Goldman Sachs

Okay, thank you Dinny.

Dinny Devitre

Thank you.

Operator

(Operator Instructions)

Nick Rolli

Welcome back to the call, we apologize there was a technical difficulty with the phone line. David Adelman if you are listening, please call in, operator could you take the next question please.

Operator

Thank you. Our next question is from Erik Bloomquist of JP Morgan.

Erik Bloomquist - JP Morgan

Hi good morning Dinny.

Dinny Devitre

Hi Eric.

Erik Bloomquist - JP Morgan

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

Dinny Devitre

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

Erik Bloomquist - JP Morgan

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

Dinny Devitre

Well, that's the way we have been operating in the past and that's the way we are going to operate in the future.

Erik Bloomquist - JP Morgan

Okay thanks. Then with respect to the US and the Federal Excise tax, is it likely that the industry will work together given that the interest seems to be aligned on this in a similar fashion to the way the industry defeated the California proposition to increased taxes?

Dinny Devitre

Yes, that's a fair assumption.

Erik Bloomquist - JP Morgan

Can you give us more color on that?

Dinny Devitre

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

Erik Bloomquist - JP Morgan

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

Dinny Devitre

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

Erik Bloomquist - JP Morgan

Thank you.

Dinny Devitre

Okay.

Operator

Our next question comes from Ann Gurkin of Davenport.

Ann Gurkin - Davenport

Good morning.

Dinny Devitre

Hi, Ann.

Ann Gurkin - Davenport

Wondering if we get start with the FDA, kind of these proposed FDA bill, I guess, the one change I heard is, with respect to the user fees and the language has changed to give you maybe the FDA similar latitude in raising user fees not just based on a volume or market share basis. Can we talk about that? And kind of do you see user fees moving in the direction of what pharmaceutical companies pay to the FDA to support the approval process?

Dinny Devitre

I am not going get into the specifics of that and because quite frankly I'm not an expert on it. And maybe in fact it’s a problem that you know more about the FDA bill than I do, but I know that one of the issues is the user fee but that is under discussion and we'll just have to see what the marked up version of the bill looks like.

Ann Gurkin - Davenport

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

Dinny Devitre

I am not sure.

Ann Gurkin - Davenport

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

Dinny Devitre

I can't comment on that, Ann.

Ann Gurkin - Davenport

Okay. Great. I've heard about the EU, I think issue the tentative report regarding potentially lifting the ban on smokeless tobacco and their comment is due in August, is that correct? Is there any update there?

Dinny Devitre

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

Ann Gurkin - Davenport

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

Dinny Devitre

Well frankly, if we look at the fact that, we are sort of very committed to doing everything possible to get costs down, to be as productive and as patient as possible. And of course the main area in this regard is optimizing the allocation of production between various plants around the world. And we came up with this plan, because we believe it's the best way moving forward. It also prepares Philip Morris USA's for the situation where you have a declining industry here, at the same time PMI had some spare capacity in the European plants and with a minimal amount of expenditure could take on the extra volume, so it all looked work out very well from that point of view and as you know that we’re making the investment in shutting down barriers but the returns are terrific.

Ann Gurkin - Davenport

Okay.Right thanks Dinny.

Dinny Devitre

Thank you, Ann.

Operator

Our next question comes from David Adelman of Morgan Stanley.

David Adelman - Morgan Stanley

Good morning Dinny.

Dinny Devitre

Hi David, sorry you got cut off earlier.

David Adelman - Morgan Stanley

No, that’s okay. I wanted to ask a few things Dinny, first in terms of the consumption decline in the US cigarette market, do you think there is something more effort than simply higher pricing and then lower levels of manufacture promotional spending?

Dinny Devitre

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

David Adelman - Morgan Stanley

Okay. Secondly Dinny if you think hypothetical there will be either in this year or in the future a substantial FET increase. Lets just work under that hypothetical for a second, I mean it obviously goes without saying you have to pass that on to consumers what are the prospects or how aspiration of, do you think it is to believe that the industry would be able to get sufficient incremental pricing above and beyond that to offset the adverse effect of the unprofitability of lower unit volumes.

Dinny Devitre

Well first of all let me again underline that you use your own words. I mean that's a hypothetical situation your outlining and there are a couple of factors we’ll have to look at, first of all whether the extent of the increase, if there is any increase and then whether its phased in or whether all are front loaded and the fact of the matter is that the price elasticity is around point three. So, you'll have to factor that in with any price increase. But I think if you look at markets around the world and you look at the experience in the United States itself after the MSA, I think one can work around increases. Although obviously the kinds of increases they are talking about, which we are very, very much against and which we sincerely hope will get nothing near that will come to pass. But at those levels, obviously there is going to be a hit on industry volume.

David Adelman - Morgan Stanley

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

Dinny Devitre

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

David Adelman - Morgan Stanley

Okay. And then Dinny I know it's very early days on Imperial, Altadis but, what's your position on your willingness to rely on Logista as a distributor in France and Spain, Italy and Morocco if its owned buy Imperial or controlled by Imperial?

Dinny Devitre

At this stage, no change in strategy or philosophy.

David Adelman - Morgan Stanley

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

Dinny Devitre

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

David Adelman - Morgan Stanley

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

Dinny Devitre

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

David Adelman - Morgan Stanley

Indeed, Japan this quarter. Okay.

Dinny Devitre

Yeah, in this quarter.

David Adelman - Morgan Stanley

Okay. All right. Thank you very much.

Dinny Devitre

Okay, David.

Operator

Thank you. At this time, the floor is now open for questions from media representative. (Operator Instructions). Our next question comes from Christine Farkas of Merrill Lynch.

Christine Farkas - Merrill Lynch

Thank you very much. Good morning, Dinny.

Dinny Devitre

Hi, Christine. Good morning.

Christine Farkas - Merrill Lynch

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

Dinny Devitre

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

Christine Farkas - Merrill Lynch

Okay.

Dinny Devitre

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

Christine Farkas - Merrill Lynch

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

Dinny Devitre

No, the volume we include for Mexico are the brands we own. There is another approximately 5 billion units that were Grupo Carso brands which we will now include obviously in our volume going forward.

Christine Farkas - Merrill Lynch

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

Dinny Devitre

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

Christine Farkas - Merrill Lynch

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

Dinny Devitre

No, in fact, I think we are sort of seeing, as I said, in the EU the situation was quite good, it's become stable and predictable if you go across the rest of the geographies, Russia looks like a good consumer. They are trading up and it's becoming more of a premium market.

Japan, we've described the problem in terms of the market declining, it's important in Japan for Philip Morris International to grow its market share and it has plans to do that.

Indonesia looks fine and most of the Latin America also looks, okay. So, I can't see any sort of difficult issues there on the horizon like we were experiencing in the past few years.

Christine Farkas - Merrill Lynch

Okay. Great. Thanks, Dinny.

Dinny Devitre

Thank you.

Operator

Our next question is from Chris Burritt of Bloomberg News.

Chris Burritt - Bloomberg News

Hi, good morning.

Dinny Devitre

Good morning.

Chris Burritt - Bloomberg News

Could you provide some color on pricing perhaps the average price on Marlboro in the US in the quarter versus your earlier quarter?

Dinny Devitre

Yeah. In the second quarter, we were at an average price on Marlboro of $4.17 a pack compared to $3.92 a pack in the second quarter of '06, so that's an increase of about $0.25 a pack in that period. But, the gap would be lowest end of the market continues to remain in that sort of mid 40% range.

Chris Burritt - Bloomberg News

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

Dinny Devitre

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

Chris Burritt - Bloomberg News

Thanks very much.

Dinny Devitre

Thank you.

Operator

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

Dinny Devitre

Hello, Chris?

Operator

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

Thomas Russo - Gardner Russo & Gardner

Hi, Dinny. I have a question, I was a bit late and you might have covered these two topics. One is the question as to what extent you've been receiving back from jurisdictions that held its funds, relating to litigation and the timing of the release and the receipt of those funds. And the second question would have to do with share repurchase and if slashed when that you would turn to having the ability and appetite for share repurchase?

Dinny Devitre

As far as receipt of funds is concerned, the big one of course is Engle, and there are no major hurdles to getting that back as some procedural issue that are ongoing and we expect to receive those funds before the end of these year. And there is about 200 million of other funds which we are expecting the money to come back $200 million and that’s sort of going to come back partly in 2007 and partly in 2008.

Thomas Russo - Gardner Russo & Gardner

Okay.

Dinny Devitre

And the other question was regarding stock buyback and I am not really in a position to preempt the Board on the timing or the amount of stock buyback program. I'd only say that, it’s been Altria’s policy in the past to reward shareholders through dividends and buybacks and at an appropriate point in the future, I’m sure we will return to such a policy.

Thomas Russo - Gardner Russo & Gardner

Okay. Thank you.

Dinny Devitre

Thank you.

Operator

Our next question comes from Brian D'Ambrosio of SuttonBrook.

Brian D'Ambrosio - SuttonBrook

Hi, the market is looking the last major deal out there, I guess, could you further comment on that and then the second is to follow up on the logistical question, is that something that you guys could or would look at given Imperial probably would revealing absence for the business?

Dinny Devitre

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

Brian D'Ambrosio - SuttonBrook

(inaudible) is probably the last major deal out there. So I guess what are the other areas for M&A, even geography or anything any comment you would have on that.

Dinny Devitre

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

Brian D'Ambrosio - SuttonBrook

Okay. Thank you very much.

Dinny Devitre

Thank you.

Operator

Our next question comes from Rafael Urquia of Citigroup. We'll proceed with the next question. Our next question comes from Erik Bloomquist of JP Morgan.

Erik Bloomquist - JP Morgan

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

Dinny Devitre

No, we are going to be probably neutral, with no net debt.

Erik Bloomquist - JP Morgan

Okay. So no net debt, no net cash and that's due to the?

Dinny Devitre

I mean we will have cash and we will have debt roughly equivalent to each other.

Erik Bloomquist - JP Morgan

Okay, very good. Thank you.

Dinny Devitre

Okay

Operator

Thank you there appears to be no further questions at this time.

Nick Rolli

Okay. Well, thank you very much for joining us on the quarterly call, again we apologize for the minor interruption we had and the technical difficulty. But if you do have any additional questions fell free to call Mike Kenny or Anthony Sanchez or me Nock Rolli.

Thank you again for joining us and have a great day.

Operator

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

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Source: Altria Group Q2 2007 Earnings Call Transcript
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