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Altria Group, Inc. (NYSE:MO)

Q3 2012 Earnings Call

October 25, 2012, 09:00 am ET

Executives

Brendan McCormick - VP, Investor Relations, Altria Client Services

Marty Barrington - Chairman & CEO

Howard Willard - EVP & CFO

Analysts

Judy Hong - Goldman Sachs

David Adelman - Morgan Stanley

Chris Growe - Stifel Nicolaus

Thilo Wrede - Jefferies

Vivien Azer - Citigroup

Bonnie Herzog - Wells Fargo

Michael Lavery - CLSA

Thomas Russo - Gardner, Russo & Gardner

Nik Modi - UBS

Karen Lamark - Federated Investors

Andrew Kieley - Deutsche Bank

Michael Felberbaum - Associated Press

Operator

Good day and welcome to the Altria Group 2012 Third Quarter Earnings Conference Call. Today’s call is scheduled to last about one hour including remarks by Altria’s management and a question-and-answer session. (Operator Instructions) Representatives of the investment community and media on the call will be able to ask questions following the conclusion of the prepared remarks.

I would now like to turn the call over to Mr. Brendan McCormick, Vice President, Investor Relations, at Altria Client Services. Please go ahead, sir.

Brendan McCormick

Good morning and thank you for joining our call. I am joined this morning by Marty Barrington, Altria’s Chairman and CEO and Howard Willard, Altria’s Chief Financial Officer. This morning we will only be discussing Altria’s business results for the third quarter and first nine months of 2012 and will not be discussing the status of tobacco litigation.

Our remarks contain forward-looking and cautionary statements and projections of future results, and I direct your attention to the forward-looking and cautionary statement section at the end of our earnings release for the review of the various factors that could cause actual results to differ materially from projections. For a detailed review of Altria’s business results, please review the earnings release that is available on our website, altria.com.

Altria reports its financial results in accordance with US Generally Accepted Accounting Principles. Today’s call will contain various operating results on both a reported and on an adjusted basis, which excludes items that affect the comparability of reported results. Descriptions of these measures and reconciliations are included in today’s earnings press release and are available on our website. In addition, comparisons discussed in this conference call are to the same prior-year period unless otherwise stated.

Now it gives me great pleasure to introduce Marty Barrington.

Marty Barrington

Thanks Brendan. Good morning everyone and thank you for joining our call. Altria delivered solid financial results for the third quarter and first nine months of 2012 while taking steps to strengthen its ability to create shareholder value in the future. Our tobacco businesses grew their adjusted operating companies’ income and expanded their margins for both the third quarter and first nine months of 2012.

Each of our tobacco companies also grew their retail share for the same time periods while investing to develop their brands for the long-term. Products introduced in recent years continued to support these income and retail share gains. Our tobacco companies remain focused on developing and commercializing innovative new products to meet the volume preferences with all tobacco consumers.

The business performance of our operating companies enabled us to increase our already strong cash returns to shareholders. Altria increased its dividend by 7.3% in the third quarter, our 46th dividend increase in the last 43 years. We also returned cash to shareholders by repurchasing over $260 million of our stock during the quarter. Earlier today, we announced a $500 million expansion of our current $1 billion share repurchase program.

We also took steps to enhance our capital structure during the quarter. We purchased high coupon debt and issued new lower cost debt. These actions reduced our 2018 and 2019 debt maturity tariffs, lowered our future interest expense and reduced our weighted average coupon rate.

Altria grew its 2012 adjusted diluted EPS by 3.6% for the third quarter and 7.8% for the nine months. These results were consistent with our expectations and include the negative impact of an increase in Altria’s 2012 full-year effective tax rate on operations related to the debt tender offer.

Smokeable Products segment delivered solid adjusted OCI growth and adjusted OCI margin expansion for the third quarter and nine months through higher list prices and effective cost management. We coupled this solid OCI growth with retail share gains on Marlboro.

Marlboro’s new brand architecture has contributed to the brand’s results. Marlboro’s brand building initiatives across our four product families have included a successful expansion of new products, equity building promotions that engage millions of adult smokers and promotional offers intended to generate trial and conversion by adult competitive smokers.

In addition, PM USA expanded Marlboro NXT, a product in Marlboro Black family into 27 states at the end of third quarter. Marlboro NXT contains capsule technology that allows adult smokers to switch from non-menthol to menthol taste. Marlboro’s growth was complemented by retail share gains by L&M in the Discount segment.

PM USA strong shipment volume outperformed the industry and its principal competitors on both a reported and on adjusted basis. Black & Mild also delivered strong retail share growth for the third quarter and nine months behind products that were introduced in recent years. Black & Mild’s results also benefited from the 2012 third quarter introduction of Black & Mild Jazz into select geographies and its seasonal offering Summer Blend.

In smokeless tobacco, USSTC’s objective is to increase its income through volume growth primarily by focusing on Copenhagen and Skoal. USSTC aims to maximize the combined performance of these two leading premium brands by focusing on strengths of each brand.

Copenhagen and Skoal grew their combined reported shipment volume and retail share for both the third quarter and the first nine months. This performance helps the Smokeless Product segment growth it’s quarter and nine month adjusted OCI and adjusted OCI margins.

Copenhagen continue to be the primary driver of volume and retail share growth as it benefited from new products introduced in recent years including the recent expansion of Copenhagen Southern Blend. Skoal’s volume and retail share comparisons were impacted by competitive activity and Copenhagen’s strong performance. Skoal’s nine month comparisons were also impacted by last year’s SKU delisting and the introduction of Skoal X-TRA.

USSTC is taking steps to improve Skoal’s performance and recently announced fourth quarter expansion of Skoal ReadyCut into over 20 states. Skoal ReadyCut offers adult tippers and easier to control long cut product.

In the Wine segment, Ste. Michelle delivered strong adjusted OCI results for the third quarter and nine months through higher pricing, higher shipment volume and improved premium mix.

We are pleased with our business results through the first nine months of 2012 and reaffirm and we expect to deliver adjusted diluted EPS growth of 7% to 9% for the full year, representing a range of $2.19 to $2.23 per share. We also expect to deliver full year reported diluted EPS between $2.03 and $2.07 per share.

I will now turn things over to Howard, who will discuss our business results in more detail.

Howard Willard

Thank you, Marty. Good morning everyone. In the Smokeable Products segment third quarter reported operating company's income grew by 3.9%, primarily due to higher list prices, effective cost management and higher reported shipment volume. These favorable factors were partially offset by higher promotional investments behind Marlboro’s new brand architecture, increased resolution expense and unfavorable mix due to L&Ms volume growth in Discount.

For the first nine months reported operating companies income increased 4.2% primarily due to higher list prices, effective cost management and lower charges related to tobacco and health judgments. These favorable factors were partially offset by higher promotional investments behind Marlboro, increased resolution expense, unfavorable mix due to L&Ms volume growth and lower reported shipment volume.

Excluding special items identified in our earnings press release, 2012 adjusted operating companies income for the Smokeable Products segment increased by 4.3% to $1.6 billion for the third quarter and 3.7% to $4.7 billion for the first nine months.

Adjusted operating companies income margin income margin from 0.4 percentage point to 42.4% for the third quarter, an increased 0.8 percentage point to 41.6% for the first nine months. PM USA’s reported cigarette shipment volume increased 1.2% for the third quarter, primarily due to retail share gains and changes in trade inventories; partially offset by the industry’s rate of decline and one less shipping day.

PM USA believes the trade depleted less inventory during the third quarter of 2012, versus the prior year period benefiting comparisons of reported shipments. For the first nine months of 2012, reported cigarette shipment volume declined 0.4 of a percent, primarily due to the industry’s rate of growth partially offset by volume growth as a result of retail share gains.

When adjusted for trade inventory dynamics and other factors PM USA estimates that its adjusted cigarette shipment volume was down approximately 1% for the third quarter and 0.5% for the first nine months. Total cigarette category volume was estimated to be down 3.5% for the third quarter and 3% for the nine months.

PM USA increased its retail share by 1.2 share points to 49.9% for the third quarter and by 0.8 of a share points to 49.8% for the first nine months of 2012. Marlboro gained a share point to deliver a 42.7% retail share for the third quarter and was up 0.5 a share point to 42.6% for the first nine months.

For the third quarter and the first nine months PM USA’s discount portfolio increased its retail share by 0.6 of a share point to 3.9% and 3.8% respectively, as L&M share gains were partially offset by basic share losses.

Reported cigar shipment volume was down 14% for the third quarter, primarily due to the timing of promotional shipments and other changes in trade inventories and one less shipping day, partially offset by volume growth from retail share gains.

Middleton believes the trade built inventory in the third quarter of last year prior to Middleton’s December 2011 price increase announcement, which impacted volume comparisons. For the first nine months Middleton’s reported cigar shipment volume declined 0.6 of a percent primarily due to changes in trade inventory, partially offset by retail share gains.

Black & Mild retail share increased to 0.8 of a share point to 29.9% for the third quarter, and was up 1 share point to 30.1% for the nine months primarily driven by the success of its Classic, Sweets, Wine and Jazz untipped cigarillos.

Turning to smokeless products, third quarter reported operating company's income was up slightly to $246 million and grew 2.7% to $678 million for the first nine months of 2012, primarily due to higher pricing, higher volume and effective cost management. These favorable factors were partially offset by growth in products introduced in recent years at a lower popular price, higher restructuring charges related to our cost reduction program and higher promotional investments.

When adjusted for special items, primarily related to restructuring charges the smokeless products segment operating company's income increased 3.3% to $254 million for the third quarter and 6.2% to $705 million for the first nine months of 2012.

USSTC and PM USA’s reported smokeless product shipment volume increased 5.9% for the third quarter, driven by Copenhagen strong 12.1% volume growth as well as Skoal’s 2.8% volume gain.

Partially offset by volume declines in the balance of the portfolio. Shipment volume for the first nine months of 2012 increased 1.9% as volume growth on Copenhagen was partially offset by volume declines in the balance of the portfolio.

When adjusted for changes in train inventories and other factors, USSTC and PM USA estimated that their combined 2012 third quarter adjusted smokeless products volume grew approximately 5%. USSTC and PM USA further estimate that the smokeless product category grew by approximately 5% over the 12 months ended September 2012.

USSTC and PM USA’s retail share of the smokeless products category increased 0.4 of a share point to 55.5% for the third quarter and 0.5 a share point to 55.4% for the first nine months of 2012.

Copenhagen and Skoal delivered strong combined retail share growth of 1.6 share points for the third quarter and 1.8 share points for the nine months.

Copenhagen grew its retail share by 2.3 share points for the third quarter and 2.4 share points for the nine months.

Skoal’s retail share declined 0.7 of a share point for the third quarter and 0.6 of a share point for the nine months as comparisons were impacted by the factors mentioned earlier

In the wine segment, St. Michelle grew its third quarter reported operating company income by 13% to $26 million. When adjusted for the impact of 2011 costs related to the UST acquisition, third quarter operating company’s income increased 8.3%.

For the first nine months of 2012 reported operating company’s income grew 16.7% and adjusted operating company’s income increased 8.6%, excluding acquisition related costs from last year. St. Michelle shipment volume increased 3.7% for the third quarter and 4% for the nine months.

The financial services segments third quarter reported an adjusted operating company’s income decreased 4.8% to $79 million, primarily due to a $35 million decrease in the allowance for losses that favorably impacted operating company’s income in 2011. This factor was partially offset by 2012 third quarter recoveries related to PMCC’s leased investment with American Airlines which filed for bankruptcy in November 2011.

For the first nine months of the year, the financial services segment’s reported operating company’s income increased by more than 100%, primarily due to PMCC’s leverage lease related charge of $490 million in the second quarter of last year higher gains and asset sales, recoveries related to America Airlines and a decrease in the allowance for losses that favorably impacted operating company’s income earlier this year.

These favorable factors were partially offset by lower lease revenues in 2012 and a 2011 decrease in the allowance for losses that favorably impacted operating company’s income last year. Excluding the leverage lease charges the financial services segment’s adjusted operating company’s income grew by 32.1% to $173 million for the nine months.

PMCC allowance for losses at the end of the third quarter was $99 million versus the $188 million at the end of the second quarter of 2012. This reduction reflects write-offs related to the American Airlines bankruptcy.

Altria repurchased 7.7 million shares of its common stock in the third quarter, for a total cost of $262 million. Earlier this week Altria’s Board authorized the expansion of our current share repurchase program by $500 million to $1.5 billion. Altria has $550 million remaining in this expanded program that it intends to complete by the end of the second quarter of 2013. This program remains subject to the discussion of the Board and market conditions.

During the third quarter UST repaid $600 million of debt the matured in July. Altria also purchased $2 billion of notes during 2018 and 2019 with coupons of 9.7% and 9.25 respectively.

In connection with the debt tender offered, the company issued $1.9 billion in new 10 year notes with the coupon rate of 2.85% and $900 million in new 30 year notes with a coupon rate of 4.25%. Our current cost management program remains on track and we have recorded net pretax charges of $264 million over the past four quarters.

We expect to incur the remaining pretax restructuring charges in the fourth quarter of 2012. Charges related to this program is reflected in full year diluted EPS guidance. Marty and I are now happy to take your questions. While the calls are compiled let me cover a few housekeeping items. Marlboro’s price GAAP versus the lowest effective price cigarettes was 36% in the third quarter. Marlboro’s net pack price in the third quarter was $5.79 while the lowest effective price cigarette was $4.24. The cigarette discount category’s retail share was 27.4% for the third quarter. The estimated weighted average cigarette state excise tax as of the end of September was $1.41 per pack, an increase of $0.04 per pack versus the prior year.

Copenhagen’s third quarter retail price was $4.08 and its price GAAP versus the leading discount brand was approximately 37% in the quarter. CapEx was $38 million for the third quarter and $77 million for the first nine months of 2012.

We estimate that our 2012 full year CapEx will be between $100 million and $125 million. Ongoing depreciation and amortization was $56 million for the third quarter. We estimate that 2012 full year ongoing depreciation and amortization will be approximately $230 million.

Operator, do we have any questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We will take questions from the investment community first. Our first question comes from Judy Hong of Goldman Sachs.

Judy Hong - Goldman Sachs

Marty you saw in the last couple of days you know obviously we've heard from your competitors about the promotional environment and so their view that you as a price leader is pressuring the pricing environment and basically putting pressure on the overall industry profit pool. So maybe just if you can just give us your perspective on your promotional strategy and how would you sort of defend against those comments from your competitors?

Marty Barrington

Listen I'm not going to comment on what other folks are saying. I will tell what we are trying to do. What we are trying to do in this multiple segments is to maximize income while maintaining modest share momentum on Marlboro; that has been the strategy for some time that strategy remains constant. We have I think a good plan in place for 2012 to execute against that strategy and that's what you see playing out in the marketplace. We are implementing a new Marlboro architecture which is part of our investment in Marlboro. What I would say is that, it’s a competitive industry, it’s always been competitive, it’s competitive today, likely to be competitive as we go forward. I don't see anything that particularly unique about it. Marlboro is investing in its new architecture and that's a wise thing to do because Marlboro has been the engine of income growth in this multiple segment for Altria Group. So that's how we look at it and we are pretty happy with how that's playing out this year.

Judy Hong - Goldman Sachs

Okay and if I sort of look at your income growth this year on this multiple segment, so you are sort of down kind of 0.5% to 1% volume. You are getting pricing sort of 2% to 3%. Your operating profit up 4% to 5% and then if you look at the last couple of years you had volume down sort of 4% to 5%, pricing up 5% to 6%, getting to a similar operating profit growth of sort of 4% to 5% pricing up 5% to 6%, getting to a similar operating profit growth of sort of 4% to 5%. So if you kind of take us through your thought process and one versus the other in more price driven strategy as opposed to more share and volume driven strategy. From your perspective, kind of how you think about which is maybe the more appropriate strategy either in the near or longer-term basis?

Marty Barrington

I just want to return to what I said is that the strategy is to maximize income while maintaining moderate share momentum on Marlboro. It's not a question of choosing different strategies as much as it is. There are ways to grow income. We talked about cigarette pricing. Pricing is of course important in cigarette category. It has been important, it will remain important but of course you can grow your income through other ways and we’ve spoken about this previously. We're trying to manage our cost structure as efficiently as we can. You saw the PM USA took a higher list, took list prices up in the middle of the year. We reduced our promotions actually, our promotion allowances on Marlboro as we’ve gone through the year.

We will recall that on Marlboro special blend, we had geographies where it was promoted at $0.75, other geographies where it began at the dollar and within the year those allowances have come down not once but twice, first to $0.90 and then to $0.85. We've spoken about Marlboro Black. We had promotional allowances to generate trial and conversion among adult competitive smokers. We produced those allowances as well similarly to Marlboro special blend.

So for us, and we’ve talked about this previously, it's a balance between maximizing income while never taking your eye off of Marlboro which is after all the driver of that success from time to time and we don’t look at this necessarily quarter-to-quarter as much as we look at it overtime because if you look how Marlboro has grown overtime that’s how its happen whether it was Marlboro Red in the 50s or Menthol in the 60s or Gold in the 70s or now Black, we grow it overtime that’s how we think about it overtime and guess what it’s been a great contributor to the growth in adjusted EPS that it’s our long-term goal.

So that’s kind of how we think about it Judy and I guess the last thing I would say on it for context is the macro environment is a factor right, we continue to be in an environment out of the great recession where the recovery has been modest at best. Consumers remained under pressure, tobacco consumers remain under pressure. We have to meet the consumers where they are and so in that environment it’s hardly surprising that pricing may be a bit more restrained than in periods where housing is booming and unemployment is low and everybody is feeling good and consumer confidence is high that is not the situation the data tell us otherwise so that’s not to be discouraged about it and there are some signs that it may be improving and we sure hope so, but that’s how we have been thinking about it which is trying to be sensible in that environment following our strategy, maximizing income and keeping Marlboro healthy.

Operator

Your next question comes from David Adelman of Morgan Stanley.

David Adelman - Morgan Stanley

I also wanted to ask you a couple of pricing based questions in the cigarette category I probably doesn’t surprise you.

Marty Barrington

Glad to have your question in any event David.

David Adelman - Morgan Stanley

Whether it’s the economy or the competitive stat or the equity of Marlboro, do you think there is a practical matter you are in a position where if you take more pricing than the category Marlboro share doesn’t grow like last year or if you take less pricing than the category Marlboro share does grow which is this year?

Marty Barrington

Well, I think it’s our job to manage that balance honestly David, that's the short answer which is, if you are trying to maximize income like we are, we want to of course try to do that as best we can. At the same time, you want to make sure that Marlboro is healthy. Marlboro is one fantastic brand right, it’s got high equity, it can command premium pricing, it has high loyalty but it’s not the only brand in the marketplace. And we try to be cognizant of both the macro environment and the competitive environment and our job is to balance that equation.

If you look at it, it’s tempting again to look at a sort of within the quarter. But if you look at Marlboro share growth what do we see sure its up in the third quarter, but actually for the nine months what should up, it’s up five-tenths. If you look at it over a longer period of time, but you look at it say from, well I don't know, let's call the end of the third quarter of 2008 to the end of the third quarter of 2012, Marlboro shares up eight-tenths. So eight-tenths over four years, I think we would characterize that as moderate share momentum and I think it shows in the equity and the brand, there shouldn’t be any mistake that pricing is important and it will continue to be important but it is a balance and we are trying to be sensible about how we will do it, I think that's how we think about it.

David Adelman - Morgan Stanley

Okay, and there is a follow-up question. Marty both with Marlboro but also Copenhagen and Skoal, if you look at the smokeless business, the growth and the brand initiatives have been principally at price points below the traditional full price premium brand, whether it’s Copenhagen Wintergreen or Skoal X-TRA or bulk of the Marlboro line extensions and clearly you have manage that from a price mix perspective and a profit delivery perspective, but the question I wanted to ask you in that context is, what's the risk of that two years from now or three years from now that those efforts have in effect eroded the premium brand equities; you do account for a lot now of those brands respective market shares?

Marty Barrington

Yeah, I think we are quite confident in the equity of those brands David and there's good reason to be confident in those brands. If you look at Marlboro again, just to take Marlboro before we go to smokeless, remember Marlboro all sells at the same list price, right. So what you see in the marketplace so is the implementation of different promotional allowances to achieve different aims. And we've spoken about this previously with you and others on the calls, but just to take one second, special blend well for example is to make sure that for more price sensitive consumers in the franchise that they have a place to go during this difficult economic period.

Your strategic choices obviously are you cannot meet them where they are in your franchise with a big huge brand like Marlboro and you can let them go. We think the better strategy is to have a price point for them within the franchise and retain their business and I think that makes good sense and by the way you see that the margin increases at the Marlboro level again, so we are managing the margin there.

If you look at the brand equity components of Marlboro they continue to be extremely small, right. We've shared the TNS scores overtime, it has high brand loyalty. The price gaps were so constant during the worst recession you would have thought that you would have seen an erosion in equity that they wouldn't command those price gaps, they have been absolutely constant during the period.

The smokeless business David, of course it’s a different situation right, because we are trying there to grow income by participating in the growth in the category. It’s a growing category unlike cigarette which is a declining category as you well know, so if we can participate in the volume growth there and with Copenhagen and Skoal together gain some share, we can grow our income quite nicely and I think you see that actually over the first nine months in the smokeless business.

To be sure, we do have SKUs in the smokeless franchise that are at popular price points as well as having price points there that are mainline and the reason for that is again that's where some of the business is. So we have a competitor that has an offering at a popular price point. We believe that Copenhagen and Skoal can compete there and should compete there; all the while we want to manage the margin at that franchise level if you will and guess what, we've been pretty successful in doing that. Copenhagen and Skoal have grown together very nicely, I mean if I look at it from again, call it say Q3 of ’09 after the acquisition to Q3 ’12 their combined retail share growth is about four points and the margins have expanded all the while.

So that's a bit more complex I suppose, but we think that the strategy is right there and again just to return I guess to the core of your question, while we are trying to manage through that environment we are not concerned about the equity of those brands.

Operator

Your next question comes from Chris Growe of Stifel Nicolaus.

Chris Growe - Stifel Nicolaus

I had a question for you in particular with Marlboro Black as an example. I know certainly the measured of success for a new product in this category is the degree to which you can reduce promotion in the time in which you can do that. So perhaps our expectation is a little high that promotion would come down. I do characterize still the Marlboro Black promotion is a bit high. It has come down to a unit, but still high. So I'm just curious as you look at the brand and the way it’s positioned today, is it the economy, is it the attempt to retain some of those Marlboro consumers that will shift. It's resulting in a requirement for you to keep promotions at a relatively high rate or do you see this is just probably the natural progression as kind of building this brand and I know you could rush it down?

Marty Barrington

The latter; I think its part of the natural progression of building the brand. Remember Chris, brands are build in three months. Marlboro Black was launched earlier this year. This is a category in which there are relatively high loyalty rates; people are in the category, like their brands. There are some participating more in the price value equation, but for premium brands, you have to have an offering to persuade someone not to buy the pack that they have been buying in to try yours and that’s the purpose of those promotions, because we believe we’ve got a terrific product, it’s in a terrific pack, it's in a terrific franchise, but we have to offer, we have to raise awareness to begin with. Then we have to send trial and hopefully we will get some conversion.

But again, I would point out as you know, these promotional allowances have come down and I think you know what one might conclude from that is, is that those allowances are doing their job. We’ve said previously, we don’t have any desire to have promotional allowances any higher than they need to be to achieve their purpose. I think you should probably read in to that that Marlboro Black is achieving its purpose. We're very happy with that product. We think it's a great addition to the Marlboro franchise. It's got great demographics. It's contributing to the equity. It's a long-term play and that the ultimate success of Marlboro Black, I think it'll be measured over the years not over a quarter or two.

Chris Growe - Stifel Nicolaus

Did you suggest that margins for the Marlboro brand were up this quarter?

Marty Barrington

Smokeable segment, I said that margins were up.

Chris Growe - Stifel Nicolaus

In the Smokeable segment, okay sure, I got you. And then just one final question, it’s in relation to inventory levels just to kind of give a base where we are today on inventory and that’s been jumping around quite a bit and still like in the fourth quarter. But where do we stand today on sort of your inventory level, I know you mentioned that it was less de-loading that occurred in the prior year; how would you characterize inventory today?

Marty Barrington

Yeah, it doesn’t make, for us it’s kind of washed out over the last nine months Chris, as you know it does add over the course of the year there is just not a lot of difference over the nine month period. Howard referred in his remarks to the fact that there was less depletion in the third quarter which flattened the results a little bit, but it’s not really significant for the nine months.

Operator

Thank you. Your next question comes from Thilo Wrede of Jefferies.

Thilo Wrede - Jefferies

Marty, given your comments about the macro environment and price sensitive smokers, is it fair to assume that as long as the economy doesn’t pick up, there is maybe a chance that promotions for some of these [non-exemptions] will be dived back much more significantly?

Marty Barrington

Well, we will see overtime Thilo is the answer. Like you and everyone else I am sure everyone hopes that things are going to improve and if they do obviously we will all take that into account as we look at our promotional allowances; I just don’t know how to predict that going forward.

Thilo Wrede - Jefferies

What’s your best assessment there how much Marlboro market share would be at risk if you took away promotions all together?

Marty Barrington

We don’t think about it that way; we are managing the brand in a very different kind of way. We are trying to maximizing coming to category while making sure that Marlboro is healthy. So that’s just a completely different way of looking at it which isn’t ours.

Thilo Wrede - Jefferies

But market share is part of the equation, right?

Marty Barrington

Sure, we are trying to maintain modest share in the Marlboro.

Thilo Wrede - Jefferies

Okay. And then Howard a question for you, given the market share losses for Skoal and some of the smaller UST brands, since you acquired UST, at what point will you have to seriously consider asset impairment tax and what point do we have to get concerned about write-off for some of these brands?

Howard Willard

Yeah, well as you know that's a calculation we do on a pre-regular basis; we certainly revisit that in any case of the fourth quarter. So I think we will wait and see; I think when you look at Copenhagen and Skoal, they have had quite nice growth over the time since the acquisition, but obviously Copenhagen has have the stronger share than the Skoal. So we’re certainly doing those kinds of calculations and if we end up in an impairment situation we will certainly let you know, but that's how we do quite regularly.

Thilo Wrede - Jefferies

Just from an accounting perspective, is it just the volume growth you have to look at or do market shares play a role in that determination as well?

Howard Willard

Well, the primary driver of the impairment tax is really income; and if looking and what the expected income is out into the future and comparing that to the valuations that were used in valuing the trade marks at the time of the acquisition. So income is the bigger driver than either share or volume.

Operator

Thank you. Your next question comes from Vivien Azer of Citigroup.

Vivien Azer - Citigroup

Just to circle back on the competitive landscape part of (inaudible) issue; I think about the growth in the total tobacco profit pool which is something you guys have pointed to in the past. Over the last four years it’s been fairly volatile, ranging from anywhere to 2% to 8%. As you think about the total US tobacco profit pool growth going forward can you give us an indication of what you think the right growth rate is?

Marty Barrington

Well, I'm not going to comment on profit pools, I’ll just comment on how we think about running our business which is as you know we have the company positioned to participate as a total tobacco company we have this terrific business of PM USA, we have a business at Middleton, we have a great UST smokeless business. So as those companies follow their plans and maximize their income and participate in the way that we described it earlier in the call, we expect obviously that we will do just fine with that. So I would limit my comments to what our plans are maybe and that's supposed to be anything else.

Vivien Azer - Citigroup

Understood. I would just like to turn to NXT for a second. I know it’s definitely very early days given the roll out that you've done in late September, but can you give us any indications of early consumer response to that brand.

Marty Barrington

No honestly Vivien I wish I could, but it’s really literally weeks so I just don't have anything to give you there I'm sorry.

Vivien Azer - Citigroup

Any color on kind of future plans for the roll out.

Marty Barrington

Well, I mean we've announced our plans for what we are going to do with Marlboro NXT. I think it’s a terrific product; it’s a nice offering, its going to be a nice addition to the Marlboro Black family. Everyone has high hopes for us again, but as you correctly pointed out you have to see what it does in the market. We've got a good plan for it, a good support plan. So I think it will do fine, we just have to see the data.

Vivien Azer - Citigroup

And just lastly, can you comment on what your share of menthol looks like today and whether it’s up relative to the end of 2011 given the success we've seen for Marlboro Black.

Marty Barrington

I don't know that I have a comment on that. I would have to maybe Brendan will get back to you. I just don't have the number in front of me. Sorry.

Operator

Thank you. Your next question comes from Bonnie Herzog of Wells Fargo.

Bonnie Herzog - Wells Fargo

I also have a question on Marlboro maybe asked a little differently and it’s related to innovation. I'm curious how much of your share gains in the quarter, do you estimate were being driven by the new line extensions, and I'm trying to understand if you have comfort with how much incremental growth you are getting from these versus growth from your underlying core Marlboro brand and I'd be curious to hear how full your pipeline is next year for Marlboro and then overall.

Marty Barrington

Okay. Well innovation is a great topic, thanks for raising it. We don't break out at the sub segment level as you know, but we can observe it right that if you look at innovation in Marlboro, its going through a period really I think of accelerated innovation, isn't it. We've got Marlboro Black which we are very happy with. We've got Marlboro NXT, you remember we have the packaging innovation on Marlboro 83, and while we don’t disclose our pipeline of course, we have excellent brand management teams. It is actually part of the power of the architecture, which we have explained previously.

We have our brand management structure now, aligned against the four product families within Marlboro and each of them is developing excellent plans, not just for this year and next year but beyond, which includes a variety of product ideas, programmatic ideas and the likes.

So we are pretty happy about how Marlboro architecture is rolling out and innovation is a key component of that.

Bonnie Herzog - Wells Fargo

And then I guess the last question would be on your discount cigarette segment which has sustained pretty strong momentum this year. Could you talk a little more about your strategy for this segment, and then in terms of L&M and its share gains, is the brand taking share do you think from other discount brands or is the growth maybe being driven by down trading from some of the premium brands or are you seeing both?

Marty Barrington

Good question, our strategy of course is while we focus on premium and again more than 90% of PM USA shipments are premium, there is a discount segment in the category of about 27%. We want to make sure we have an offering there and the offering that we have is L&M and it's doing a very nice job there I think.

In some respects, it's taking share that our former discount brand Basic sheds as it raises its price and its margins. Our strategy is obviously to just to have an offering there. Our retailers like for us to have an offering there. There is some business there. We have a competitor obviously it’s got a significant offering there. We want to make sure that we’ve got a competitive offering. So our strategy on L&M is to have that offering there for that purpose and as you’ve seen, this year certainly has been a contributor to volume which is nice.

Operator

Thank you. Your next question comes from Michael Lavery of CLSA.

Michael Lavery - CLSA

As you talk about maximizing income, I would love for you to give a little color there, because this year certainly it's being helped by the restructuring, the cost savings that you’ve got and those are as you said skewed towards this year. As you move in to next year, do you think about maximizing your income on an operating basis or on a net income basis? And by that I mean, how much would the interest expense savings become part of that equation?

Marty Barrington

Well, a couple of different questions in there; let me try to unpack and to do justice to it. Certainly I am not in a position to talk about what we're going to do going forward, but when we talk about maximizing income I would refer to the comments I made earlier Michael which is you can do that through a variety of ways, right pricing is important, has been important, will continue to be important. We do manage our cost structures carefully because they can contribute. We watch the promotional allowances very carefully. So that strategy I think should be seen as constant without commenting on what we may do in the future. Do you want to talk about interest expense Howard?

Howard Willard

Sure. I think Marty just referred to the strategy for the smokeable business. I think when we look at the overall company, we’ve talked about our longer term objective of growing our EPS 7% to 9%, and certainly there we have multiple levers. Certainly the biggest contributor is the smokeable business, but we’ve also seen nice contributions from our investment in SABMiller as well as the smokeless business and some of the other areas and you importantly point out that as a result of the tendered refinancing we did this year, we expect to see a reduction in interest expense. But when we think about our overall EPS growth, I think we look at really all of those levers as opportunities to increase EPS overtime.

Michael Lavery - CLSA

That’s helpful, but just to be clear so you are saying when you talk about the cigarette business and maximizing income there, you don’t necessarily mean operating income?

Marty Barrington

No, I don’t think anybody said that. What we said is, there is a number of ways that you can within the PMUSA business smokeable segment to maximize income there is pricing; there is cost management and the likes. I wouldn’t take that from the comments, and then Howard’s correctly pointing out that the Altria business model which is diversified in, I would argue differentiated from our principal competitors is that there are multiple levers for us to achieve our long term goals of adjusted diluted EPS including our smokeless business and our wine business and our exposure to the SAB alcohol assets and the like, you know its provided us with a number of levers in order to achieve those goals. I think that's where we are trying to communicate if that wasn't clear.

Michael Lavery - CLSA

That's helpful. On the market share side, do you have specific objectives there and how significant is the 50% share mark psychologically. Is that an internal objectives, because obviously you reach that again in last quarter, it’s fairly [below] right now, is there something that you focus on?

Marty Barrington

You talked about [PMU] Michael?

Michael Lavery - CLSA

You are right.

Marty Barrington

Yeah, I think it’s to best explained by the overarching strategy of maintaining modest share for month-to-month. Marlboro while maximizing income out of the smokeable segment, and I think that there is no magic numbers anywhere; you have to look at this, competitively said, you have to look at the environment in any point of time. As long as we are following that strategy, maximizing income and delivering to our shareholders to what they expect that's how we think about.

Michael Lavery - CLSA

Okay, thanks. And then just one last question back on the introductory pricing, I know you’ve explained how variable that is for [contrail], but is there any expectations with those wouldn’t talking like a Black or special blend become [imperative] with the rest of the portfolio given the state of list prices or did they - currently do they have a discounted profile, what is the right way to think about how those compared?

Marty Barrington

Well, I would refer to the explanation, I gave earlier which is each of those SKUs has a role to play, we have promotional strategies to design to help them achieve the objectives set for those roles and obviously as you know we don't want to spend more promotional dollars than we have to, to achieve them because we are trying to maximize our income there. So I wouldn't think of it as any one moment in time as much as it is promotional allowances that support the strategy of growing those brands.

Michael Lavery - CLSA

I guess what's making me wonder a little bit is that the Black strategy with a sort of a premium value almost mid price point and a little bit of a way is reminiscent of something like (inaudible) down in smokeless but are you suggesting that its not meant to going permanently be in that sort of a new lower tier but that its just a gradual process to get that drifted back closer to drifting in price?

Marty Barrington

Yeah, I think we've explained that it’s a promotional allowance designed to raise awareness and generate trial and conversion of adult competitive smokers and that's its purpose.

Operator

Thank you. We would now like to take questions from the media. (Operator Instructions) Your next question comes from Thomas Russo of Gardner, Russo & Gardner.

Thomas Russo - Gardner, Russo & Gardner

Hey Marty, I switched over to the media. Marty thank you for being on the call and a couple of quick questions for you. But first has to do with whether you and Murray might be spending any particular amount of time down in Madison County and in general look at cost of the, developing aspects of litigation but specifically the price files case that might be revisited. What's your sense there?

Marty Barrington

Well, we haven't heard anything. I think we've got updates out on the price case but I think that the issue has been brief there Tom and its sitting with the judge and I don't think we've heard anything as of this morning.

Thomas Russo - Gardner, Russo & Gardner

Howard, congratulations on refinancing so much high cost that was terrific, do you have the capacity to keep going back to the market, like you did with the longer data paper and taking advantage of today's remarkably low rates for the [prefunding] in the sense the future pay downs of other blocks of debt?

Howard Willard

Yeah, I think if you are asking do we have the ability to do what we did this year into the future and I would say that, that's certainly an option. But its just one of many options we have in thinking about how to use our cash and how to reduce our effective interest rate and I think we will make those decisions as the year progresses.

Thomas Russo - Gardner, Russo & Gardner

Congratulations on that move though, just fantastic. And what about the role of the lower interest rate as it impacts your pension obligations and your funding requirements and how you might be rethinking that the overall pension as to your liability exposure in light of the high net [percentile] cost by remarkably low rates?

Howard Willard

Yeah, I think you raised an important point which is as the discount rate has continued to trend downward this year that does have an impact on our pension costs and that's something we are looking at quite carefully. I'm pleased to say though that as you look at the overall market performance this year, the market performance has been a bit more positive than its been in some years in the past. So there's some offset there but that's certainly something we are looking at quite closely because both of those factors are going to have an impact on pension expense going forward.

Operator

Your next question comes from Nik Modi of UBS.

Nik Modi - UBS

Just a couple of quick questions. On the architecture, if I have the strategy, right, I mean it seems like you’ve been really focused on the Black portion of the architecture so far this year. Is it fair to assume that you're going to kind of work your way around architecture over the following quarters and years? Is that kind of a way we should be thinking about it?

Marty Barrington

Yeah, I think what we’ve said Nik is that we’ll be rolling out our investments in that architecture through ‘12 and ‘13.

Nik Modi - UBS

Okay, perfect and then just following upon Barney’s question on the innovation. You said your folks are working on a lot of stuff. But in terms of what's already approved by the FDA, I mean is the pipeline still relatively focused. It seems like you guys had a lot of stuff in the marketplace before the proper dates. So I am curious on how full your existing approved pipeline is, that will be helpful?

Marty Barrington

I understand your question. We were I would say plan full about the substantial equivalent stake and so I think we're in pretty shape. Obviously the other dimension to your question is, in light for the FDA obviously to start moving on substantial equivalents because people have applications that are pending and I think that’s a fair request. They're building out their structure over there and they’ve made comments about how they’re going about that. I would expect that overtime you are going to see the FDA start to rule. So I just wouldn’t want to leave anyone with the impression. I don't think that there is going to be some sort of a magic date and if you are in before you are okay and after that you are not. I think that will probably result overtime.

Nik Modi - UBS

And the last question Marty is just kind of a bigger picture question. The Altria business model has been kind of moderate share gains and balancing with profit growth and this quarter, I mean, obviously 100 basis points of share gains from Marlboro is pretty big number for a pretty large brand. And your new CEO and I know I have been getting a lot of questions so I am sure your folks have been getting the same about strategy and if it’s changing, it’s very clear from what you have been saying that it’s not changing, but certainly the numbers would suggest otherwise. So I was hoping you can just give kind of your viewpoints so you can help clarify for people exactly kind of what’s different about the strategy, what’s not, relative to the prior year’s which is obviously have been very good for the stock price? Thanks.

Marty Barrington

Yeah, thanks for asking that question. The strategy is not changing Nik. We have been very successful at doing what we are doing. I think again as I mentioned once or twice this morning I think it looks, it depends in some respect to how you look the time period sure enough if you look at the quarterly comparison it’s a 100 basis points. If you look at it over the nine month period its five-tenths if you look at over a four year periods it’s eight-tenths. I think that’s consistent with how we have been taken about that overtime and we have no intention of changing that, it’s been enormously successful for Altria.

Operator

Thank you. Your next question comes from Karen Lamark of Federated Investors

Karen Lamark - Federated Investors

I must have I missed it, did you give the comparable estimated market share for discounted brands in the prior year. I think you suggested 27.4% but I wondered if you could give the year-over-year comparison? And that’s first question.

Howard Willard

Yeah, I mean if you look at the discount share that we spoke about was 27.4% in the prior year quarter it was 27.9%. So it’s come down modestly.

Karen Lamark - Federated Investors

Okay. And not to be, how do you define discounts is it simply by brand and known brand positioning that is it does not include premium discounted premium brands or line extensions is that true?

Howard Willard

Yes, the way we define discount is we have a set of brands that we identify as discount brands and it does not include or promoted on premium brand volume.

Karen Lamark - Federated Investors

Does that changed overtime or let’s say the last year or so?

Howard Willard

No, it’s been largely consistent for sometime.

Karen Lamark - Federated Investors

Okay, is it to assume that if the macro pressures and prices that if smokers persist that, you would not change that definition, in other words, you would not include anyone’s wine extension promoted premium brands, is that true?

Howard Willard

Well, I hesitate to make a statement of what we might to do in the future on something like this, but I can tell you it certainly not something we’ve considered. This has been the way we define discount for quite sometime and to me as this times it seems quite logical.

Operator

Thank you, your next question comes from Andrew Kieley of Deutsche Bank.

Andrew Kieley - Deutsche Bank

Marty, I just want to ask last question on promotion, if the cigarette competitors are adjusting their promotion programs as well in response to the economy or other factors. How do you think about compatibility of that kind of situation with the profit pool on your sort of long-term income objectives?

Marty Barrington

Well, I am going to go back to what I have said Andrew, which is we’ve got two plans in place. We take everything into account when we put them in place and we are going to execute against our plans which are consistent with the strategy on that. I have outlined and certainly I wouldn’t comment on what we might or might not do going forward, we are going to stick to our netting.

Andrew Kieley - Deutsche Bank

Okay, on Marlboro, would you say at this point that the brand has, I don't know some what more attractive opportunity in Menthol than in non-Menthol?

Marty Barrington

I think Marlboro has got a big reach. It appeals to lots of adult smokers, its proven that, not just recently but over decades as you've seen the charge with how the brand grows first with Red and Menthol and Gold and Black. It’s a big brand, it’s got a lot of room for a lot of flavor segments, it’s got a room for a lot of adult smokers and that's how we think about it as opposed to one particular segment or another.

Andrew Kieley - Deutsche Bank

And just last question for Howard, if you could comment on the cost savings program, of the dollar amount accelerated sequentially or sort of where we are on the status of the program.

Howard Willard

We continue to make progress on the cost reduction program and we are really on track for $400 million in savings by the end of next year.

Operator

Your final question will be coming from Michael Felberbaum of Associated Press.

Michael Felberbaum - Associated Press

First, can you talk a little bit more broadly about the Marlboro brand architecture and how that plays into your ability to maintain and gain market share, and what are the top selling brand. Secondly your competitors have made some investments in electronic cigarettes and other next generation type products, and wondering if you can comment at all about any of your plans in that area.

Marty Barrington

Thank you for your questions. We've explained previously I think that the Marlboro architecture is the next evolution really in how that brand which has grown over time can continue to grow into the future, and we have a product families in it, Red, Green, Gold and Black, we've set up our SKUs at retail so that its much more evident to an adult smoker when they walk in what the Marlboro architecture looks like. We have our brand teams arranged around that. It actually provides some room for the brand to operate. Remember it’s about a 42 share brand, so it’s really up if you will while they are all Marlboro and they all stand to where, or come to where the flavor is.

They do have slightly different positions and we want to give Marlboro the license if you will to reach out to all the smokers who want to be in the franchise. It’s a terrific brand with great equity and great premium pricing and we believe that the architecture is the next logical step about how to grow that brand over time and you will see that played out in the marketplace through products and programs and at retail when we like. We are aware of the developments in each cigarettes, it probably represents what we already know which is that there are some adult smokers who are looking for alternatives in the tobacco space and some of them have gone to e-cigarettes as an exploration at least about whether that's going to be for them and that's a situation obviously that we monitor closely and we will keep an eye on that.

Operator

Thank you. At this time I would like to turn the call back over to Mr. Brendan McCormick for closing remarks.

Brendan McCormick

Thanks everyone for joining our call this morning. If you have any follow-up questions please contact us in Investor Relations and we look forward to talking to you soon.

Operator

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

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