Altria Group, Inc. (MO) Q3 2013 Earnings Report, Transcript and Summary

Good day and welcome to the Altria Group Q3 2013 earnings conference call. (Operator instructions) I would now like to turn the call over to Ms. Sarah Knakmus, Vice President, Investor Relations for Altria Client Services. Please go ahead ma’am.

Thank you. Good morning and welcome to Altria’s Q3 earnings conference call. We are here this morning with 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 Q3 and first nine months of 2013 and we will not be discussing the status of tobacco litigation. Our remarks contain forward-looking cautionary statements and projections of future results. May I direct your attention to the forward-looking and cautionary statement section at the end of our earnings release for review of the various factors that could cause actual results to differ materially from projections. Time periods referencing these remarks are to the relevant 2013 period unless another year is identified. Similarly, comparisons are to the comparable year or period unless otherwise stated. For a detailed review of Altria’s business results please review the earnings release that is available on our web site Altria.com. Altria reports its financial results in accordance with U.S. generally accepted accounting principles. Today’s call will contain various operating results on both a reported and 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 web site. Now I will turn the call over to Marty.

Thanks Sarah. Good morning everyone. In the first nine months of the year Altria continued to execute against our long term objectives of delivering consistent adjusted diluted EPS growth in the range of 7% to 9% and maintaining a strong and growing dividend. Strong Q3 results driven by contributions across our businesses helped produce adjusted diluted EPS growth of 9% for the first three quarters. Also during Q3 we increased our dividend by 9.1% marking the 47th dividend increase in the 44 years. Overall our businesses are on track against their full year objectives and Altria remains focused on creating long term value for shareholders. During both the quarter and the first nine months our strategies and diverse business model continued to produce strong results. Our tobacco operating companies grew adjusted operating companies income behind their leading premium tobacco brands and are alcohol assets also delivered income growth. Additionally we used our capital structure to reward shareholders through share repurchases and we expanded our buyback program. In the smokable product segment, PM USA balanced income growth with shared gains in a competitive environment. Higher pricing helped drive income growth in both the quarter and for the first nine months. PM USA grew its total retail share in both periods and held Marlboro’s retail share flat versus its strong performance in both periods a year ago. The Marlboro Black family continues to contribute to the brand success and later this month PM USA will expand distribution of Marlboro Edge nationally. Marlboro Edge offers adult smokers bold smooth flavor. In third quarter, Q3 PM USA benefited from stronger shipment volume as volume declines moderated versus the previous quarters of 2013. PM USA’s reported cigarette shipments grew 1.2% for Q3. After adjusting for calendar differences and changes in trade inventories, PM USA estimates…

Thank you, Marty. Good morning, everyone. In the smokeable product segment third quarter reported operating Company's income grew by 11.5%, primarily due to higher pricing from previously disclosed NPM arbitration panel decision and higher reported shipment volume. These factors were partially offset by higher promotional investments, higher resolution expense and higher selling, general and administrative cost due to the timing of spending. For the first nine months of 2013, the smokeable product segment's reported operating Company's income grew by 16%, primarily due to PM USA's NPM adjustment settlement, the NPM arbitration panel decision and higher pricing. These factors were partially offset by lower reported shipment volume and higher resolution spends. Excluding the special items identified in our earnings press release, adjusted operating Company's income for the smokeable product segment grew by 3.1% to approximately $1.7 billion for the third quarter, and increased by 2% to approximately $4.8 billion for the first nine months. PM USA grew its total retail share by two-tenths of a share point to 50.7% for the third quarter and by three-tenths of a share point to 50.6% for the first nine months. Marlboro's retail share was unchanged versus both prior year periods at 43.7% for the quarter and 43.6% for the first nine months. PM USA's discount share was 3.9% for both periods, up three-tenths of a share point for the third quarter and up five-tenths of a share point for the first nine months. L&M contributed to PM USA's discount share gains in both periods. Cigar shipment volume increased 6% for the third quarter and decreased 6.6% for the first nine months. Black & Mild's retail share decreased 1.1 share points for the third quarter and 1.6 share points for the first nine months. Turning to the smokeless product segment, reported operating Company's income, for…

Thank you. [Operator Instructions] Our first question comes from the line of David Adelman from Morgan Stanley. David Adelman – Morgan Stanley: Good morning, everyone.

Good morning, David. David Adelman – Morgan Stanley: Marty, I was surprised in the discreet third quarter that the smokeless division’s margins were down with volume and pricing up, can you just speak to that what the factors were and there was this illusion to the timing of expenses, what exactly is going on there?

Yeah, it’s just the cost coming in-and-out of the quarter at different times, David. I think the better number to look at the margin question is really the nine month period. You can see there that actually the margin for that segment is up six-tenths of a percentage point to 42.2, so that’s how we look at it over time. Again, you know, for sort of a larger reference point, if you look back to the period of 2008 to 2012 as you know this segment really grew its margin quite substantially by more than seven percentage points. So, I think a quarter is really too short a period to look at this, there is nothing particularly significant except for timing. David Adelman – Morgan Stanley: Okay. And then on e-cigarettes, I’m curious having MarkTen in the marketplace, what do you know now about the product, about consumer’s reaction to it in terms of consumer’s overall view towards e-cigarette that you might not have known actually being in the marketplace.

Yeah, that’s a terrific question. Thank you for asking that. We’re having a very successful lead market in Indiana, it’s too early, obviously, to rummage around, I think, in numbers but here’s what we know. It was very enthusiastically received by the trade. We were shooting to get coverage, as you know, across where cigarette volume is, we’ve got coverage in moiré than 3,000 stores, covering about 85% of cigarette volume. We’ve gotten very good consumer feedback about the product. And we had a learning plan, the particulars of which I won’t go into, as you might expect, for competitive reasons, but we had several questions that we wanted to ask about our offering. And I think the lead market, Indiana, has given us excellent insight into the consumer, into the offering we have, its competitive position, how it’s being received at the trade. And so, you know, as our announcement says this morning it’s on to Arizona, we’ve taken those learnings, we’ve incorporated them into our offering that we will have in Arizona. Our aspiration there is to cover about 2,000 stores and that’s how we’re trying to learn our way in this emerging category. We have new consumers, new products and we think that’s the right way forward. But we’re really pleased with what we’ve learned in Indiana. David Adelman – Morgan Stanley: Great. Thank you very much.

Thanks for calling in, Dave.

Our next question comes from Thilo Wrede from Jefferies. Thilo Wrede – Jefferies & Company: Good morning, everybody. Marty, your competitors this week have talked about the promotional environment in cigarettes being less promotional. Is that a view that you share?

I think I would refer to what we typically said about the segment. You know, it’s a competitive space. It has been competitive, it remains competitive. I think what we’ve observed, obviously, as new products come in-and-out of the market and people try to get consumer awareness of those, you see promotions from time-to-time and that’s what we would observe. Thilo Wrede – Jefferies & Company: So, I interpret that as that you don’t see much of a change then?

I think it’s about what it’s been, which is to stay competitive. Thilo Wrede – Jefferies & Company: Okay. Given that environment, is there any opportunity for you to accelerate your price increases in smokeables?

Well, that’s our strategy always, is to improve our profitability in the smokeable segment. We look at that regularly. As you know, that’s done through a combination of factors, including list price increases and changing our promotional levels as is appropriate. As we’ve discussed previously, we can do that not necessarily on a national level, but we can go into regions and states and even markets to adjust those promotional levels. So, that’s certainly our strategy. We are trying to maximize income while always making sure that the Marlboro share in particular remains in good form with some moderate momentum. Thilo Wrede – Jefferies & Company: Okay. Thanks a lot.

Our next question comes from Chris Growe from Stifel. Christopher Growe – Stifel Nicolaus: Hi, I just want to ask first of all on keeping the wide range of EPS for the year and therefore has implications for Q4 is there any unique to Q4 we should consider be it at the low end or the high end of the range and unique to the comparisons?

There is one that I would mention Chris, which is that there is one fewer shipping Monday in the smokeless business and as you know a lot of volume goes out on our Mondays and there is one fewer of those in Q4 than there was in Q3, so that is a factor. You know we are investing obviously in our E-vapor business so those are two factors I might bring to your attention. Christopher Growe – Stifel Nicolaus: Okay, and I want to ask, with the stronger volume in performance this quarter, not only for an adjusted basis, but on a reported basis, the OTI for the smokable segment came in a little below my expectations, so I am just curious if again there was anything unique to the costs this quarter? Or maybe even the phasing of the cost savings? Any factors you can help us understand the margin performance for that division.

No, again, I think the best way to understand that Chris is that is best understood over time. We are trying to maximize income, we look at that over time, and you know if you look back at some other figures again for context, you know that they are higher, in the 2012, I think it was 4.2. We are making investments in Marlboro. We continue to roll out the Marlboro architecture. We have improved the web site. We have got digital technology for our marketing platform now, so I think that is the way to understand it. Howard you may want to say more.

Yes, I think just two comments on Q3. I mean when you look at year-over-year pricing, the price realization was affected by the comp from last year and then there were more expenses in Q3 from a year-over-year trend perspective than there were in the first half but I don’t think that is a particular change in trend. It is just that they just happen to fall more heavily in Q3 and certainly part of that is related to the phasing in the cost reduction program. We got more of the cost savings earlier in that program but I still think to go back to the nine month numbers are probably more reflective of the overall trend. Christopher Growe – Stifel Nicolaus: Okay, that is very helpful. If I could ask just one quick follow up to the question that David asked it about and your comment how you have made some changes, some learnings that are from Indiana, was there any change to the actual physical product that you are selling in Arizona?

I am not going to get ahead of what we are going to do in Arizona but I can tell you that we are always looking at the product. I think we have talked earlier that for this product Chris it is on the earlier part of the technology curve probably than the later part of the curve, so we are consistently looking at that product to see if we can improve its acceptability to the adult tobacco consumer. As you know the way we think about going to market is through our value equation with not just product but price and promotions and packaging and the like. We are looking at all of that to make sure that our total bundle and offering to the consumer is the best we can offer. We will have more to say about that as we get closer to December. Christopher Growe – Stifel Nicolaus: Okay.

Thanks for calling.

Your next question comes from Vivien Azer from Citigroup. Vivien Azer – Citigroup: I wanted to circle back on the timing of the investments, I heard you loud and clear, that more investment to come on the E-vapor business, should part of the investment timing that we saw drive the increase in SG&A were first out in the fourth quarter, or is there more incremental spending to come Q4?

Well I think specifically looking at our investment in E-vapor, there has been a ramp up in the back half and I think probably a further ramp up in Q4, obviously with a new test market being opened up. I think as it relates to expenses in the rest of the business, I think that is more of a Q3 phenomenon. Vivien Azer – Citigroup: Okay, understood. On your smokeless business it looks like maybe Copenhagen is finding its footing from a price gap perspective and now holding steady at 36% and potentially finding an inflection point in the average price per can, can you comment on how you view Copenhagen from a price gap perspective today, and where it can go from here?

Well, I guess I’ll start, again, with the strategy, which is, you know, we’re trying to make sure that Copenhagen and Skoal are growing together and you saw that in the numbers both for the quarter and the nine months, together they’re growing their volume quite nicely, they’re growing their retail share. Copenhagen, as you know, we’ve put some SKUs there, Vivien, that really have taken off. That includes products that compete at the popular price level and it’s that mix, I think, that you may be referring to. We’re pretty happy, overall, with Copenhagen’s performance in the marketplace, it’s a very highly differentiated product and we like its performance. Vivien Azer – Citigroup: Terrific and one last one on the smokeless business. It looks like Skoal’s market share declines are accelerating and can you dive a little bit deeper into what’s driving that?

Yeah, I think as we’ve discussed previously, we’ve been working hard at Skoal, you know, that’s a brand that requires some further work on its positioning at the time that we acquired that brand. We’ve been hard at work at Skoal. Obviously, we started first with Copenhagen, Copenhagen has really taken off as we’ve given it its SKUs and gotten it positioned correctly in the marketplace. You know, the strategy, I think, continues to work quite effectively because of the combination, but there’s no denying that we would like to see Skoal’s share stabilize and we’re working very hard to make sure that that happens.

Bonnie Herzog – Wells Fargo Securities, LLC: Good morning.

Hi, Bonnie. Bonnie Herzog – Wells Fargo Securities, LLC: Hi. In terms of Edge, you mentioned you’re rolling it out nationally later this month, so could you talk about this national rollout relative to your recent rollout of Marlboro NXT and what are similarities and potential differences of your rollout plans and which line do you believe has the most upside potential?

Sure. Good question. I think it’s best understood in the context of expanding the Marlboro Black family. And so we know how we do this right. We look for places in the market where there may be an unmet need or there’s place in our portfolio to look for attracting competitive smokers to our brand. Edge is what the latest of that. It’s very similar, actually, to the approach with NXT, which is we try to put the market in front of the consumer, we try to learn, if successful, we try to expand it. We try to raise awareness through some introductory pricing and then we try to move it on to the promotional platform that’s best, but I think it’s best understood as part of the Marlboro architecture and in this Marlboro in particular. Bonnie Herzog – Wells Fargo Securities, LLC: Okay. And then, Marty, I’m curious how you think broadly about line extensions and maybe what the right number of line extensions there should be on any kind of – or any of your brands and if there is a point where there might too many extensions that could possibly hurt Marlboro’s brand equity? I just want to understand your thinking there.

It’s a good question. You always want to be thoughtful about your brand portfolio and we examine that rigorously. We never bring an SKU to market simply for the sake of bringing it to market. We have to satisfy ourselves, generally speaking, that there is a consumer need for it and that it fits in with our overall brand strategy. And in Marlboro’s case, in particular, we always want to make sure that any SKU we bring to the market is going to enhance its equity and its premium that – and we don’t bring anything out in the Marlboro portfolio until we’ve gone through those filters and Marlboro Edge is a good example, I think, where we have satisfied ourselves. We have high expectations for Edge to add to the overall portfolio as well as to contributing to Marlboro’s equity. But you are right, you have to be thoughtful about your portfolio and we try to do that particularly on Marlboro but certainly on all our brands. Bonnie Herzog – Wells Fargo Securities, LLC: Okay. Then just my final question on MarkTen, just a bit of a follow-on question. How did it perform relative to your internal expectations and what have your repeat purchase trends been in the State? And that I’m sure that you’re seeing quite a bit of dual usage with cigarettes, you know, just any other consumer trends?

Again, I think it’s too early to talk about the numbers, because I just don’t think that they are well-developed enough to share and to be confident in them, but I can tell you that with respect to who’s trying to products and e-vapor generally, we do know that there is dual use. And in particular as adult smokers try e-vapor products we know that some of them are satisfied others are not, some of them use them situational-y. We have a pretty robust, as you might expect, consumer research program into who adult vapors are, their patterns of use, how they may be segmenting, the products that we want and that’s all part of our learning plan in Indiana. And, again, for proprietary reasons I’m not going to discuss that at this time but I can tell you that we’ve learned a lot, it’s informed our judgment about moving forward in Arizona and we’re very excited about being able to move this platform forward.

Our next question is from Judy Hong with Goldman Sachs. Judy Hong – Goldman Sachs: Thanks, good morning.

Good morning Judy. Judy Hong – Goldman Sachs: First, I just wanted to get clarification on the wholesale inventory level at the end of the third quarter, I think some of your competitors have also noticed a movement to really limit inventory loading in fourth quarter ahead of the price increase speculations, so I was just wondering if you expect a similar limitation to put on wholesalers and that potentially limits some of the volatility that we continue to see on a quarter-to-quarter basis on the inventory movement.

We have an allocation program that we have had for a long time so that is hardly anything new to us and with respect to the third quarter inventory levels, I think we referenced as a bit of a build but there is nothing really very significant in cigarette inventory levels from third quarter to third quarter a year ago in our observation. Judy Hong – Goldman Sachs: Okay, and then a couple of questions on the E-cigarettes, I think this is more of a broad category question, and now that you have participation in the category I am just curious to your observation about the pace of category growth that you are seeing at this point versus maybe a year ago. Sequentially it looks like the pace of that category growth is a little bit more modest, I was just curious what you think is driving that and whether we really need something, a bigger innovation, or better consumer acceptance to really accelerate a category growth and then related to that, in terms of how your dialogue with some of the regulators both at the FDA level and at the state legislators are evolving as you now have a stake in the category with your product.

Thanks, those are all excellent questions. Let’s talk first of all about the category. Obviously the category has grown very quickly off a very low base. Whether it will continue to grow at that trajectory, of course, no one knows yet. We have identified, I think, the factors that are likely to be contributing to that. We have run scenarios against these. We have talked about these previously I think. You know one is the product itself. As the products get better and become more acceptable to adult smokers you would expect for perhaps greater transition to the product. Second is regulation. If they are regulated very heavily by the FDA in ways that don’t encourage adult smokers to try them or to switch to them depending on what the FDA says about that, that certainly is going to have a big effect on the category growth and then of course we have to deal with excise taxes. We have engaged with all of the stakeholders in those questions for some time now including, I would say, even before we even entered Indiana. We have strong views on this. We think that the FDA should regulate on a scientific basis and we have been communicating with the FDA regularly both about the category and our product. The same has been true with respect to excise taxes. I think you know we have a robust government affairs organization and we have a lot of experience here. We are trying to help legislators think about the correct excise tax approach which in many ways is bound up in the same question as the regulatory approach. So we are fully engaged on this and I think as to how fast it grows or how slow it grows those will be the factors, in our view, that will determine that largely. Judy Hong – Goldman Sachs: Okay, great. Thank you.

Thanks for your call.

Our next question comes from Filippe Goossens from Mitsubishi Securities. Filippe Goossens – Mitsubishi Securities: Yes good morning Marty, thanks for taking my call. I have a couple of questions on E6 if I may. One of your competitors stated yesterday they see E6 as actually a global opportunity hence their acquisition of a player in the UK markets. Is there an understanding between yourselves and PMI as to your ability to enter that space as well globally that is what you would decide to do at some point in time?

Well I think you are referred back, obviously to the spin-off of PMI and there were arrangements in place of course dealing with the existing businesses at that time which was cigarettes. Obviously cigarettes and E-vapor is a category that has emerged since that time so the answer is no. Filippe Goossens – Mitsubishi Securities: Okay and then secondly, it is probably still too early to tell but based on your current read with regard to the potential of E6 now in the U.S., do you think that at some point in time this would start to cannibalize the smokeless category as well?

Well, we’ll have to see, I guess. We haven’t really been – you know, the question usually comes in the form of whether it’s going to take some volume away from cigarettes and what we said there, of course, is that it’s still small, it’s hard to tease that out. We know that some adult smokers are certainly trying e-cigarettes and so it will have some effect on volume, but you can’t tease it out. We haven’t seen very much about that on smokeless, but I guess time will tell.

Michael Lavery – Credit Agricole Securities (USA) Inc: Good morning. When you’re launching Marlboro Edge, does that have any impact on the rest of – how you think about discounting and promotions on the rest of Marlboro Black and has it allowed you to dial back any of the discounting levels on other SKUs there?

Well, Marlboro Edge is a premium product and it’s in the premium family of Marlboro. What we try to do there is to offer introductory pricing to try to attract competitive adult smokers to it, so that’s I think the best way to understand that, which is, it’s a premium offering. We do offer some promotions to try to get some awareness and certainly trial because we think if they it, they’ll like it. Michael Lavery – Credit Agricole Securities (USA) Inc: Yeah. I guess, what I’m getting at is you’ve had some of these similar launches over the last couple of years now and some of these ones that are, you know, one or two or more years old. How long does introductory pricing last, I mean, is there some color you can give on what the discount levels are doing on these ones that have had introductory pricing, is that sort of passing the baton to Marlboro Edge or do some of those still have more extended periods of introductory pricing level?

Well, I think the way to think about it is, is the total competitive set. So, you want to have introductory pricing to try to make sure that the product has awareness that it’s out there that it’s a new product and that it’s available. We also offer, as you grow brands, and as you know in this category, brands don’t grow overnight and particularly when you have the big share, like we do in Marlboro, bigger than the next 10 brands combined, you know, these are trends that take place over time. And so we have promotional plans in place for them that we evolve over time, but it’s always designed to how we’re doing against the competitive set of adult competitive smokers. And that’s how we think about it. As you’ve heard us discuss many, many times, we take the long view in this business and with this segment and we’re patient. Michael Lavery – Credit Agricole Securities (USA) Inc: Okay. Thanks. And then just looking at the other segment, you know, there was the help in the, you know, what used to be PMCC plus other line from, you know, what looks like an asset sale. Can you give any sense of how much, in fact, that might have had or what that run rate would have looked like without that there?

Yes. I mean, we’re not breaking out the other between the various contributors, but certainly within the third quarter you had a contribution from PMCC and then the other item in there is our investments in the e-vapor category. And so that results from the combination of the two. Michael Lavery – Credit Agricole Securities (USA) Inc: Alright. And then you mentioned on 4Q, is it just one less shipping day specifically for the smokeless segment or is that for everything?

Smokeless only. Michael Lavery – Credit Agricole Securities (USA) Inc: Okay. And just kind of following up on Judy’s question on the inventory. Is there a build – it looks like you might have had a modest build into or at the end of 3Q? Is there much of an impact you would expect that to have on 4Q shipment to kind of make up for it?

Yes. I don’t think that – we did have a modest build in the third quarter and that compares to the prior year when there was a modest drawdown in inventory. But I wouldn’t expect that it’s going to have much impact on the fourth quarter but it’s too soon to tell. I think we’re going to have to see how things shake out in the latter part of the quarter.

Okay. Thank you very much.

Thanks for your call.

[Operator Instructions] Your next question comes from Chris Evert from Bloomberg News. Chris Evert – Bloomberg News: Hey, good morning. Thanks for taking my call. Marty, I want to ask about e-cigs, kind of a broader question. You know, as they gain popularity around the country I’m guessing that companies are beginning to look into whether to allow vaping in the workplace. How do you see that playing out? And what are the factors, FDA regulations and others that is going to direct or – what factors are going to guide how vaping in the workplace plays out?

Okay thanks for your question. Our view on that is it should be guided by the science. As the science develops around vaping and in this case your question really goes to the heart of is there any risk from second-hand vaping if you will and as the FDA looks at all of these questions, I think that there you need a scientific [indiscernible] space approach to that. What we would like to see in the short term is that regulation should have a good reason for its basis and in the absence of a reason or knowledge about that we would like, obviously, to have the FDA have an opportunity to do the work that is required. So I think that it will follow from the science. It will follow from the evidence and we are engaging with the FDA and other regulators about that.

Your next question comes from Thomas Russo from Gardner Russo & Gardner Thomas Russo – Gardner Russo & Gardner: Hi, good morning.

Hi Tom. Thomas Russo – Gardner Russo & Gardner: Hi, good morning. I have a couple of questions on excise taxes. On the increased excise tax level, any upcoming planned increases and if not what are the prospects for any federal excise tax activity? Second as for the smokeless category, where do you stand in the process of converting states from ad forum to specific and what is the general level of excises taxes looking out for the next 12 months for the smokeless?

Okay let me take those in turn. Let me start with the FET. Tom as you know there is a proposal [indiscernible] in the budget and there is some activity trying to persuade people to get behind that. We oppose that. As you know these taxes are aggressive with a huge increase in 2009. You know so far there has not been a lot of traction on that but we are monitoring that carefully with our federal government affairs team. Thomas Russo – Gardner Russo & Gardner: Good.

The second question Tom was about smokeless and ad [indiscernible]. We continue, obviously, to advocate where it is appropriate to do so, to move the weight base, we think that it is a much fairer system. There are opportunities that present itself in the states from time to time to advance that argument and we do that forcefully when we have opportunities to do that. I would say the FET outlook generally, Howard in his remarks, I think covered what we have seen so far, both with respect, really with respect to cigarettes and we are always guarded. State budgets are better than they were but they still have gaps in them and we are watchful. You may have seen there was a media report on a proposal for an excise tax increase in the city of Chicago. So these things pop up from time to time and our approach to them is to try to get in there and advocate for why they are unfair on our adult consumers. Thomas Russo – Gardner Russo & Gardner: Good, thank you.

Thanks for calling.

Presenters there are no further questions in queue at this time. I would now like to turn the call back over to Ms. Sarah Knakmus for closing comments.

Thank you all for being on the call today.

Thank you. If you have any questions please contact our IR department and thank you all for joining us.

And thank you. This does conclude today’s conference call.