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Philip Morris International Inc. (NYSE:PM)

Q2 2008 Earnings Call

July 23, 2008 9:00 pm ET

Executives

 

Nicholas Rolli - Vice President of Investor Relations and Financial Communications

Hermann Waldemer - Chief Financial Officer

Analysts

David Aldeman - Morgan Stanley & Co., Inc.

Adam Spielman - Citi Investment Research (Europe)

Christine Farkas - Merrill Lynch

Erik Bloomquist - J.P. Morgan Securities Ltd. (UK)

Judy Hong - Goldman Sachs & Company, Inc.

Jonathan Fell – Deutsche Bank Securities

Filippe Goossens – Credit Suisse

Christopher Growe – Stifel Nicolaus & Company, Inc.

John [Blancter] – UBS

Ann Gurkin – Davenport & Company LLC

[Prea Oreguta] – Lehman Brothers

[Pam Duke] – Financial Times

Christopher Barrett – Bloomberg News

Thomas A. Russo – Gardner Russo & Gardner

 

Welcome to Philip Morris International’s second quarter 2008 earnings conference call. (Operator Instructions) I’d now like to turn the call over to Nicholas Rolli, Vice President, Investor Relations and Financial Communications for Philip Morris International.

Nicholas Rolli

Early this morning we issued a news release which contains detailed information on Philip Morris International’s 2008 second quarter results. If you do not have a copy, you may access one on our website at www.pmintl.com. Following the completion of the spinoff, historical basic and diluted earnings per share amounts were recalculated based on the actual number of shares distributed by Altria Group, Inc. on the distribution date.

In our first quarter earnings release we provided a reconciliation of 2007 reported results to 2007 pro forma adjusted results by quarter and for the full year. For your reference this document is also available on the website.

As we take you through our second quarter earnings results today, please note that we will refer to certain results as being after adjustment. This will imply that this data has been adjusted for the impact of currency and acquisitions. Furthermore to provide you with a pure organic comparison we will also exclude the impact of the transfer of our US duty-free business to Philip Morris USA in August last year. This latter adjustment is not included in the numbers in our press release issued today.

Please also note that unless otherwise stated we will be talking about results in the second quarter 2008 and comparing them with results in the same period in 2007. References to international tobacco market shares are Philip Morris International estimates based on a number of sources.

Today’s remarks contain forward-looking statements and projections of future results and I direct your attention to the Safe Harbor statement in today’s presentation and news release for a review of the various factors that could cause actual results to differ materially from projections.

And now it’s my pleasure to introduce Hermann Waldemer, Chief Financial Officer for Philip Morris International.

Hermann Waldemer

As you have seen from our press release we have reported excellent second quarter results. These results combined with our continued strong business momentum, currency favorability, higher pricing in a number of markets such as Italy and Russia, and planned reinvestments in key markets have enabled us to raise our annual guidance. Our revised adjusted full-year diluted EPS guidance for 2008 is between $3.32 and $3.38 representing a growth rate of between 19% and 21%. Diluted earnings per share were $0.86 up 22.9% or $0.16 per share. Of this increase $0.06 or about 40% of the increase reflects the strength of our business and favorable currency accounts for the other $0.10. In the first half of the year reported EPS was up 26% or $0.36 per share with business growth and currency each accounting for about half.

Net revenues excluding excise taxes were 15% higher at $6.7 billion representing an increase of $874 million. After adjustments, net revenues increased by 4.4% driven by higher prices as well as improvement volume and mix in several key markets. Reported operating company’s income for OCI increased by 23.7% to $2.8 billion. After adjustments, OCI was 9.8% higher. We achieved double-digit OCI growth in EEMA, Asia, and Latin America. Our cigarette volume reached 223.2 billion units an increase of 1%. Organic volume increased by 0.6%. Strong growth was achieved notably in Argentina, Egypt, Indonesia, Korea, Mexico, Russia and Ukraine. This is an improved performance that reinforces our confidence that we can achieve our longer-term goal of 1% to 2% volume growth.

Marlboro shipment declined by 2.4% or 79.1 billion units. After taking into account the impact of the transfer last year of our US duty-free business, Marlboro shipments were up in all geographical regions except the EU. The brand continues to perform strongly in Argentina, Egypt, Indonesia, Korea, Mexico, Romania, Russia and Ukraine. Our [enormative] line extensions are helping to strengthen the vitality of the brand and its overall equity.

Increased shipments of Parliament and Virginia Slims have reinforced PMI’s leadership position in the premium segment. Parliament shipments were up 28.1% thanks to tremendous momentum in Korea, Russia, Turkey and Ukraine. Virginia Slims shipments increased by 12.2% reflecting both volume growth in existing key markets such as Japan and Korea as well as the penetration of new markets such as Greece and Romania.

Our two key brands in the mixed price segment are L&M and Chesterfield. Outside of the EEMA region the volume of L&M grew by 3.4% driven by France, Germany, Netherlands and Poland. L&M is the second largest brand in the cigarette industry in the EU region behind Marlboro and over the last 12 months has been the fastest growing brand in Germany. We have revamped the brand in Russia and Ukraine. While L&M shipments continue to decline in these markets, we were able to more than offset this volume decline through higher shipments of Chesterfield. Chesterfield sells at a premium to L&M and consequently generates higher margins. Globally, we are delighted by the performance of Chesterfield as it maintained its very strong momentum with an increase in shipments of 18%.

Our key brands are in good shape and we are continuing to strengthen our international brand portfolio leadership through the development of a successful innovation pipeline. We have talked to you previously about the success of Marlboro Filter Plus in a number of markets. Let me share with you some other examples. Marlboro Intense is a rich flavorful usually shorter cigarette in the red pack. It was launched initially in Turkey and more recently in Belgium and the Netherlands. In Italy a lighter-tasting version was launched in March as Marlboro Compact in a silver pack. To support our leading position in the growing menthol segment we have launched Marlboro Crisp Mint, Marlboro Fresh Mint, and Marlboro Ice Mint in a number of markets in Asia and Latin America. These refreshing products are performing well. For example, Crisp Mint reached a 1.4% share in Hong Kong, Fresh Mint 0.4% in Malaysia, and Ice Mint 0.3% in Japan. I will discuss our latest menthol innovation Marlboro Black Menthol when I talk specifically about Japan later.

We have successfully developed a number of new products in response to an increase in demand in several markets for cigarettes with a slimmer diameter. Premium-priced Virginia Slims UNO has notably achieved an 0.3% market share in Greece and Romania in May and an 0.2% share in Japan in the quarter. Mid-priced L&M Link has achieved a 1.5% market share in Poland.

Let me now take you through the designs in key business developments in our four regions. Industry volume in the EU region is estimated to have declined by 3.7% during the second quarter driven by the one-time impact of recent public smoking restrictions, higher prices, and the long-term decline in smoking incidents. Our shipment volume decreased by 4.4% to 64.8 billion units and our estimated market share was down slightly to 39.4%. Revenues net of excise taxes after excluding the very positive currency impact declined by 1.7% and OCI was essentially stable. These results were impacted by the total market declines and the need to temporarily absorb some tax increases in the Czech Republic and Poland where we had shorter inventory durations of OTX products than our competitors. During the first half of the year revenues net of excise taxes in the region were essentially stable and OCI increased by 5% net of currency.

Business fundamentals in our four key new markets continue to strengthen. In Germany our adjusted cigarette market share was up 0.3 points to 37%. L&M is growing and Marlboro is sequentially improving its share. We also expanded our position in the important German fine cut category with a market share increase of 4.8 points to a record quarterly level of 16.5% thanks to our enormative tobacco block and the strength of our L&M and Next brands. Our profitability in Germany is both in the quarter and the first half of the year.

In Italy and Spain we continue to improve our profitability during the quarter. Our share is up in the first half in both markets. Chesterfield is performing very well and Marlboro is resilient. In France while share is down on a year-on-year basis by 2.5 points due to the impact of a less favorable price point for Marlboro. Our market share of 40.9% has been stable since the fourth quarter of last year.

The outlook for the EU region is improving. We have recently announced price increases in Italy, the Netherland, and Switzerland and have strengthened our competitive position in the important German market. Public smoking bans have now been implemented across most of the yield and we expect a one-time impact on total industry volume to have been largely absorbed by year end. The very large tax-driven price increases in Central Europe related to EU excision are moderating. The Czech Republic has now reached the excise tax level currently required in the EU. Hungary, Poland and Slovakia should reach it next year.

In this context I would like to comment on the update to the tobacco excise directive that the EU Commission is proposing. First, I would like to emphasize that we welcome the review as it is an opportunity to improve the framework for excise taxes in the EU. Second, a proposal essentially in land was what we had expected following a broad consultation. The next step is for the EU Commission to discuss the proposal in detail with the member states, a process that will allow individual countries to convey their views one each element of the proposal. As a unanimous agreement is needed on every proposed change to the current directive amongst the 27 EU member states, we expect that the proposal will be modified prior to its finalization which is foreseen during the second half of next year. We are pleased that the EU Commission recognizes that there is little justification for significant differences in the taxation level for cigarettes and fine cut products. We also welcome the proposed increased flexibility to be given to governments in terms of the excise tax structure and the level of the minimum excise tax. We, however, regret that the Commission has not taken this opportunity to propose an abolition of the excise incidents rule and are concerned that tax increases resulting from the proposal could have unintended consequences in certain EU countries if implemented as currently proposed.

During the second quarter the EEMA region continued to achieve very strong results with volume up 3.2%, net revenues excluding excise taxes and currency 10.2% higher, and OCI excluding currency increasing by 22.9%. We are benefitting from the premium SCU of our portfolio as consumers continue to trade up. The resulting volume growth and improved product mix has been further boosted by price increases, thus driving profitability to record levels. Russia is central to these excellent results with PMI shipments increasing by 8.3%. Continued strong consumer up-trading has benefitted Chesterfield, Marlboro and Parliament. Revenues net of excise taxes and currency rose by 24% driven by favorable volume and mix and higher prices. This has enabled us to increase profitability to record levels. Our shipments grew by 2.9% in Turkey. While our share was essentially stable we benefitted from consumer up-trading with very strong Parliament growth. This more favorable mix along with higher prices has been driving profitability. In the Ukraine, shipments increased by 8.2% driven by Chesterfield, Marlboro, Parliament and Virginia Slims. As a result our market share reached a record level of 35.2%. Our profitability will be further boosted by the recent retail price increases in this important market.

Cigarette volume in Asia grew by 1.9% to 56.8 billion units with growth in Indonesia and Korea more than offsetting the decline in Japan. Marlboro is performing very well across the Asia region with a volume increase of 1.8%. Marlboro Filter Plus and Marlboro Mix 9 Kretek have reinforced the brand’s equity helping to drive the brand synergy to record levels in Korea and Indonesia and Marlboro continues to perform strongly in the Philippines. Marlboro’s success is complemented by the tremendous performance of Parliament driven by Korea whose shipments were up over 50% in the region and Virginia Slims which experienced double-digit growth. Revenues net of excise taxes were up 4.9% excluding currency. We achieved a 15.2% increase in OCI net of currency. In Asia, excellent results notably in Australia, Indonesia and Korea more than offset the decline in Japan. We are very proud of our results in Indonesia. Our shipments there were up 14.9% as our entire portfolio grew with A Mild and Marlboro performing particularly well.

Let me focus for a moment on Japan. During the second quarter industry volume was down by 1.6% helped by freight purchases in advance of the implementation of the new vending age control mechanism. PMI shipments meanwhile declined further by 7% due to the declining total market and an optimization of stock coverage levels. Our share reached 23.9% which was open 3 points below the prior year’s level but stable compared to both the first quarter of this year and the last quarter of 2007. Marlboro’s share remains stable at 9.8%. We are launching Marlboro Black Menthol during the first week of August to reinforce the brand’s performance. This enormative new product has a unique refreshing mint flavor and provides a bold cooling sensation. Lark’s share of 6.8% was marginally down from last year but slightly up compared to the first quarter of 2008. Recently launched Lark Menthol X has achieved a market share of 0.3% and the new Lark Classic is doing well in test markets. Virginia Slims has continued to expand to reach a market share of 2.1% driven by the successful launch last year of Virginia Slims Noire. These results show that our increased focus on innovation is starting to have a positive impact and we expect improved results going forward fueled by additional marketing investments. While we are focused on restoring share growth momentum, we are also very conscious of the pressures on profitability from a declining market which is subject to price controls. While we oppose the recent call for a massive tax and price increase we believe that this debate may encourage the government to consider revising the tobacco law to allow pricing freedom.

Latin America had another very strong quarter on all accounts. Our cigarette shipment volume was up 7.9% and 1.3% excluding acquisition driven by strong results in Argentina and Mexico partly offset by Colombia. In Argentina our shipments increased by 8.8% and we gained 1.9 points to reach a market share of 70.3% driven by Marlboro and the Philip Morris brand. In Mexico the total market remains stable while we were able to increase our market share by 3 points to 67.2% driven by Benson & Hedges, Delicados and Marlboro. In Latin America as a whole our revenues net of excise taxes increased by 8% excluding currency and acquisitions while our OCI was 15% higher on the same basis.

Let me say a few words about our actions to enhance shareholder value. On May 1 we started our two-year share repurchase program. Since then we have spent $2.1 billion out of the $13 billion approved by the Board of Directors. In total we have so far purchased 41.4 million shares at an average price of $51.48. On June 18 we announced our first quarterly dividend as a public company of $0.46 a share. As stated previously we expect to return a total of $21 billion to shareholders over the next two years which reflects about 20% of our current market capitalization. In order to help finance these and other business requirements, we successfully erased $6 billion in May and the US dollar bond offering at what we believe our attractive rates. During the second half of the year we intend to continue to access the capital markets provided financing conditions are suitable.

To sum up, our business in EEMA, Asia and Latin America are performing very well. We have strong volume growth and improved mix and higher prices and margins. The outlook for the EU region is improving with pricing power remaining strong and an enhanced competitive position notably in Germany. Japan remains a challenge due to continued to price controls in a declining market. We have however stabilized our market position and have the strategies in place which we believe will enable us to grow share again. Enhanced innovation is driving better organic volume and we are on track with our productivity saving programs and our financial measures to return significant cash to our shareholders. As you can see, we are delivering against the targets that we established and shared with you in March.

I will now be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from David Adelman - Morgan Stanley & Co., Inc.

David Adelman - Morgan Stanley & Co., Inc.

First, with respect to share repurchases, what’s the argument against maintaining for the foreseeable future the execution pace in the second quarter? You are basically buying back $1 billion a month. Why not keep that going?

Hermann Waldemer

On the share buyback we have always been and will stay on a steady pace there. We actually did opportunity purchases given the attractiveness of the share prices and will continue to do that when appropriate.

David Adelman - Morgan Stanley & Co., Inc.

Why weren’t diluted shares outstanding? They were flat sequentially. Why weren’t they down Q2 versus Q1?

Hermann Waldemer

We started the share repurchase on May 1. Remember there is the 30-day delay after being quoted so it starts only on May 1 and then it is going in weighted averages so it washes in over time.

David Adelman - Morgan Stanley & Co., Inc.

Could you clarify your comment in your prepared remarks with respect to the EU tax proposal about regretting the absence of an abolition of excise tax incidents rule? What specifically are you referring to there?

Hermann Waldemer

Article 4 Excise Review. The way I would put it is I see three good elements in there, one watch-out, and I would say one overriding remark which is probably what I should start with. The overriding remark is that any change to the existing laws, the existing directive, needs unanimous agreement of all 27 member states. So therefore that’s going to take a while and I expect something final say in the second half of 2009. Then the watch-out which is precisely your question is the proposed incidents increases that you see in the proposal. That could trigger price increases, excise driven price increases in some markets which could actually lead to the known undesired side effects from counterfeits to border sales to all these things that we have seen before. So that’s really what I would call the watch-out. But very importantly let me also say about the good things in there, because it’s really three good things. More flexibility on the minimum excise tax which right now is capped at 100% of the most popular price class; that’s a good one and important one. Proposing to raise the specific element which today can go up to 55% to 75% is another very good element in there. And the partial alignment of roll-your-own make-your-own at two-third of cigarettes taxation is also a good element.

David Adelman - Morgan Stanley & Co., Inc.

Are you willing or prepared in Germany to have Marlboro at a per-pack price point above 5 Euros alone as you’ve repeating the situation you’re suffering through in France?

Hermann Waldemer

Of course future pricing, I will not comment on that. We will decide once the moment is there. I think that’s what I have to say on pricing in Germany.

David Adelman - Morgan Stanley & Co., Inc.

It’s early days but is there any evidence in the market place of any change in the behavior of Altadis/Imperial subsequent to the consummation of that merger?

Hermann Waldemer

No, not really, this is competition. There has been competition before. We will have to see. Certainly there will be a lot of integration going on in these companies but we focus on our own place here and really everybody around to target increased revenues and increased profitability in our own place. That’s what we concentrate on.

Operator

Our next question comes from Adam Spielman - Citi Investment Research (Europe).

Adam Spielman - Citi Investment Research (Europe)

First of all, have you seen either in the second quarter or in your trading since then any signs at all that a weakening economy either in the European Union or elsewhere is causing either weakness in volumes or weakness down trading? I know for example that you’ve seen some down trading away from over in France, but we saw that in the first quarter. What I’m interested in is whether there has been any incremental worsening really anywhere in the world? That’s my first question.

Hermann Waldemer

Starting with the EU region the down trading we have seen there in the last couple of years, that was mostly triggered by price repositionings of previous mid-price and even premium brands by competition to the low end. While there’s nothing left I’m afraid to be priced down there by competition, so that is over. We are operating in a more normal competitive situation going forward. If I then expanded the other, on a worldwide basis in light of increasing inflationary pressures, rising food prices, and all of that, then actually I must say we can see that Indonesia would eventually be a market where you could expect to see something like that. We don’t. Actually our volume in Indonesia is up 14.9%. The market overall is up in Indonesia and that is an environment with high inflation and with reduced fuel subsidies for the people earlier this year. So we can’t see there. If I go over to Latin America, there actually we have to see that Latin America is rather a part of the world which is a source of commodities and where actually salary increases are still in most places above inflation, so we don’t see that either. So cigarettes are probably a fairly resistant product to these type of things. The only place where I could see a little bit of that would eventually be Colombia where you see it at the lower end of the price spectrum where you see some impact there. More stick purchases and less purchases overall but there it’s the lower bracket income class of population because in that very same market by the way Marlboro is growing.

Adam Spielman - Citi Investment Research (Europe)

Actually you already touched on what was going to be my second question which is to really focus on Indonesia. Obviously in May the price of gasoline went up by 30% I believe. Your volume as you say in the second quarter was exceptional. But if we can just look forward, firstly what do you think volume is going to look like because presumably it’s going to have to slow down from 15%? And also just to reiterate, you see no signs that the increase in fuel is having any impact on your business even in July in Indonesia?

Hermann Waldemer

No. I cannot exclude that for the future that this is going to have an impact at a certain point in time but right now I just do not see that. I agree with you that 14.9% volume growth is of course an exceptional number and will not be a number that keeps on going there for the next 10 years, but no we don’t see any of that. What is of course important in the context probably is as well that [inaudible] you have roughly I would estimate an inflation of 10% in Indonesia. Cigarette prices were up about 6.5% so a little bit below inflation. And if you go through our portfolio Marlboro is up 27%, A Mild is up 20%, and DJI Sam Soe is up 4% so this is really going very, very nicely. And we also express our confidence going forward in that market by putting the Greenfield there which actually the official opening is going to be on August 20.

Adam Spielman - Citi Investment Research (Europe)

In your earlier remarks you referred to price increases in Italy, in Holland or the Netherlands, and Switzerland. Are those very recent increases or were those ones back in Q1?

Hermann Waldemer

No, no. These are recent increases. The Italy price increase for example if I remember correctly was the last week of June.

Operator

Our next question comes from Christine Farkas - Merrill Lynch.

Christine Farkas - Merrill Lynch

On the cost savings you did talk about cost savings being on track. Will you quantify those? Do you plan to give us an update for example in dollars or perhaps where you may have allocated these cost savings so far year-to-date?

Hermann Waldemer

On the productivity and cost savings we are on track. We will meet our productivity and cost savings target over the next three years of $1.5 billion. So if I may go through a little bit the main elements and what are we doing there. In manufacturing where we said $850 million in manufacturing productivity. The first big element there is the resourcing of volume from USA factories to PMI factories. We will be one or two months ahead of schedule with bringing that over. Remember that was almost $180 million by 2009. Perfectly on track. The clustering which was all regrouping the technical functions and procurement functions in about 10 places around the world is progressing. Rationalizing non-strategic SKUs, product specification simplifications, is an ongoing job as we go ahead. On the $450 million G&A procurement, the headcount reductions in the regional and PMI HQs are essentially done. The financial service centers are up and running. The human resource shared service centers are being implemented as we speak and are being rolled out. And the other, essentially by the end of the year you can say we will have implemented one SAP program around the world as an REP backbone system for the company. And in the EU the cost cutting program that is also part of the secret of our profitability increase in addition to of course the pricing variance there; we keep on going there. We have an early retirement program for example in Germany in our one-time charge is this quarter, so we keep on going. So we’ll stay on track with all of that and we will give a detailed review once a year.

Christine Farkas - Merrill Lynch

You certainly did talk about Indonesia. Can you tell us what your share was in the quarter?

Hermann Waldemer

Indonesia is actually a very difficult place in terms of news and shares. The shares in Indonesia show us essentially stable shares given the volume increase that I know for sure because these are simply sales and revenues. I would rather think that those shares for the moment are somewhat understated in Indonesia.

Christine Farkas - Merrill Lynch

I was just curious given you’ve provided that share in the past but not this quarter it looks like. It’s at least stable if not higher.

Hermann Waldemer

The share numbers as I have in front of them, they are stable; they’re not higher, but there is always a certain delay in certain floors. It’s a big country. It’s difficult to measure.

Christine Farkas - Merrill Lynch

On Poland, just as a broad statement I was pleased to see underlying organic volume growth. So that’s favorable. And looking at a country like Poland and keeping your comments about trading up across many of your regions, we should be lapping the price increases soon I believe but remind us when that is. But there’s also some down trading. Can you just put the two in context as to how the outlook is for that market?

Hermann Waldemer

Poland is a very important market. I would talk about 65 billion cigarettes market and another probably 7 billion to 8 billion in roll-your-own cigarettes tobacco. In 2007 this market really turned into a much more profitable market. The problem in Poland for the time being is still the missing forestalling regulations, i.e. these huge durations of old priced old taxed products that are in the market. You had some competitors, some brands, in there with durations of up to one year so when the consumer sees the new price, actually the next price has already taken place. So that’s a bit unfortunate and it’s because we’re a big company in that market. It forced us to do some absorption in the second quarter of excise taxes which is something we really don’t like to do unless we are forced to do, which we were here in Poland and actually also in the Czech Republic.

In Poland this is the last round that is coming, the last excise increase in the context of EU excision fortunately on 2009. So we will have one more round of this gain so it’s going to normalize in the third or fourth quarter of this year but it’s going to restart then as of January 2009. However the good thing is as well that there are a couple of excise structure improvements eventually considered in Poland although forestalling regulations will not come unfortunately in 09, or unlikely to come.

So going forward we are soon out of that effect of the EU excision and that then will be the moment that actually there is room for up-trading in that market. Today there is not much up-trading in that sense if you like because prices are going up already that steeply. Once they stabilize we will benefit actually from our premium portfolio and what you see now in terms of down-trading what you talked about is really rather at the very low end of the market and is traditional 70 mm products. At the end of the day we made a conscious choice there between volume share and profitability for the sake of profitability.

Operator

Our next question comes from Erik Bloomquist - J.P. Morgan Securities Ltd. (UK).

Erik Bloomquist - J.P. Morgan Securities Ltd. (UK)

Implicit in the increased guidance is a slowdown in the second half in terms of the earnings per share. I was wondering if you could talk about the places where we should be thinking that there is going to be a sequential slowdown in the second half versus what we’ve seen in the first half?

Hermann Waldemer

It comes down to the overall guidance development there. What we took into account is the business momentum overall which is very positive to start with. The currency projections of course and importantly as I said already in the first quarter the spending pattern which has skewed anyway towards the second half. And the additional investments that we are making into the markets, they will actually also hit the market and be visible to the consumer and therefore will hit the income statement also principally in the second half so that’s our additional investment. And of course financing costs go up with the build-up of the leverage on our balance sheet. In terms of investment where we go, that of course Japan is one of the places to go but I wouldn’t go into individual markets because that would be too sensitive from a competitive point of view.

Erik Bloomquist - J.P. Morgan Securities Ltd. (UK)

So is it fair to characterize what you’re saying that the slowdown in the second half EPS is more driven by PMI investment than by any anticipated slowdown in your markets?

Hermann Waldemer

That’s right, I would say. If you look at growth that you have seen in the first half of the year in the actual, as we said it’s 50/50 between currency and business. Actually for the second half I see a higher proportion of business than currency of the growth.

Erik Bloomquist - J.P. Morgan Securities Ltd. (UK)

Second question is with respect to Japan. I was wondering if you could talk a little bit more about the potential for a Japanese large tax increase and also expand on your comment that PMI hopes that the discussion on tax could lead to a reform of the Japanese tax structure.

Hermann Waldemer

The proposal that is on the table is being discussed now. Let’s first really properly situate what that is. It is a group of 45 members of Parliament that have gotten together and are developing that proposal. There are hearings that are bringing that proposal together. But it remains a proposal that then goes to the Budget and to the Finance Ministry which is the decision body. So therefore also in terms of timing that goes to that decision body somewhere towards the end of the year and you will not see any impact of whatever the outcome is before sometime like spring next year.

Then I would say that all around the world governments have seen that abrupt increases don’t work. I think that the real chance in there is that this can lead to a discussion of the imbalance in the system that you have today. You have price control on one hand, you have the wish to reduce consumption from the health side on the other hand, you have government stake in one of the top four cigarette companies around the world, and then at the end of today you have price control in the Japanese home market. So over time I would think and I would hope that this could lead to a better discussion about how to bring that forward in terms of eventually moderate regular excise increases accompanied by pricing freedom in the market. So let’s hope that this is a trigger point that can lead to a decent discussion on those points.

Erik Bloomquist - J.P. Morgan Securities Ltd. (UK)

My last question is related to the current EU tax proposal. As you noted in your remarks one of the things that they’re doing is increasing the potential level of minimum excise tax. As I recall from the Spanish experience in 2006, that tended to benefit premium brands. Is that a fair way to characterize one of the outcomes of this tax proposal is we should see a benefit through the EU as it’s implemented over time toward more premium product?

Hermann Waldemer

I would think so. As a government you don’t want to raise your taxes and therefore prices on one hand and then see the people simply trade down and actually deliver less taxes and smoke as much as before. Then as a government you have neither achieved the Finance Ministry targets nor the Health Ministry targets. Spain is a good example there that of course minimum taxes at an effective level put limits to down trading and therefore achieve on one hand the government’s targets and should help actually then the more decently priced products on the market.

Operator

Our next question comes from Judy Hong - Goldman Sachs & Company, Inc.

Judy Hong - Goldman Sachs & Company, Inc.

First, just clarification in terms of your guidance and you talked about some of the drivers, but can you quantify how much is currency driven versus operating performance that’s coming in better than expected?

Hermann Waldemer

What we took into account are of course also, as I said before, the currency projections, I think I will go that really for the increase that you will see in the second half that really the business portion of that is really the more important part than the currency part. But I wouldn’t want to split it up in detailed numbers.

Judy Hong - Goldman Sachs & Company, Inc.

If we look at your EU performance in the second quarter, your operating profit was flat if you take out currency versus the first quarter where operating profit was actually up 9% and the volume decline really didn’t change much from quarter to quarter. So I’m wondering why the operating profit actually slowed down in the second quarter versus the first quarter? And secondly, in relation to that, you sound actually more optimistic about EU outlook going forward despite the second quarter performance, so if you could talk a little bit more about what gives you comfort that the trends will improve and as you look out for the balance of the year, are we expecting that EU profit to actually see positive trends in the back half of the year?

Hermann Waldemer

There are two rather I would call them almost short-term effects that you see in the EU and actually if you look through the markets, about 50% of EU markets are actually affected by one of the two effects that I will describe. The first one is that actually smoking bans are now implemented essentially everywhere in the European Union and then of course as well all know, there’s a more or less strong one of impact and then it goes back to normal trends. So that is of course hurting overall total markets and therefore the volumes of the market participants. Take Germany, UK, France, Portugal together then the market decline in those in the second quarter is 6.1% and revenue decline in those markets in the second quarter is 3.8%, so that’s very much driven by that but as we all know this is a one-time one-off impact.

And then the second short-term effect is really the EU tax formalization in the excision countries which as I said is essentially done by year end. Poland’s to come on January 1, 2009 so going into 2009 otherwise it’s just Hungary, Slovakia, and in 2010 you will have Romania, Bulgaria, Baltic but all the rest is done. The big ones are done. On the positive side going forward is that the pricing power is intact so we have realized substantial pricing in the EU so in the quarter $77 million and that’s despite the fact that we absorbed for Czech and Poland together $45 million again for this stalling effects that we had in those two markets so that’s a one off. The hit was in Q2, that’s not something that comes every quarter as I said before. We hate doing these things unless we have no choice for competitive reasons so we did it.

 

Judy Hong - Goldman Sachs & Company, Inc.

And the price increases you’ve taken in Italy and Netherland and Switzerland, can you quantify the magnitude of the price increases?

Hermann Waldemer

The price increase in Italy we did is essential 10 Euro cents across the board, Switzerland is essentially 20 [inaudible] across the board and Netherlands is, if I remember correctly, is 40 Euro cents. Again, for example Marlboro going to $4.40.

Judy Hong - Goldman Sachs & Company, Inc.

How do we think about your operating profit growth this year coming in well above your long term target of 6% to 8% even with some of the challenges that we’ve talked about in the EU that should get better going forward? When we think about that 6% to 8% long term growth outlook and we look at this year’s performance, is that number maybe somewhat conservative in your view and if trends stay relatively stable that there’s actually potential for growth targets to be actually higher than what we are at, at this point?

Hermann Waldemer

No. Guidance is our mid to long term guidance and that guidance remains unchanged. So, if I look at this year’s results, then we are simply pleased to see that our innovation activity really begin to pay off, that we see improved organic volume growth on our way to our midterm target. We are not there yet. So, that’s a positive. We see that our productivity cost reduction programs work, we see that we are able to realize pricing around the world so we are happy about the conciliation but that doesn’t change our midterm guidance.

Operator

 

Your next question is from Jonathan Fell – Deutsche Bank Securities.

Jonathan Fell – Deutsche Bank Securities

A couple of things, first of all, on EU I just wanted to clear up this Czech and Poland thing. Is there going to be any effect of you swallowing excise increases in those countries in the third quarter, or has that already unwound as we speak?

Hermann Waldemer

Most of it is done.

Jonathan Fell – Deutsche Bank Securities

And the other thing on the EU was I think last quarter when we were speaking about this, there was some prospect in Germany of registration which could put a minimum pack size of 20 cigarettes in place. Where have we got to on that debate now?

Hermann Waldemer

Well, we continue to support it as I said last time. However, we regret that as it looks like now, the 20 pack rule will not be implemented in the short term. That doesn’t mean that it cannot come back.

Jonathan Fell – Deutsche Bank Securities

Any particular reason why? What has caused you to think it won’t be implemented in the short term?

Hermann Waldemer

That’s the news that I have, that it is not being implemented so all I can say and repeat and that is what we have also told the German government that we do support such a change in the law.

Jonathan Fell – Deutsche Bank Securities

As I look at your quarterly rate of dividend now, $0.46, even at the low end of your EPS guidance range for this year $3.32, the payout ratio will be coming in at 55% against your target of 65%. Are you expecting the board to review that dividend rate at the end of August?

Hermann Waldemer

Well, the payout ratio is 65% as you correct say. We are now at $0.46 which is 3.5%, 3.6% dividend yield. This is an entirely decision of the board. We have regular board meetings throughout the year, yes there is one at the end of August. We will see, this is in the entire discretion of the board.

Jonathan Fell – Deutsche Bank Securities

But they haven’t indicated to you yet when they might review that rate. Because, most companies it’s not a secret really when they start to review dividends.

Hermann Waldemer

The Board will decide. It is a Board decision.

Operator

 

Your next question comes from Filippe Goossens – Credit Suisse.

Filippe Goossens – Credit Suisse

You talked about pricing in Italy, Switzerland and the Netherlands but can you maybe just broaden the comments a little bit and talk to us about how the pricing environment or competitive environment more specifically is in the European Union and how you look at potential room for price increases in both Germany and Spain? If my memory serves me right, I think Germany the last time you took pricing was in October, 2006 where Spain was, I think, early 07.

Hermann Waldemer

I’m afraid I’m sorry I will not comment on future pricing. I can only really comment on what we did and I think our actions speak for themselves.

Filippe Goossens – Credit Suisse

Then second question, can you talk a little bit about the ongoing restaging on L&M in the Russian market please?

Hermann Waldemer

In the Russian market, L&M you’ll remember that we had revamped L&M both in the Ukraine and in Russia. Yes, L&M is still declining in the Russian market, that’s right. But, if you take then as a comparative loss in the Ukrainian market where actually we did the change already before Russia, i.e. first. There, we can now really see improvement so it is really declining much less now in the quarter than it did before so we see rejuvenation of both the brand franchise and a more effective smoker profile. But, I’d like to focus there really as well on the portfolio aspect of our franchising the market. We have tracked ourselves with just a number of the smokers that are actually leaving the L&M franchise and as Chesterfield is priced 2 Rubles higher than L&M, this is actually a much better margin. And, if you take L&M and Chesterfield together, then actually the Chesterfield growth outweighs the decline of L&M.

So, we keep on working on L&M but I urge you to look at it in a portfolio comparison as well and not only for the L&M brand but on L&M itself we keep on going with our programs. We said from the very beginning that this is not going to be a short term fix.

Filippe Goossens – Credit Suisse

Moving on to the Czech Republic, Hermann when will the inventory adjustment be anniversaried?

Hermann Waldemer

Well, it depends if you talk about our brands then probably we will be the ones who bring the new consumer prices to the consumer first. As I said, you had a couple of market participants in the restorations after one year so we will have to see when that comes. But, I would expect in the Czech Republic that the fourth quarter becomes a normal quarter and then actually 2009, we could come back to a normal fair environment overall where there is normal competition in the markets. So, 2009 should be a normal market. It’s now we’re working our way through a messed up market. I think it’s important also to mention here that the Deputy Ministry of Minister of Finance of the Czech Republic, although the final decision comes later in the year, has said that there are no plans to increase tobacco excise tax again as of January 1, 2009. So, yes we should have it behind us soon I hope.

Filippe Goossens – Credit Suisse

In the US historically people have always assumed that price elasticity of demand is about .3. We’ve never really focused on the European Union in terms of what price elasticity is there. But, the question I really have Hermann, based on how you’re seeing things develop, particularly in the European Union given rising inflation across the board. Do you think that this inflation is starting to perhaps have an impact on price elasticity? In other words, its wanting to raise pricing 5% per annum let’s say if there’s no inflation in the general economy but with household product companies, personal care companies, them raising pricing anywhere between 5% and 10%, could that ultimately have an impact on the price elasticity of demand for cigarettes? Have you done any work on this so far Hermann?

Hermann Waldemer

That is actually something that is just almost impossible to answer. Yes, we have done some work but it’s impossible to come to a clear conclusion. You actually can argue the other way around, you can say that in a highly inflationary environment, people are more use to price increases because they see it in all products everyday while in a low inflation environment, if your cigarette prices go up only and nobody else’s prices go up, it might be even more difficult. So, you can turn it around the other way. All I can say is what I said earlier, that so far we haven’t seen impact of inflationary pressures on our product. And, overall, I think it is fair to say that cigarettes in general can withstand such an environment better than any or most other consumer products.

Operator

 

Your next question comes from Christopher Growe – Stifel Nicolaus & Company, Inc.

Christopher Growe – Stifel Nicolaus & Company, Inc.

Could you quantify in the quarter or give us a feel for how much your volume was down in the Czech Republic? I know that’s been a tough market but what decline would you have seen in that market this quarter?

Hermann Waldemer

A quarter number for the Czech Republic, I don’t have here but it is such a screw up at the end of the day in that market that you really have to wait until it washes out. At the end of the day, if the measures we took on the marketing side, on the pricing side, on the absorption side, we have defended our cake in the market, if you like, and we look forward to a more normal situation next year.

Christopher Growe – Stifel Nicolaus & Company, Inc.

Am I correct that you’ve already raised your prices to reflect the new tax level in the Czech Republic?

Hermann Waldemer

You will see in the third quarter, it will be the first one to pass on really to the consumer.

Christopher Growe – Stifel Nicolaus & Company, Inc.

As you’ve raised your guidance for the year have you also reflected perhaps some increases in marketing or promotion in this higher guidance? Are your spending levels going higher even as your guidance is going higher?

Hermann Waldemer

Yes, we have reflected in that guidance that we have skewing of expenses towards the second half and we have reflected in that guidance the additional investments that we plan to make in a number of markets.

Christopher Growe – Stifel Nicolaus & Company, Inc.

In the quarter, Marlboro was a little weaker than I expected but you did have a little tougher comparison there too. But, given all the new product benefits, a pretty robust R&D pipeline across your portfolio, is the second half of the year when you’re closer or on track with getting at least in the range of your long term volume growth of 1% to 2%? Or, is the second half a period where you could see that even being a little below that long term guidance?

Hermann Waldemer

We will keep on working as much as we can on our innovation pipeline, on excellence in marketing of sales out in the markets. We are really pleased to see the improvement in the second quarter here. We will do everything to stay on track and to keep on improving and to keep on refilling the innovation pipeline.

Christopher Growe – Stifel Nicolaus & Company, Inc.

Then in the second half could volumes be up closer to 1%? Or, should we see consistent progress we should say sequentially in your volumes?

Hermann Waldemer

I wouldn’t want to change the volume projection that we had given earlier for the year. I would rather prefer that we keep on working as good as we can.

Operator

 

Our next question comes from John [Blancter] – UBS.

John [Blancter] – UBS

First of all you [inaudible] a number of times that the market expense is going to go up in the second half. As a percent of net revenues, was there growth in the first half or was it essentially flat as a percentage of sales in the first half?

Hermann Waldemer

Flat in the first half, growth in the second.

John [Blancter] – UBS

Secondary, on the proposals to include this idea of a much closer alignment between tax on factory made cigarettes and roll you own, what do you think the future of roll your own is within the European Union if this proposal is passed in any shape or form?

Hermann Waldemer

Look first, the proposal is not full equalization so therefore there will be always a role for that segment because even in that proposal there remains a substantial size differentiation tax advantage still for this type of product so there will be always that part of the market. Will there be in such a conciliation more up trading to cigarettes? I would hope so. Nevertheless, we are also very present in that market and we are increasing as we speak our presence in that market. Take Germany as the best example or take the acquisition of the InterWorld trademark as the second example, there is always some market there, even with such a change in the excises.

John [Blancter] – UBS

But do you think it’s likely to cause some double digit or significant declines in volumes in some of those markets where at the moment [inaudible] questions on the tax even if the market continues to exist?

Hermann Waldemer

There wouldn’t be very much speculation at this point in time. Let’s wait until we have something more final there on what is really going to come out of the commission. Then, you can see what that means in terms of rollover prices and then we can have a better view of that that can eventually mean. That’s too early.

John [Blancter] – UBS

Lastly, just on Japan, you obviously mentioned the cigarette market was down 1.6% because of trade purchases prior to the implementation of the vending machine age verification I didn’t realize that the market was reacting quite in that way. Why was there a big trade impact because of the change in vending machine age verification and also my understand is that age verification had been done, [inaudible] in machines over time and implemented at the time. Secondly, how successful, how’s the implementation of this tax payable card been? As there been a rapid shift? Is there an ongoing rapid shift from vending to OTC in Japan?

Hermann Waldemer

First, in terms of implementation there has been implemented really by region, by area so now in the Tokyo area was the last area that was being implemented now actually in July so it’s fully rolled out. Now, you can in every area you had the load and the deload impact but when one deloaded the next area loaded so it’s very hard to read for the moment what the real impact is. We will know in the next two or three months because now it’s everywhere. As for card, actually when it started as low as 15% or something in the area when it was the first area when it was rolled out, in that very same area the penetration is now about one third of the people who have that card so it’s improving but it’s of course, still far away from 100% of the smokers applying for such a card. So, over time it will increase. Will there be a substantial shifting to convenience stores? Yes. And that’s of course, what we have prepared in our sales programs.

John [Blancter] – UBS

Does that mean that there might well be quite a substantial asset write off of a lot of these vending machines that exist both all of the packing companies and some of the retailers as well.

Hermann Waldemer

Now, I can of course only speak for ourselves. In our case, we did adapt our vending machine product somehow before all that came in to place so it’s not a surprise for use and therefore there are no surprise write offs that I would expect in that area.

Operator

 

Your next question is from Ann Gurkin – Davenport & Company LLC.

Ann Gurkin – Davenport & Company LLC

I just want to ask you about lease costs that you all highlighted in our March presentation. I think $550. Is that still a number you’re using?

Hermann Waldemer

In the lease situation is as I said before, this stays an area of concern. Supply is below demand but really let me focus on that this is manageable. Just maybe best is I give you the proportion of simply our numbers of the first half. We have lease inventory sitting on our balance sheet of $4.1 billion. That means a duration of our lease inventories are well beyond one year. The year-to-date income statement costs expense of lease in the first half of the year is $1.7 billion. You have to put that in to relation of the net revenues excluding excise tax which is $13 billion and the actual price impact that we have had, price increase impact that we have had year-to-date in June, is some $50 million. So, it’s there, $50 million is $50 million and we take it serious and you look at that how to increase supply but the overall thing is of course manageable.

Ann Gurkin – Davenport & Company LLC

But that $550 number, is that still a number you are using through 2010 or is that number going up?

Hermann Waldemer

The number you have been using is correct, yes.

Ann Gurkin – Davenport & Company LLC

If I could get an update also on China. I think you are all licensing Marlboro production with the Chinese and vice versa distributing some of their brands. Can we just get an update on that?

Hermann Waldemer

The China domestic, the license production has actually started in two factories in [inaudible] and [inaudible]. So, we are very pleased, that’s a major step forward and the products will be on the Chinese market in the month of August. On the international JV side, we are also progressing. RGD, Red Golden Dragon which has been launched in Czech is having 0.5% share, 0.4% in Slovak and has just now been launched also in Poland. [Dubellis] we are doing which is a mid-priced brand, we are doing test market launches now in the Ukraine and in Russia. It’s launched in Romania this year and by the end of the year you’re going to have six market launches out of the international JV so yes, we are making progress, steady progress going forward.

Operator

 

Your next question comes from [Prea Oreguta] – Lehman Brothers.

[Prea Oreguta] – Lehman Brothers

You indicated at the end of your remarks that you would expect to continue to access the capital markets in the second half of the year provided that markets are suitable. Now, in the past I believe that you had indicated that if you were to come to market again it would likely be in Europe. I wanted to know if that was still the case and then secondly if you could just highlight your leverage target for the end of the year?

Hermann Waldemer

Yes, we of course look at other currencies so your first question clearly, it is not just the US dollar but it’s also the other major currencies like Euros, Swiss Francs, that’s what we look at. The leverage for the year, well right now we are at net debt to equity ratio something like 0.4 so we keep ample flexibility and in that sense nothing has changed in terms of what we have said earlier, i.e. what the share repurchase program is so on and so forth. But, that’s the way we go.

Operator

 

Your next question is from [Pam Duke] – Financial Times.

[Pam Duke] – Financial Times

What are your credit facilities at the moment? And, do you have any idea how much you would access in the second half?

Hermann Waldemer

Well, we will decide how much and the amounts once we get to the market so that is something I wouldn’t want to reveal already right now. You have seen that we have done a very successful $6 billion bond offering in May at really what we believe very attractive rate at a weighted average of 5.7%. That I believe, really, really good. And, we look at the other ones as they come and we look at the right moment and what the market gives and then we look also at the right size so it’s nothing you really can say well ahead.

[Pam Duke] – Financial Times

And the funds raised, would that be to continue the share buyback program or are you looking to perhaps fund acquisitions?

Hermann Waldemer

Look, it is for the overall business. These funds provide us the flexibility for all of it, for share buybacks, for acquisitions should there be attractive acquisitions. We always look at them but, I will of course, not go further than that. So, really for the overall business, it’s nothing earmarked specifically to one or the other activity.

[Pam Duke] – Financial Times

This time last year we were just costing a big wave of consolidation within the tobacco sector. Do you think there is still room for further industry consolidation?

Hermann Waldemer

I do not expect the large scale industry consolidation that you have seen the last two years, I would not expect anything of that size.

[Pam Duke] – Financial Times

And given the sales and revenue performance in your European business, I was just wondering whether you can perhaps elaborate a bit more on your strategy for Europe? How you plan? Do you think sales or revenue will stabilize any time soon? Or, are we looking at a continued decline in the European market?

Hermann Waldemer

The European market I would say is a market where of course, in terms of overall market size this is going to continue to decline. I think that European markets, EU markets will probably decline on the midterm basis between 1% and 2% going forward. That doesn’t necessarily mean that revenues decline because, as I said, the pricing power is intact so whilst volume will certainly go down in that part of the world, that does not mean that therefore profitability is going to go down. That’s the big difference to say the emerging markets but, both mature and emerging markets in that sense are good markets, they’re just different.

[Pam Duke] – Financial Times

Do you see any acquisition opportunities as far as your European business is concerned at the moment? You mentioned earlier that the money raise is not earmarked for anything specific but, if there are any attractive acquisition activities that would be something you would consider.

Hermann Waldemer

We always look at acquisition opportunities around the world and if they are a strategic fit and if they have attractive financial returns then we look at that wherever that is around the world. At the same time, we certainly have the financial flexibility to do them if we want to do them but, otherwise I really have to stop it there because I cannot go in to geographies or potential targets.

[Pam Duke] – Financial Times

Would [inaudible] be a market PMI would be interested in getting in to?

Hermann Waldemer

Well, we are overall a tobacco company and not just a manufactured cigarette company.

[Pam Duke] – Financial Times

Is that a yes?

Hermann Waldemer

I think that’s the answer.

Operator

 

Your next question comes from Christopher Barrett – Bloomberg News.

Christopher Barrett – Bloomberg News

Could you provide an update on your activities in China and how soon we’re going to see the cigarettes coming and going to and from that country?

Hermann Waldemer

It really is our business in China is twofold as I said under China domestic side we are very pleased at the localized production for Marlboro in those two Chinese sectors has started and on the international JV side where we are working with our Chinese partners on the commercialization of Chinese heritage products in the international arena. That is key to our relationship. I believe that we are today, and that has always been our target the preferred partner of CNTC, China National Tobacco Corporation, this is a huge company, this is a huge market and anything there you will see it will take time. This is not for tomorrow. In our guidance we have always said that we don’t expect in the short term substantial impact on our financials these volumes will be in dollars. However, going forward, this is of course an extremely important business development market and here I close the loop, that’s why we are happy that we have made progress again in the last couple of weeks with the startup of the licensed production of Marlboro.

Christopher Barrett – Bloomberg News

So, would it be accurate to say that Chinese smokers are now able to buy Marlboros made in their country? Or, is that still in the production distribution stage?

Hermann Waldemer

It is being produced now. Distribution will start in August however, there would be certainly more demand in China than the supply will be. This is a supply driven market, not a demand driven market so it’s not that Marlboro is available in any desired quantities around the country, it is a stock.

Operator

 

Your final question comes from Thomas A. Russo – Gardner Russo & Gardner.

Thomas A. Russo – Gardner Russo & Gardner

Hermann, in your release you mentioned that one interesting factor was the Marlboro impact of the allocation of duty free in the US over to Altria from PMI and I wonder how, as you look out over time and PMI develops a portfolio in local markets and starts to look different from Altria’s portfolio, how will this relationship best serve PMI’s interest when travelers returning to their home lands look to buy products in duty free that may bear no relationship to those products which Marlboro naturally addresses? So, how will you get the proper marketing support and encouragement for those travelers with this arrangement?

Hermann Waldemer

Look the split of the trademark between geographies is nothing unusual, you see it in many other trademarks as well. The genes and the origins of the backbone of Marlboro is what Marlboro stands for and nobody on either side of the Atlantic is going to change what really Marlboro stands for. That being said, Marlboro has always been adaptive to the tastes, to the preferences of the consumers around the world and it’s actually extremely important. The best example is probably Marlboro Filter Plus which has tremendous success in a number of markets. Take one, Romania, it’s now 1.5% national share and 2.3% in the City of Bucharest. I bet you that Marlboro Filter Plus is a one milligram product, would not sell much in the US so it’s a normal situation I would think and nothing that concerns me.

Thomas A. Russo – Gardner Russo & Gardner

Then thinking about some questions about the dividend payout ratio and it raises a broader question about the role of currency and reported results. Assume a year and a half from now we have a vastly different currency picture, what steps does PMI take going forward to protect against the possible reverse of the dollar’s decline on its OCI and then its net? And then accordingly, on the dividend that you would natural project from that net income? What steps do you take to buffer against the OCI impact of currency?

Hermann Waldemer

We always look at transactional exposures. I’ll give you one example. For example, the dollar dominated purchases of leaf tobacco, that’s something that we always look at but it’s always transactional hedges. We have not done in the past, and it’s not our policy to do respective hedges there going forward. I believe, we stick to our business, to our underlying business that has always been our philosophy in that area.

Thomas A. Russo – Gardner Russo & Gardner

By the way, just as a side, the fact that you’re up and running in China, and it wasn’t really highlighted on the printed release, I think you’re being far too modest. I know that Lewis has spent an enormous amount of time getting to this point and I would have thought you would have celebrated it a little bit more that you’re actually up and running and producing in China. That’s quite a milestone. Are there any Virginia blend Marlboros or is it an American blend Marlboro that’s being produced? Are there any other western manufacturers in such a position today?

Hermann Waldemer

It is an American blended product that is being produced there, it is a true Marlboro in there. TH difference, and I will let others speak for themselves but the difference really is that we have an agreement with the top of China National Tobacco and not just with a factory somewhere in the country. That I think is key to future success. We are happy about it, about the recent achievements in China, believe me.

Operator

 

I would like to hand the floor back to management for any further or closing remarks.

Nicholas Rolli

Thank you very much for joining us today. I just want to let everyone know that the investor relations team is available in Switzerland if you have any follow up questions and you can reach us at the telephone number that’s in our press release today. Thank you for joining us and have a good day.

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