Remarks by Dinyar S. Devitre, Senior Vice President and Chief Financial Officer, Altria Group, Inc. at Prudential Back-to-School Consumer Conference

Prudential Back-to-School Consumer Conference

Introduction

It is a pleasure to be here today.  My remarks contain certain forward-looking statements and I direct your attention to the Forward-Looking and Cautionary Statements section in today's news release.

Overall, Altria Group is on track to deliver solid results in 2004 and we remain confident about our ability to generate long-term growth.

There has been no change to our previously announced guidance for diluted earnings per share at the higher end of a range of $4.50 to $4.60 for the full year 2004, assuming current exchange rates.  This includes charges for the Kraft restructuring, charges for the agreement that Philip Morris International signed on July 9 with the European Community, and the one-time tax benefit reported in our second quarter as a result of the reversal of tax accruals. 

This afternoon, I will focus on the key issues and opportunities for long-term growth at our operating companies.

Since you heard a full presentation on Kraft Foods by Roger Deromedi earlier today, I will not be covering our food business.  However, I want to reaffirm two key messages.  First, Kraft is successfully executing on its Sustainable Growth Plan to build superior brand value, transform its portfolio, expand its global scale, drive out costs and enhance the effectiveness of its organization.  And second, the sequential improvement in the business is clear proof that Kraft's investments are starting to generate rewards, and we are optimistic that Kraft should be able to continue to report improving results as the second half unfolds.

In our domestic tobacco business, I will discuss what PM USA is doing to grow its income over the long term, the successful strategies it is employing to drive share in a highly competitive industry, and its investments in innovative new tobacco products.

In our international tobacco business, PMI is facing serious challenges in some of its largest and most profitable markets in Western Europe.  I will cover PMI's plans to address these challenges and highlight some of its most significant long-term opportunities for growth.

I will also touch on the vast potential of Altria Group's shareholder value and how fully committed we are to delivering superior returns to our shareholders over the long term.

Improving Litigation Environment

In addition, I want to emphasize that we continue to believe that the litigation environment is improving.  Although there have been some procedural setbacks, we believe that the positive fundamentals witnessed over the last couple of years remain very much in place. 

I would like to briefly comment on three cases being closely followed by investors - Engle, Price and the Department of Justice case.

In the Engle case, as you know, a Florida appeals court overturned the $145 billion verdict against PM USA and others and decertified that class action in May 2003.  In September 2003, the appellate court reaffirmed that decision and in May of this year the Florida Supreme Court granted review of the appellate court's decision.  Oral arguments are scheduled for November 3, and we expect a decision in the first half of 2005. 

We have always felt that the Florida Supreme Court might take the case solely to review the appellate court's decision that individual claims for punitive damages in future cases in Florida are barred as a result of the settlement agreement between the tobacco industry and the state, an issue that has nothing to do with the appellate court's de-certification of the class and finding that the award of punitive damages to the class was improper.  In addition, we believe that given the extremely high profile of the Engle case, the Florida Supreme Court might want to add its imprimatur to the appellate court's decision.

In the Price "Lights" class action case, the Illinois Supreme Court agreed in September 2003 to review the original trial judgment, thereby shortening the appellate process.  Oral arguments are expected late this year and we hope to get a favorable decision in 2005.

Our optimism regarding the Price appeal rests on our belief that the certification of the class and the judgment of the trial court were inconsistent with Illinois law, and that the issues the trial court decided are national in scope and governed by federal laws and policies.  Every pack of Marlboro Lights ever sold has contained the Congressionally mandated U.S. Surgeon General's warning, and the company has followed all federal laws in measuring and reporting tar and nicotine yields.  We believe that the court will ultimately agree that it is not appropriate for a state judge to substitute his judgment on these issues for those of the Congress and the U.S. Federal Trade Commission. 

In the Department of Justice case, a trial date has been set for September 21.  Assuming that the case goes to trial as scheduled, we do not anticipate a decision by Judge Kessler before the second quarter of 2005.

The core issue for investors is disgorgement, and on this issue oral arguments on our appeal to the DC Circuit Court of Appeals have been scheduled for November 17.  We remain optimistic that the appellate court's decision will either support our position that disgorgement is not an appropriate remedy or significantly narrow the scope of any potential disgorgement.

In each of these three cases, we have very strong arguments that form the basis for our optimism.  Although the risk of adverse headlines will continue as these cases make their way through the legal process, I believe that, taken together, litigation developments are likely to have continued positive effects for PM USA throughout 2004 and into the future.

Philip Morris USA Inc. (PM USA)

Turning now to our tobacco businesses, I will start with Philip Morris USA, the clear leader in the U.S. tobacco industry.  PM USA has faced several external challenges over the past few years, and I would like to begin with a discussion of the most recent developments in those areas.

First, a weaker economy presented a major challenge for PM USA beginning in 2002.  Among other things, concerns about jobs led many adult smokers to consider discount brands as an acceptable alternative to premium brands.

However, the latest economic data suggests that the economy is improving, with solid GDP growth in the second quarter of 2004, a declining unemployment rate and improving consumer confidence.  We are hopeful that these favorable trends will continue throughout this year.

Second is the rate of increase in state excise taxes.  After a dramatic increase in 2002, weighted average state excise taxes have been increasing more moderately, reaching $0.70 in 2003 and are expected to reach approximately $0.77 per pack by year-end 2004.

Third is the wide availability of cheap imported cigarettes.  After increasing in 2002 and 2003, import volume declined in the first half of 2004 versus the first half of 2003 and the latest 12-month moving average data show a decline for cheap imports since the middle of 2003.

Fourth is illegally sold cigarettes, including counterfeit and contraband.  PM USA has intensified its efforts to stem the flow of counterfeit cigarettes, working in conjunction with law enforcement agencies. 

Just recently, PM USA achieved an important victory when the U.S. District Court for the Southern District of New York found that Internet cigarette retailer Otamedia, based in Switzerland, is selling cigarettes into the U.S. in violation of the law.

As a result of enforcement efforts, we believe that the availability of counterfeit cigarettes has declined in states where PM USA had experienced especially high counterfeit levels, such as California.  However, illegally sold cigarettes continue to represent a serious problem there and in many other states.

Turning now to PM USA's most recent results, operating companies income grew 24.3% to $2.2 billion in the first half of 2004, primarily reflecting the impact of pre-tax charges of $182 million in 2003 for the tobacco growers settlement, as well as higher results from operations in 2004.

Volume in the first half of this year was essentially flat.  Looking ahead, PM USA anticipates lower volume in the second half of the year versus the second half of 2003 as a result of increased competitive activity, the timing of holiday purchases and higher state excise taxes.

One of PM USA's most important initiatives has been to manage Marlboro 's price gap versus deep discount brands.  PM USA believes that it can continue to gain share with price gaps in the mid- to high-40% percent range, and will further benefit as the domestic economy recovers and consumers have more disposable income to spend on premium brands.

As a result of more aggressive price-gap management and effective promotional programs, PM USA's retail share as measured by the IRI/Capstone Total Retail Panel has shown solid growth, reaching 49.8% in the second quarter this year.  That was a gain of 1.3 share points versus the same period a year ago and the largest share gain among the major manufacturers. 

By investing in its premium brands, PM USA has contributed to the recent growth of the premium category, which was up 1.1 share points to 73.2% in the first half of 2004, and its share of the premium category rose nearly 1.0 share point to about 62% in the first half of 2004.

The discount category's share has continued to decline, decreasing 1.0 share point versus the year-ago period, to 26.6% in the second quarter of 2004.

And importantly, there has been a flattening of the deep-discount segment, comprised of all other manufacturers' discount brands and major manufacturers' private label brands, which has remained at about 12% since the fourth quarter of 2002.

Marlboro continues to evince solid momentum, gaining 1.8 share points to 39.6% in the second quarter.

After the successful launch of Marlboro Blend No. 27 last year, PM USA continued to enhance Marlboro's brand equity with the March 2004 national launch of Marlboro Menthol 72mm, which has contributed to incremental share growth for the Marlboro Menthol family this year.

PM USA also has a strong franchise in the Parliament brand, which has solid underlying strength and demographics and was aided by last year's launch of the Ultra Lights version. 

Parliament is particularly strong in the Northeast, where it gained 0.2 percentage points in the second quarter of 2004, reaching a 5.3% share, more than triple its share nationally.

During the third quarter, PM USA is expanding distribution of Parliament Lights 100mm round corner box.

Virginia Slims continued to show relative stability in the second quarter of 2004, down slightly to 2.3%.  PM USA is launching a new premium line extension in the third quarter, Virginia Slims Ultra Lights 120mm box.

PM USA enjoys strong operating margins, driven by its highly productive manufacturing, marketing and sales infrastructure.  In the first half, PM USA's operating companies income per thousand cigarettes was nearly twice that of Reynolds American on a pro forma basis, and almost at parity with Lorillard, which enjoys the benefit of being focused on one brand in the premium category.

PM USA has a well-established and disciplined program of cost management that drives its cost-reduction initiatives and helps to enhance its income. As part of this effort, PM USA made a significant and long-term reduction in its costs by relocating the company's headquarters to Richmond, Virginia.  In addition, PM USA is evaluating every element of its cost base to find areas for additional improvement, including benchmarking its manufacturing operations and installing higher-speed equipment.

PM USA is also supporting several legislative initiatives related to state escrow statutes that were enacted in the wake of the Master Settlement Agreement. 

Complementary NPM legislation that includes tougher escrow deposit requirements has now passed in 43 states and the District of Columbia, and allocable share legislation has been enacted in 36 states.

Looking at the longer term, PM USA and Philip Morris International continue to make considerable investments to develop, scientifically evaluate, commercialize and launch products with technologies that potentially reduce a smoker's exposure to harmful compounds in cigarette smoke.

PM USA continues to evaluate these product technologies to determine whether they meet the criteria for reduced-exposure claims recommended by the Institute of Medicine, which is part of the United States National Academy of Sciences. 

PM USA will not make any reduced-exposure claims about these products until this evaluation is completed.  PM USA intends to test market these products, without any reduced-exposure claims, in order to gauge adult smoker acceptance of taste and flavor.

Finally, we applaud the Senate's passage in mid-July of a bill granting the FDA regulatory authority over tobacco products, including design and manufacturing performance standards, national product standards and the authority to combat illicit tobacco products.  We look forward to working with all our stakeholders to support this important legislation.

To sum up, the investments PM USA has made are clearly paying off with solid financial performance and strong retail market share gains, particularly for Marlboro.

Looking ahead, PM USA expects volume to decline slightly in 2004, with moderate retail share gains and operating companies income growth in the low single digits this year.

And going forward, balancing income and share growth remains an important goal at PM USA.

Philip Morris International Inc. (PMI)

Turning now to our international tobacco business, PMI is achieving solid growth throughout the world, driven by its superb brand portfolio, although overall progress has been constrained by continued weakness in France, Italy and Germany.

In the first half of 2004, PMI's operating companies income rose slightly to $3.3 billion, primarily reflecting a $250 million pre-tax charge for the PMI/EC agreement, as well as slightly lower income from operations.

Absent the charges for the EC agreement and certain minor items, PMI's operating companies income was up 8.6%.

This number was admittedly flattered by favorable currency of $361 million.  However, PMI has consciously invested in the business to accelerate long-term growth by supporting its brands, increasing R&D, expanding its sales forces and managing price gaps around the world.

First half volume was 389.6 billion units, an increase of 3% including acquired volume.  Volume performance was constrained by lower volume in France, down 26%; in Italy, down 7%; and Germany, down 12%.  These markets represent about 16% of volume and 26% of operating companies income for PMI through June year-to-date 2004.  Volume was up 7% in all other markets.

We believe that PMI can successfully address the serious challenges it faces in Western Europe over time.  Tax-driven price increases on cigarettes have resulted in lower incidence of smoking and reduced consumption, while volume for other tobacco products, including roll-your-own and tobacco portions, is rising rapidly in certain markets.  The issues faced in France, Italy and Germany are different, so I'll update you on the actions PMI is taking in each market, starting with France.

Although price gaps between premium and the lowest-price brands have remained reasonable in France, several tax-driven price increases over the last three years have impacted smoking incidence and cigarette consumption as premium cigarettes have risen to 5.00 euro for 20 sticks.

This year, cigarette industry shipments in France are expected to decline to about 57 billion units, a reduction of 20% compared to 2003.

However, this is partly offset by higher border sales, mainly in Spain, and the growth of fine cut.  Thus, cigarette consumption is expected to be down 13% to 16% and tobacco consumption down 10% to 13%.

This month, PMI will make a robust entry into the rapidly growing fine-cut segment with Chesterfield roll-your-own.

In the cigarette market, the relatively modest price gaps have helped support the premium segment, which accounted for 46% market share in the second quarter of this year.

PMI's share of the premium segment has remained at about 74.4%, reflecting the resilience of Marlboro.  Furthermore, PMI's share of the lowest-price segment is up, due to the success of L&M and recently launched Basic.

Overall, PMI's market share trends in France have improved this year versus 2003, with share trending up on a weekly basis since the end of February.

In addition, a new law was recently passed that effectively establishes a minimum reference price below which cigarettes cannot sell, and this goes into effect later this month.  The government has announced that it is unlikely to raise taxes again this year and next, which should provide some stability in overall consumption trends. 

While France is essentially a consumption issue, in Italy PMI faces a market share issue.  In Italy, the price gap between Marlboro and super-low price brands widened significantly last year, reaching 65% in March 2003.

This resulted in the rapid growth of the super-low-price segment, which grew to a 17% share of the total market in July of this year, while the premium and low-price segments lost market share.

PMI's overall market share declined due to losses in low-price Diana, and to a lesser extent Marlboro.

However, on a sequential basis, PMI's market share in Italy has been stable since April, and based on latest weekly shares reached 51.8% by mid-August.

To restore both volume and share growth in Italy, PMI launched L&M in May to establish a presence in the lowest-price segment and also introduced a new, more contemporary pack design for Diana.

It also expanded the field sales organization by over 60% in the last two years, which has enabled PMI to increase retail coverage and frequency in this large and profitable market. 

Furthermore, in July the Italian government issued a decree that provides for the introduction of a minimum tax based on current prices of the most popular price category, which is 2.80 euro per pack, rather than last year's price of 2.50 euro per pack.  Going forward, the minimum tax will be adjusted twice a year.

If higher taxes on lower-priced brands are passed on through retail price increases, the price gap between Marlboro and super-low-price brands would be narrowed further, from the current gap of 40%, and PMI's volume should benefit in Italy.

PMI's new distribution arrangement in Italy will also yield positive results for its business.  PMI is now finalizing arrangements with Logista, a subsidiary of Altadis that purchased the erstwhile monopoly distribution system from BAT to distribute its brands beginning next year, and expects the new arrangement to enable it to significantly improve its cash flow and distribution costs in Italy.

Turning to Germany, PMI is basically facing a consumption issue.  A difficult economic environment, coupled with a tax-driven price increase in March, resulted in a 13.4% decline in the cigarette market in the first half of this year.

Against this background, PMI's cigarette market share was down slightly in the second quarter of this year to 37.2%, reflecting a modest increase in private-label brands.

However, combined consumption of cigarettes, fine-cut, tobacco portions and cigarillos declined by a more modest 7.0%.

Volume for tobacco portions is up over 100% in the first half of 2004, as they sell at half the price of premium cigarettes but are taxed at the rate of roll-your-own.  Margins on tobacco portions and manufactured cigarettes are relatively similar. 

In April, PMI entered the rapidly growing tobacco portions segment with Marlboro and Next.  Both are performing well, have solid profit margins and room to grow.  Regretfully, however, performance is constrained by temporary capacity shortfalls.

PMI is just starting to participate in these other tobacco segments in Germany and elsewhere in Europe and has potential to generate solid volume growth, leveraging its strong trademarks.

Overall, the challenges in France and Italy are manageable and we believe the worst is behind PMI in those markets.  However, Germany will remain a challenge, particularly in light of the currently scheduled tax increases expected in December 2004 and September of 2005.  The December tax increase is currently being debated and there is no certainty that it will be implemented. Clearly, any postponement or cancellation would be good news.

Notwithstanding challenges in these markets, PMI has considerable opportunity for long-term growth around the world.  Outside Western Europe, PMI's business is performing very well, with gains being achieved in Asia, Central Europe, Eastern Europe, Middle East and Africa, Latin America and worldwide duty free.

In Asia, PMI is achieving strong volume growth in many markets including the Philippines, Korea, Thailand and Malaysia.

In Korea, for example, PMI's product portfolio has significantly expanded in the last 18 months, which enabled the strong results so far this year.  Recent successful introductions include Marlboro Ultra Lights, Lark and Elan Super Slim Ultra Lights.  All of these brands are performing well, with Elan achieving a 1% share only five months after its launch. 

In the EEMA region, continued strong performances in Ukraine, Turkey and the Middle East are driving volume gains.

In Russia, although shipment volume was essentially flat due to inventory changes at our distributors, market share is up 1.7 percentage points to 26.2% in the first half, driven by L&M, Marlboro, Next, Chesterfield and Parliament.

Growth in the Central Europe region was due primarily to acquired volume in Serbia and Greece, as well as continued gains in Romania.

Another market representing a significant opportunity is Japan.  Together with Russia, it is one of the largest markets in the world, excluding China and the U.S., with industry volume of over 302 billion units in 2003.

Volume in Japan was down 6% in the first half of 2004, reflecting a difficult comparison versus the prior period, given the July 2003 tax-driven price increase and a lower total market.

However, PMI continues to extend its long-term market share growth trend, driven by Marlboro and Lark.

You recall that Japan Tobacco (JT) and PMI have announced that JT's license to manufacture and sell Marlboro cigarettes in Japan will not be renewed at the end of April 2005.  In preparation for the change, PMI has increased its sales force in Japan by 30%, enabling it to increase the frequency and quality of sales calls.  It also is expanding its vending machine network, which will grow by 23% this year, with plans to further increase the number of machines in 2005.

Regaining control of Marlboro in Japan will provide significant benefits to PMI.

First, PM Japan becomes a more valuable partner and supplier with retailers, particularly in 30,000 convenience stores where the shopper demographics are favorable for Marlboro.  And let me remind you that Marlboro 's share among legal-age to 24-year-olds is more than three times its total market share.

Second, we believe PMI can give more focus to growing Marlboro.  Under the license agreement with JT, PMI was limited to two promotional cycles for Marlboro per year.  Regaining control gives PMI greater flexibility to increase the frequency and depth of the promotional support for Marlboro.

Third, PMI will keep 100% of the profits generated by Marlboro, rather than sharing that profit with JT.  As a result, profitability of the brand will increase significantly, to about the same margin per thousand as Marlboro in Germany.

PM Japan has strong positions in the growth segments of the industry, including the 1mg, menthol and 100 millimeter categories, with shares that exceed its overall market share, boding well for future volume growth.

With superb trademarks such as Marlboro, Parliament, the recently revamped Philip Morris brand and new products such as Virginia Slims Rosé and Lark Pacific Green, PMI's future looks very bright in Japan.

PMI continues to invest behind its superior brand portfolio, led by Marlboro, its top priority.

Marlboro's image remains far stronger than that of its competitors and its scale is unrivaled.  Marlboro 's volume is nearly as large as the next seven competitive international brands combined. 

To keep Marlboro contemporary and relevant, PMI is also supporting Marlboro with promotions linked to its highly successful racing sponsorships, bringing the excitement of motor sports to its consumers.

Total Marlboro volume of 162.5 billion units was down 2.0% in the first six months of 2004, due mainly to declines in France, Italy and Germany. 

Excluding these markets, Marlboro was up a solid 2.5% in the rest of the world.  Furthermore, Marlboro continued to gain share in the first half of this year in many key markets, including Spain, Mexico, Portugal, Belgium, Argentina and Poland, as well as Japan.

Marlboro should also benefit from its superior demographics.  In most markets, its share among legal-age to 24-year-old smokers exceeds its overall market share.  This is the picture we find across the world, and it underscores how strongly PMI is positioned for growth.

While Marlboro 's strength and vibrancy have generated 38.5% share in the U.S. and 23.8% share in Western Europe, the brand has considerable share growth opportunity in other geographic regions, including Latin America, Central Europe, the Middle East, Japan, Asia, Africa, Eastern Europe and China.

PMI's other international brands also continue to grow.  A great example is L&M, which was up nearly 8% in the first half of this year.  This brand has become the number three cigarette worldwide, reflecting a successful pricing strategy, effective image advertising and geographic expansion to over 70 countries.

To sum up on PMI's brands, Marlboro is by far the global market leader, with volume last year of 320 billion units.  L&M has achieved global brand status with volume of 106 billion units last year, while the combined volume of PMI's next four international brands -- Parliament, Lark, Chesterfield and the Philip Morris brand -- is about equal in scale to BAT's international "drive" brands.

In the increasingly competitive market environment, PMI is placing even greater emphasis on productivity.  In 2003, it generated over $70 million of productivity savings and is targeting annual gains of $100 million going forward.

The underpinning of PMI's success is its extensive infrastructure of state-of-the-art manufacturing facilities, distribution networks and sales forces.  PMI has increased its sales force by 2,400 people over the past three years.  Other investments are focused on increasing Marlboro 's visibility at retail, and these have already begun to yield excellent results.

PMI will also continue to pursue new business development activities that provide a strategic fit, strong growth potential and attractive returns.  Some of its more significant recent transactions include the acquisition of Papastratos in Greece; DIN, the leading tobacco company in Serbia; and the acquisition of the Sterling trademarks in the Philippines.

And just last week, PMI announced an agreement to acquire a controlling interest in the Colombian company Coltabaco, the largest independent tobacco company in Latin America and the market leader in Colombia.

Of course, China is a high priority and clearly one of PMI's greatest long-term opportunities.  China is a market of about 1.8 trillion cigarettes, or about a third of the world's cigarette consumption, and PMI is actively pursuing a number of initiatives there.

Developing markets are a terrific long-term growth opportunity.  Consider that last year, 61% of PMI's volume was in developing markets such as Indonesia, Korea, Mexico, Russia and Turkey, while only 39% of its operating companies income came from developing markets.  As these economies improve and adult smokers trade up to premium brands, there is clearly potential for further profitable growth. 

In addition, PMI has strong positions in segments of the industry that are expanding.  PMI's participation in lower-tar, menthol and American blend segments provides built-in momentum, as its share of these segments is higher than its 14.5% share of the total market, and the remaining 85.5% of the industry presents a huge growth opportunity for PMI.

In the second half of the year, PMI expects total volume growth including acquisitions of approximately 5.0% to 6.0%, which translates to about 4.0% to 4.5% for the full year 2004.  Excluding acquisitions, volume growth will be slightly over 1% for 2004.  PMI's situation in Western Europe, as discussed earlier, remains challenging.  However, PMI's business continues to grow strongly in many other markets around the world.

PMI should deliver approximately 10% operating companies income growth this year, at current exchange rates and excluding the impact of the EC agreement. 

Conclusion

I want to conclude by emphasizing that one of Altria's greatest strengths is its ability to generate cash flow at a level that places it among a very select group of companies worldwide.

For the five years from 2004 through 2008, we continue to project approximately $56 billion in cumulative cash flow, largely generated by our tobacco operating companies.

We will use our cash flow to fuel business growth through capital expenditures as well as strategic acquisitions, to strengthen our balance sheet and further reduce our debt, and to reward shareholders through actions such as the recent 7.4% increase in Altria's dividend, which now stands at $2.92 per share on an annualized basis.

In addition to the growth potential of its businesses, Altria has significant value potential, as you can see from the discount at which our shares trade versus the S&P 500 Index.  And looking only at our tobacco operating companies, you can see even more clearly how much value potential there is in that part of our business.  Our stock ex-Kraft trades at more than a 30% discount to its tobacco peers, further underscoring Altria's value potential.

As we've said before, the entire management team at Altria Group is focused on delivering superior returns to our shareholders over the long term and we remain confident that the Board of Directors will fully consider all alternatives in deciding how best to achieve that goal.  Thank you.

# # #

Contact Information

Altria Client Services Media Relations Tel: 804-484-8897