Altria Group, Inc. (MO) Q1 2008 Earnings Report, Transcript and Summary

Good day, and welcome to Altria Group's first quarter 2008 earnings conference call. Today's call is scheduled to last about one hour, including remarks by Altria management and the question-and-answer session. [Operator Instructions]. Media representatives on the call will also be able to ask questions, following the conclusion of questions from the investment community. I'd now like to turn the call over to Mr. Cliff Fleet, Vice President, Investor Relations and Financial Communications for Altria Group. Please go ahead, sir.

Good afternoon, and thank you for joining our call. This afternoon we will discuss Altria's first quarter 2008 business results. Our remarks contain forward-looking statements and projections of future results and I direct you to the Safe Harbor statement at the end of our earnings release for review of the various factors that could cause actual results to differ materially from projections. As a result of the completion of the spin-off of Philip Morris International, our reported results and previous year's results reflect PMI as a discontinued operation for the first quarter of 2007 and 2008. Net revenues and operating companies income for PMI are excluded from Altria's continuing results. PMI's net earnings impact is included as a single line item in Schedule 1 of today's earnings release. Altria also provided revised quarterly statements of earnings for 2006 and 2007 in our earnings release. For a detailed review of Altria's first quarter business results, please review the earnings release that is available on our website, altria.com. Please note that in this afternoon's call, we will only be discussing the first quarter business results and we will not be discussing the status of litigation. I would now like to turn the call over to David Beran, Altria's Executive Vice President and Chief Financial Officer.

Thanks, Cliff. Good afternoon. In the first quarter of 2008, Altria completed the spin-off of PMI on March 28th, reflecting Altria's commitment to enhance shareholder value. The PMI spin-off also gave us the opportunity to restructure our headquarters’ functions, which included relocating our corporate headquarters from New York City. Today, I am pleased to be conducting this call from Altria's new corporate headquarters in Richmond, Virginia. The restructuring program is expected to substantially reduce the company's cost structure and Altria expects ongoing annual savings of $250 million beginning in 2009. We have already started to realize savings from this restructuring. In connection with the PMI spin-off, Altria completed its debt tender offer and consent solicitations. We recorded a $393 million pre-tax loss for the early retirement of this debt. Altria intends to replace the retired debt through the public debt market. As part of Altria's continuing focus on shareholder return, Altria's Board of Directors has authorized a $7.5 billion two-year share repurchase program. Altria began repurchasing shares as part of this program earlier this month. Altria reaffirms its 2008 earnings per share guidance. Altria forecast that 2008 full-year adjusted diluted earnings per share from continuing operations will grow to a range $1.63 to $1.67. This represents a 9% to 11% growth rate from an adjusted base of $1.50 per share in 2007. This projection reflects the contribution of income from Middleton, the impact of share repurchases, and a higher effective tax rate. This full-year projection also reflects stronger expected earnings per share growth in the second half of this year compared to the first half of 2008. We are excited about Altria's future. The company remains committed to building our leadership position in the U.S. tobacco industry, delivering long-term shareholder value. Now, let's turn to Altria's first quarter results. On an adjusted basis, Altria delivered solid earnings per share growth in the first quarter. Adjusted diluted earnings per share from continuing operations increased 12.1% to $0.37 compared to $0.33 in the first quarter of 2007. This quarter's results were impacted by net cost and charges primarily related to PMI spin-off and the closure of Altria's New York headquarters. In addition to the pre-tax loss for the early retirement of debt, Altria had a pre-tax charge of $247 million related to the PMI spin-off that consisted primarily of employee separation cost, as well as investment banking and legal fees. These charges were partially offset by a pre-tax gain of $404 million related to the sale of Altria's former corporate headquarters building in New York City. Including the special items, reported diluted earnings per share from continuing operations were $0.29 compared to $0.33 in the year-ago quarter or down 12.1%. Now, let's discuss Philip Morris USA's results for the first quarter. PM USA's retail share grew five-tenths of a share point to 50.9% in the first quarter, driven by Marlboro, which increased its retail share seven-tenths of a share point to 41.5%. Marlboro's strong retail share gains were partially offset by share losses for Virginia Slims and Basic, while Parliament's retail share was unchanged versus a year ago at 1.9%. PM USA has focused spending on Virginia Slims, Parliament, and Basic to areas of strength to increase their profitability. PM USA continues to monitor the economic landscape, as consumer confidence levels have fallen. And at this point, we have not seen evidence of down trading to discount cigarettes. Price gaps between Marlboro and the lowest effective price cigarettes remained relatively stable at 44% in the first quarter. PM USA shipment volume decreased 1.2% in the first quarter versus year ago to 40.1 billion units, but was estimated to be down approximately 3.5% when adjusted for changes in trade inventories. For the full-year 2008, PM USA currently estimates a total cigarette industry volume decline of approximately 3%, which includes our estimate for potential state excise tax increases. Year-to-date, three states have increased their cigarette excise taxes. PM USA's operating companies income decreased 8% to $1 billion, primarily driven by lower volume, costs related to the reduction of volume produced for PMI, higher resolution expenses, the timing of promotional expenditures, and a $26 million pre-tax charge related to the previously announced closure of the Cabarrus facility. During the remainder of 2008, we expect to take approximately $114 million in pre-tax charges related to the closure of this facility. These expenses were partially offset by lower wholesale promotional allowance rates. PM USA is transitioning its infrastructure to deal with the effects of the removal of PMI volume from PM USA manufacturing facilities, which PM USA expects to be completed by the year-end... excuse me by the end of October 2008. PM USA is reducing its infrastructure in response to this volume loss. The cost cannot be reduced as quickly as volume is removed. In the first quarter, this transition impacted cost by about $20 million. PM USA plans to exit from its Cabarrus facility in 2010 and its manufacturing consolidation plan is on schedule and within budget. The company has started to relocate both employees and equipment to its Richmond manufacturing facility. PM USA continues to invest in the development of adjacent smokeless products as part of its growth strategy. PM USA has test markets for both Marlboro Snus and Marlboro MST and in the first quarter expanded these test markets. As expected, PM USA's income was down in the first quarter. The company anticipates income performance to improve as the year unfolds. Now, let's turn to John Middleton's results for the first quarter. Altria is pleased to report the first full quarter of Middleton's results as a part of the Altria family of companies. This acquisition gives Altria a strong position in the growing and highly profitable machine-made large cigar segment. Integration activities began in the first quarter of 2008 and in March, PM USA’s sales force began representing Middleton's brands at retail and supporting the execution of Middleton's trade marketing programs. Since Middleton was a product company last year, we are not providing Middleton's revenue and income results for 2007. Middleton's operating companies income in the first quarter of 2008 was $41 million, including a pre-tax charge of $2 million for integration cost. Middleton's first quarter cigar shipment volume increased 8.2% to 312 million units. And the company's retail share through February 2008 increased 2.7 share points versus a year ago to 26.8% of the machine-made large cigar segment. Black & Mild drove this increase, growing its retail share through February 2008 by 3 share points versus a year-ago period to 25.9%. For 2008, we expect Middleton to continue delivering volume and share gains in the growing machine-made large cigar segment. Turning to our financial services business, Philip Morris Capital Corporation reported operating companies income of $74 million versus $160 million in the first quarter of 2007. First quarter 2007 results reflected a cash recovery of $129 million from assets previously written down. Excluding the 2007 recovery, PMCC's operating companies income increased $43 million versus the first quarter 2007. PMCC's portfolio remains well diversified by lessee and industry segment. As of March 31st, approximately 75% of PMCC's lessees are investment grade, as measured by Moody's and S&P. Excluding aircraft lease investments, approximately 85% of PMCC's lessees are investment grade. PMCC's allowance for losses totals $204 million, which management team is prudent based on the underlying credit quality and collateral value of its existing portfolio. I will conclude by saying that we are very excited about the opportunity to build on Altria's solid track record of providing long-term value to our shareholders. In the first quarter of 2008, Altria delivered solid adjusted earnings per share growth of 12.1%, we completed the spin-off of PMI, and restructured our corporate headquarters functions to reduce cost. We reaffirmed our 2008 earnings per share guidance. Marlboro continued to grow its retail cigarette share. And John Middleton delivered strong income, volume, and share performance. I'm now happy to take your questions. Question and Answer

Certainly, sir. [Operator Instructions]. And our first question comes from Christine Farkas from Merrill Lynch. Please go ahead.

Thank you very much. Good afternoon everyone. I'm looking at your inventory or the timing issues that you might have seen in the first quarter. I am wondering if you can help us with potential impacts on the second quarter, how are your wholesale inventories shaping up and what kind of year-over-year impact might we see?

When we look at... thank you for the question, Christine. When we look at where we are at this point in the year, we are where we plan to be and I go back to... I was out talking to investors about 45 days ago and the marketplace has not changed. We have taken the overall industry [inaudible] to the higher end of 3% and that's basically due to the fact that we saw New York come in, in June with a $1.25 per pack excise tax increase effective in June. Currently, we are seeing wholesale inventories and retail inventories in the first quarter down from where they were a year ago. And we're not seeing a lot of movement at retail at this point and at wholesale, it appears that we've seen a low point. But those inventories will fluctuate based on business conditions in the marketplace.

Okay. Thanks for that, Dave. I'm wondering if I could follow up please with the margin question on your domestic cigarette business. If I look at your year-over-year correctly, it looks like the domestic margins were down. Could you talk a little bit about promotional expenses or timing or any other factor, given you had higher pricing that should have led to a little bit more in terms of margin?

Yes. I'll be happy to. And when we look at our margins and really when we look at our business, in general, we don't look at it on a quarter-over-quarter basis. We really look at it over the entire year and the longer term. And what do I mean by that? We see opportunities in the marketplace to create share growth and continue our momentum that not only benefits the first quarter, but future quarters we will do that. So, in the first quarter of this year, our spending, not only our promotional spending, but our equity spending primarily behind Marlboro was different than it was a year ago. And we do that because we like to create and keep momentum in the marketplace and we think that longer term we will get a good benefit from that. So, that is basically promotional activities, but also equity building activities in the marketplace.

Okay, great. And the final question, Dave, if I could on corporate expenses, what we saw in the first quarter, is that a reasonable run rate for the year?

With regards to our corporate expenses, we actually have reduced our corporate expenses in the first quarter about $13 million, I believe, versus a year ago. And over the two-year time period, we will get the full $250 million reduction and if we can accelerate that, we will. So, I think there is more to come there.

Great. That's all from me. Thanks for your time.

Thank you.

And our next question comes from David Adelman from Morgan Stanley. Please go ahead. David Adelman - Morgan Stanley & Co. Inc.: Good afternoon. Hi, Dave and Cliff.

Good afternoon. It’s good to hear from you. David Adelman - Morgan Stanley & Co. Inc.: Dave, let me start by asking about PM USA's profitability in the quarter. I don't think it's had a down quarter since you elected to increase promotional spending September-October of '02. And even adjusting for the $20 million you called out, you're still down quarter-on-quarter and I'm just trying to understand what's changed or what contributed to that result? Because as you highlighted your promotional spending was down year-on-year per pack.

Yes. Well, first of all we have had quarters that have been down year-over-year since 2002. And it reflects the competitive conditions in the marketplace and how we see opportunities for us to go increase our momentum behind our brands. And this quarter we saw an opportunity to do some investment spending behind... primarily behind Marlboro. We did have... we did have an additional headwind and that was the $20 million on PMI. But overall we are about where we want to be with both their share gains and with their income. And I know that causes some concern for you all when you look at it on a quarterly basis, but at this point we are right where we want to be. David Adelman - Morgan Stanley & Co. Inc.: Do you envision PM USA's underlying operating income being down for the year at this point, David?

As I said in the road show, we don't give individual guidance for operating companies. But we expect our income performance to improve throughout the year. David Adelman - Morgan Stanley & Co. Inc.: Okay, and can you quantify the dollars spent on share repurchase in April?

I will be doing that in the second quarter earnings call. David Adelman - Morgan Stanley & Co. Inc.: Okay. And then lastly Dave, what is it that leads you to believe that consumption trends will get somewhat better as we go through 2008? And why don't you think coming into the year now that we’ve lapped the weakness that was even more pronounced in the first half of last year, the consumption trends don't seem to be moving towards a more normalized rate more quickly?

Last year... that's a good question. Last year we had the activity in the first quarter both with the State of Texas, a large excise tax increase of a buck, plus their strategic step-up in the MSA payment. This year, we actually saw two states, Wisconsin and Maryland, take a dollar increase on their state excise tax, which contributed approximately $0.04 per pack on the national weighted average up to about $1.05. In addition, not only our activity, but competitive activity in the marketplace raised overall prices and just like we saw an initial step-down in volume last year in the first quarter and then it came back. I think we're seeing the same instance now. David Adelman - Morgan Stanley & Co. Inc.: Okay, thank you.

Thank you.

And our next question comes from Chris Growe from Stifel Nicolaus. Please go ahead.

In the press release, does that relate to this expensive [ph] spending level that you had in the first quarter, is that the way to characterize that?

I'm sorry, your first part of your question got cut off, if you could repeat that please?

Sure. I'm sorry. I wanted to question you on the timing of promotion, there was a comment in the press release about that. Does that refer to these first quarter investments that you were referring to that you used to stimulate share of Marlboro?

Yes, it does.

Okay. And then have you talked about the level of cost savings that could come through in 2008. Is that a figure that you're willing to quantify?

The cost savings that we have previously talked about, one on corporate expense. One... that will be $250 million over 2008 and 2009, where we will be pulling cost out of this system based on the corporate restructuring. The other costs, which are a reduction of approximately $300 million in our G&A, will be spread from 2008 through 2011 and our cost savings related to the Cabarrus... the shutdown of the Cabarrus facility moving those operations into our manufacturing center here in Richmond will be more back weighted, we actually closed that facility down.

Okay, okay. And then the... your comment about the stronger second half of the year, what is it that gives you the confidence that we should expect the second half to be better? Again, is it just the timing of promotion that leads to that comment or is there something more that’s happened in the back half that would give you some confidence today to make that statement?

As I've said, we laid out our plan this year and we looked at where we are today to the first quarter. We are where we plan to be and when we look at the share gains that we've gotten from Marlboro and the investment spending we've made, it’s given us great confidence that the year will unfold as we anticipated.

Okay, I just had one last one and I will turn it over. And I was just... if you look at your sales by channel, have you seen any noticeable slowdown in, for example, convenience store sales or maybe even a pick up in carton sale or something that would indicate some consumer weakness there, have you noticed that?

No. Long term... okay, long term we have seen increasing sales in the convenience channel as a percent of the total cigarette industry, and we haven't seen any reversal of that trend and as far as packs versus cartons, there has been a long-term trend in the U.S. cigarette market where the pack sales are increasing as a percentage of total business. So, those two trends, we haven't seen any adjustments to those trends.

Okay. Thank you.

Thank you.

And our next question comes from Nik Modi from UBS. Please go ahead. Mr. Modi, your line is live. Mr. Modi your line is live. Please go ahead.

Can you hear me?

Yes.

Okay. Sorry about that. Actually I was just saying my question has already been asked. Thank you.

Thank you.

And our next question comes from Erik Bloomquist from J.P. Morgan. Please go ahead.

Hi, good afternoon.

Good afternoon.

First, I was just wondering if you could comment on FDA, your... one of your competitors has now switched their position and is supporting the House version of the bill. Do you feel like that at this point now with the support of that component of the industry that we’re looking at realistic possibility of having FDA legislation passed sometime this year?

Well, as you know, we’ve actually supported federal regulation of tobacco products for over seven years. And we've been engaged in that process. We continue to be engaged with Congress, but the legislation is a complex process and we'll just have to see what happens as the year unfolds. It's tough to put a timing on that, but we'll see.

Okay. Thank you. And then secondly, in terms of the underlying volume decline as you noted, you are moving toward the higher end of the decline range, down 3% with the expectation. How much of that would you attribute to a simple increase in price? Are we still using any elasticity of about 0.3 or is that getting... is the consumer getting somewhat more sensitive or are we looking at an acceleration in the underlying volume decline in the U.S. market?

Currently when we look at price elasticity in the marketplace, we are still looking at elasticity of about 0.3.

Okay. And so you are not seeing any... so you would attribute the increased decline this year purely to the increase in price from both state excise tax and then manufacturer pricing?

Yes. Overall price increases in the marketplace. That's correct.

Okay. And then just a detail question. What's the average cigarette price now in the U.S.?

The average price for Marlboro is at the... through the end of the first quarter, price per pack is $4.27 [ph] a pack. The lowest effective price product in stores is approximately $2.97 a pack.

And lastly what proportion of that retail price is excise tax, that's still hovering around 52% or so?

The state excise tax in the first quarter was $1.05 per pack. And then on top of that, you have the federal excise tax of $0.39 per pack.

And then does the $1.05 include municipal taxes?

No, it does not.

Okay. So, that would be on top of that.

That's correct.

Okay. All right, thank you.

Thank you.

And our next question comes from Judy Hong from Goldman Sachs. Please go ahead. Judy Hong - Goldman Sachs & Company, Inc.: Hi. I had a few questions, Dave. First, if I looked at your revenue per pack numbers in the first quarter, it was up only 1% plus or minus and I'm just wondering why it's not more. And actually that number declined sequentially from the fourth quarter. So, I'm just wondering if there was a step-up in your promotional activity in the first quarter versus the fourth quarter. And if that's the case, why you are doing it when it looks like your competitors have actually been taking promotional spending down?

When we look at... when we look at our overall revenue per pack, it did go up slightly. What you are talking about, the question really gets to the crux of our overall investment spending behind Marlboro. And there again we tend to look over the entire year and the longer term and instead of quarter-by-quarter, we saw an opportunity to increase our share in the marketplace in the first quarter and that's what we did. But overall... overall for the year we are still planning moderate share growth and optimizing the income in PM USA, so that's still the goal. But quarter-by-quarter, it could be uneven and that's what you saw in the first quarter. Judy Hong - Goldman Sachs & Company, Inc.: Okay. And then on that note, I mean you said that you don't want to break out operating profit outlook by segment, but I mean you have the financial services that tends to be very volatile quarter-to-quarter and even year-to-year. The Middleton cigar, we don't really even have the base number to model off of. So, if you could just help us out in terms of how we should be thinking about those two businesses then from a modeling perspective, because it seems like you could see huge increases in financial services that could allow you to get to that operating income growth of mid-single digits, but could see PM USA's numbers being down?

When we look at... when we look at our overall business model, we never take our eye off the ball of PM USA. PM USA will continue to deliver the lion’s share of the income for Altria. We look at Middleton, we look at that company, we just acquired it in late December and we are pleased with Middleton's business model and the growth it has showed both in share and volume. And at this point, they are exceeding our expectations from last December. With the Philip Morris Capital Corp., their income will vary quarter-over-quarter based on the... based on the sale of assets, so it will vary. But when you look at overall, we put all those operating units into the mix. We plan to deliver adjusted underlying growth rates of approximately 9% to 11%, but we make no mistake about it, PM USA is a leading contributor to our overall performance. Judy Hong - Goldman Sachs & Company, Inc.: Okay. And then just... in terms of your Snus and the snuff product, can you talk about whether there is... the spending in the first quarter was also impacted by the investment behind those brands. I mean I imagine that they were just a limited test market, so that would not be the case, but can you talk about that and just maybe give us a color in terms of how you are seeing any progress on those products in your test markets?

Yes, I'd be happy to. As we said or as I said back in the road show and when I was meeting with the investors is that this year the Marlboro Snus and Marlboro snuff were in the investment mode. So, we actually spent more money in the first quarter behind those two initiatives than we did a year ago because we weren't in test markets then. Is it material? No, it's not, but it was a slight drag in the first quarter. As we look at those two test markets, we expanded both test markets. I'll take the moist snuff first, we expanded that into 50 counties surrounding Atlanta and we're getting great learning from that test market on how consumers feel about the product, the overall product, their overall packaging and promotional strategy in the marketplace. When you look at Marlboro Snus, we expanded Marlboro Snus from Dallas into Indi, where we replaced Taboka Snus in that marketplace. And this same sort of learning has taken place there. We're looking at all the elements of our value equation and when I say that it’s product, packaging, positioning, and promotion out in the marketplace. And between those two initiatives, we believe that the Marlboro Snus product initiative is a longer-term play because that category does not exist in the U.S. marketplace with any potential size. But we still think that it is a promising category for us to be in. Judy Hong - Goldman Sachs & Company, Inc.: Okay. And then just in terms of the full-year tax rate that we should be using?

The full-year tax rate is between 37% and 38%, about the midpoint there. Judy Hong - Goldman Sachs & Company, Inc.: Okay. Thank you.

Thank you.

And our next question comes from Thomas Russo from Gardner Russo & Gardner. Please go ahead, sir. Thomas Russo - Gardner Russo & Gardner: Hello, Dave and Cliff.

Hello, nice to hear from you. Thomas Russo - Gardner Russo & Gardner: Thank you very much. Couple of questions, when you described the Middleton progress, how far into results are you having brought the price into your sales force, you had a good early experience. What do you have for the size of the potential lift that you might get as you bring that product across your whole sales force?

Currently, we started in March, we contracted between Middleton and our PM USA sales force to increase the distribution and the merchandising efforts behind Black & Mild into retail outlets. When we look at the cigar category in the retail environment, the overall distribution with the top-selling SKUs is somewhat spotty. So, right now our sales force is in the middle of selling in the top-four packings of Black & Mild at retail. And we would expect that to benefit us in the second quarter and going forward in the second half of the year. Thomas Russo - Gardner Russo & Gardner: And so that you are recognizing the sell in at the moment and have you started to see the sell through yet?

It's too early at this point. We are still in the selling in period. Thomas Russo - Gardner Russo & Gardner: And when you showed the share gains, is that... from whom did it come and sort of how much is the growth that you will have growing the category, as a result of increasing the availability and then maybe putting some promotion behind the product.

Yes. Currently, the share gains that took place in the first quarter of 2008 was based on the business plans that John Middleton already had in the hopper, so to speak. Last year they had a successful launch of a SKU that took place in the second quarter of last year, and it was the Black & Mild line SKU and that has contributed to their overall share growth, as well as the original Black & Mild. And typically based on IRI data, we have seen that come primarily from Altitus [ph] and Swedish Match. Thomas Russo - Gardner Russo & Gardner: Dave, switching topics, you had mentioned that you had refinanced, but you had retired debt with the accompanying charge last... the past quarter. But have you yet gone into the market to fix the terms of the new date yet and if not, what are you waiting for?

No, we have not done that yet. We are in the process of looking at refinancing that debt. At this point, we had to get through the quarter and put file... we will be filing our pro forma statements with… restated with PMI as a discontinued operation. Once we have done that, we will be in a position to go out into the debt markets. Thomas Russo - Gardner Russo & Gardner: Great. And then lastly, what's your experience at present with counterfeit and with the non-fully taxed product sales. Any progress underway there?

We continue with our brand integrity group. We continue to monitor the situation and work with the state and federal law enforcement agencies. Over… I’ll take a longer-term view. We saw the counterfeit products in the U.S. spike in the year 2002-2003 and based not only on our effects, but a lot of good work by state and the federal law enforcement agencies we've seen that activity moderate. But it never goes away completely. And especially when we see states take high excess tax increases and what we're seeing this year is a trend of $1 per pack or $1.25 per pack, which presents opportunities to those that [inaudible] taxes either through contraband or counterfeit. So, we've got a lookout for it. We have plans in place to address it. But at this point we're not seeing any activity that’s unusual. Thomas Russo - Gardner Russo & Gardner: Thank you.

Thank you.

[Operator Instructions]. And our next question comes from Filippe Goossens from Credit Suisse. Please go ahead.

Yes. Good afternoon, David and Cliff. Couple of housekeeping questions first, David if I may. The first one is what should we assume for CapEx for 2008?

Overall, we've said, as we said in the road show that our CapEx would be less than 3% for overall revenue. In the first quarter we actually spent $45 million.

Then the other housekeeping item was, I was just kind of curious with regard to the layout of the P&L here in the press release. Any particular reason why the equity earnings in SABMiller are now before taxes as compared to after taxes? How do you historically use to report it?

No, we've always reported it as pre-tax. It might have shown up under the tax line, but it's always been pre-tax.

Okay, good. Now, the real questions. First, when I look at the performance of your portfolio, a little bit surprised by Basic and [inaudible] with the kind of all the economic concerns out there, that your value brands would actually gain some traction. Should we read into depth kind of the validation of your earlier statement that people are really not trading down given the current price debt structure, as we know it?

Now, when you look... when you look at our value brand, Basic, vis-à-vis the total discount category. The total discount category did not increase year-over-year. What you did see though is some trading between value brands and what it really reflects is, as I said in my remarks, we have a different strategy with Basic, Virginia Slims, and Parliament where we are looking at those brands on a regional basis so to speak and where they are strong, investing behind those brands in order to maintain their presence in the marketplace. And this quarter Basic reflects that spending, but not an overall spending shift when we look at the total consumers out in the marketplace.

Okay. It’s a similar question on the portfolio side with Marlboro, obviously you continue to gain a market share. Just kind of was looking towards getting your kind of view in terms of how you try to view the brand equity with Marlboro. And I mean I have not looked at recent data with regard to Marlboro Menthol, particularly in your product line expansions there with Marlboro Snus. But, is the focus still pretty much on trying to gain market share or might you over time and perhaps follow a little bit more what Reynolds announced during the fourth quarter that they are going to reduce some of their promotional activities with the Cool brand and start focusing more on profitably managing shares as compared to just going after share for the sake of share?

Yes. As I have said before, we look at the overall objective for PM USA. Their objective, the way they do that business is there is attention between moderate share growth to maintain momentum in the marketplace and to optimize profitability. In any one quarter one might get ahead of the other, but when you look at it over the entire year and longer term, the strategy for PM USA has not changed. Moderate share growth to maintain momentum, especially behind a franchise as valuable as Marlboro and in doing that, we believe that we can deliver one optimizing the profitability in the cigarette business. But by quarter-by-quarter you could see some variances.

Okay. And then my final question, perhaps a follow-up on Judy's earlier question on Snus. It's kind of interesting when we look at the enthusiasm of Reynolds in terms of expanding the test marketing to 17 markets now, including some kind of metropolitan markets and contrast that with the somewhat less enthusiastic comments in terms of UST's longer experience with Snus, it kind of brings up two questions. The first one is obviously you already commented on that you see this as more a longer-term project, still I would like to kind of get more an impression from you, whether you really view this as a category that where the passage of time can meaningfully contribute to your EPS? And secondly, if I follow more kind of the comments from UST this morning, I kind of wonder if consumers will have a tough time embracing Snus as a category. It makes me wonder how they will embrace all these reduced risk or reduced harm products that the industry has been talking about for so long. So, in other words if it’s tough to embrace Snus, why would they embrace reduced risk products any quicker than what we're seeing with Snus so far?

Let me address the Snus comment... the question. When we went down this path, we spent a lot of time before we even went out into the marketplace, understanding the Snus model in Sweden. And understanding what potential consumers, adult smokers would think about Snus in the U.S. marketplace. And we saw an opportunity, we still see an opportunity and our first... our first entrance so to speak with Snus in the U.S. marketplace was with Taboka. And we use Taboka, so we could get an understanding with consumers before we decided to put Marlboro on the Snus product from a branding standpoint. And what we learned in Indi gave us confidence that the Snus marketplace can develop here in the U.S., but even today when we look at Snus and that's why we are still in a learning mode both in Dallas and Indi. We don't think we have it exactly right, we don't think anyone does yet in the U.S. marketplace because we are creating a new category. And… but we will continue to get learnings from those test markets and at this point we are still confident that it will be a longer-term play in the U.S. marketplace, but that this category can develop.

And then kind of your take away as it relates to reduced risk products, if it takes perhaps longer than we would have anticipated to develop acceptance for the Snus category. What comfort as an industry do you have that… reduced risk products will have a faster adoption profile than what we might be seeing so far on Snus?

When you talk about reduced risk, you are really talking about the potential of FDA regulation of tobacco products. And that's why we've been supporting federal regulation tobacco products. In the past it’s so that it can provide a framework for further pursuit of those tobacco product alternatives that are less harmful than conventional cigarettes, and also by ensuring accurate communication about tobacco products to consumers. So, that's kind of tied into the FDA.

Thank you very much, David.

Thank you.

And our next question comes from Nick Booth from Wellington Management. Please go ahead.

Yes. I guess I had a quick question on the cigar side. You said you couldn't really give any kind of indication on profitability versus last year. But could you just give us directionally any kind of guidance just on the gross profit trends on the tobacco side, cigar side?

Yes. The overall profitability of Middleton is up versus a year ago. And we would expect that because of the… both the share gains in the overall category growth in the cigar business.

Okay. Great, thank you.

Thank you.

We have time for one more question. And our last question is from Mark Cohen [ph] from Merrill Lynch. Please go ahead

Hi Dave, Hi Cliff. Can you hear me?

Yes. Hello, Mark [ph].

Hi, guys. I just wanted to go back [inaudible] with respect to what Judy was asking you on revenue and revenue per thousand and pricing. Now, one other thing that strikes me is that... is that in the PM USA number last year, there had been some revenues related to the contract manufacturing for PMI. Is that correct?

No, that's not.

Okay. So then really we are looking at a 1% or 2% increase in revenue per stick. And that number surprises me a great deal because... because when you talk about increasing spending on Marlboro, typically you would speak of equity spending. Can you explain in further granularity what exactly you were investing in, in Marlboro and why that's showing up as a contra revenue number?

Yes. And I will do it and not in granularity because when we talk about our marketing plans in the marketplace, we like to maintain the competitive nature. When last year in the third and fourth quarters, we actually started a regional program with a special price promotion that was not in the first quarter and second quarter of last year. We’ve continued that into the first quarter of this year along with additional equity spending. So, that will modulate as we see the business conditions unfold. Unlike years ago, we basically had, but one tool. We had various tools that we can use in the marketplace depending on what's going on in any one marketplace at any point in time.

Well, but is this aimed at… I think what’s surprising about it, Dave, is that you say that the price spread versus the lowest available brand in the market is actually reasonable at 44% or so. So, I'm wondering why... why you are using price promotion to drive Marlboro, I would think that you would be... I would think that you would be playing with fire in doing that. And what kind of competitive response has that with... has that drawn?

The marketplace this quarter, but over a number of quarters has remained pretty competitive. Our overall philosophy with the brand Marlboro is to make sure that it's priced reasonably in the marketplace, but also that we continue to invest not only with their promotional dollars, but invest in our equity spending. We did both in the first quarter of this year at a different rate than we did in the previous quarter a year ago. But as I have said, we look at it over the entire year versus quarter-over-quarter. So, you will see it modulate during the year.

Okay. Is that what you mean by the timing of promotion expenses and when you say timing, what kind of shift are you talking about?

Yes, that's what I'm talking about. As far as the shift, I will not get into the details because I consider that competitively sensitive.

Okay. Thank you very much.

Thank you.

Thank you all for joining us today. If you have any follow-up questions, please call us at Altria Investor Relations. Have a nice evening.

Thank you everyone. This concludes today's conference call. You may disconnect your lines at this time and please have a wonderful day.