Altria Group, Inc.

and welcome to the Altria Group first quarter 2019 earnings conference call. Today's call is scheduled to last about one hour, including remarks by Altria's management and a question and answer session. If you'd like to ask a question during this time, simply press star then the number one on your telephone keypad. If your question has been answered and you wish to remove yourself from the queue, press the pound key. Representatives of the investment community and media on the call will be able to ask questions following the conclusion of the prepared remarks. I would now like to turn the call over to Ms. Paige Magnus, Vice President of Investor Relations and Communications for Altria Client Services. Please go ahead, ma'am.

Good morning, and thank you for joining us. We're here this morning with Howard Willard, Altria's CEO, and Billy Gifford, our CFO, to discuss Altria's 2019 first quarter business results and related matters. Earlier today, we issued a press release providing these results. We're also including slides to accompany our remarks, and all of this information is available on our website at altria.com and through the Altria Investor app. During our call today, unless otherwise stated, we're comparing results to the same period in 2018. Our remarks contain forward-looking and cautionary statements and projections of future results. Please review the forward-looking and cautionary statements section at the end of today's earnings release. for various factors that could cause actual results to differ materially from projections. Future dividend payments and share repurchases remain subject to the discretion of Altria's board. The timing of share repurchases depends on marketplace conditions and other factors. 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. Adjusted results exclude special items that affect comparisons with reported results. Descriptions of these non-GAAP financial measures and reconciliations are included in today's earnings release and on our website at altria.com. So with that, I'll turn the call over to Howard.

Thanks, Paige, and good morning, everyone. After taking steps to position Altria for long-term success at the end of 2018, we entered 2019 with an evolved business platform that includes our strong core tobacco businesses and new strategic investments with tremendous potential for growth. We believe we've made significant progress in the first quarter on key initiatives to realize the potential of this evolved business platform. This morning I'll focus my remarks on some of the key drivers of our business performance, progress against priorities for our new investments, and our perspective on the current regulatory environment. Altria's adjusted diluted EPS declined 5.3%, in line with our guidance for a mid-single-digit decline in the first quarter. We incurred higher interest expense as a result of our recently issued debt, without the full benefit of savings from our cost reduction program, which began to ramp up at the end of the quarter. And in March, we closed our investment in Kronos. Altria now owns a 45% equity interest in the company, and we're excited to support the talented Kronos team in pursuing its growth strategies. Let's now move to our core tobacco businesses and start with the dynamics affecting U.S. cigarette category volumes. We estimate that when adjusted for trade inventory movements and one fewer shipping day, cigarette industry volumes declined by approximately 5% in the first quarter. We believe first quarter cigarette industry volumes reflect both the secular decline, including adult smoker movement between categories and eVapor in particular, and historic price elasticity. We also believe macroeconomic factors, specifically gas prices, affected cigarette volumes in the quarter. Gas prices increased by nearly 20% from the end of January through March. We believe rapid and significant increases in gas prices can cause adult smokers to reevaluate their short-term purchasing decisions. And we believe this negatively impacted the decline rate in the quarter as we saw monthly sequential acceleration in volumes and volume declines over the three months of the quarter. We continue to closely monitor the category, mindful that trends typically play out over a longer period. However, because gas prices did not become a tailwind as we thought they might earlier this year, we've revised our 2019 cigarette industry volume decline rate estimate to 4% to 5%. If we decompose the cigarette industry volume performance for the most recent 12 months, ending March 31st, we estimate that volumes declined approximately 4.5%, reflecting an elevated secular decline rate due to increased movement by adult smokers to e-vapor. We previously cited a secular decline rate within a 2% to 3% range. This range typically includes one percentage point of adult smoker movement to other tobacco products. And in total for this trailing 12-month period, we estimate adult consumer shifts to evapor accounted for the historic one percentage point component, plus an additional four-tenths. We believe macroeconomic factors, specifically gas prices, accounted for about three-tenths of a percentage point additional headwind on cigarette volumes. We also believe the price elasticity component of the decline rate remains consistent with our long-term estimate of negative 0.3. We continue to believe that cigarette volumes will decline at an average annual rate of 4% to 5% over the next five years. Moving now to our smokable product segment cigarette volumes. Reported domestic cigarette volumes declined 14.3% in the first quarter, reflecting year-over-year trade inventory dynamics and one fewer shipping day. When adjusted for these factors, our cigarette volumes declined by an estimated 7%. Let me comment in a bit more detail on the first quarter trade inventory movements. which negatively impacted year-over-year reported volume comparisons by approximately 1.7 billion units, or almost six percentage points. Over the course of the quarter, wholesalers depleted PMUSA inventories by an estimated 400 million units, compared to a build of 1.3 billion units in the year-ago quarter. and the trade ended the first quarter with significantly lower cigarette inventories than it did last year. While there can be volatility quarter to quarter, industry movements typically smooth out over time. Despite this volume performance, The smokable segment's adjusted operating company's income was essentially unchanged from the prior year, as PMUSA continues to execute its strategy of maximizing profitability while maintaining momentum on Marlboro over time. PMUSA's efforts resulted in smokable products segment net price realization of more than 8% and adjusted operating company's income margin expansion of more than 3 percentage points. We remain quite pleased with the performance of Marlboro and its continued stabilization since the fourth quarter of 2017, following the disruptive California SET increase earlier that year. Investments in retail trade programs, product expansions like Marlboro Ice, and brand equity like the Marlboro Rewards Program continue to show encouraging results. with retail share up or down a tenth sequentially over the past five quarters. While Marlboro retail share has remained stable over the last five quarters, L&M has ceded share to deep discount offerings, which negatively impacted PMUSA's overall retail share. We continue to believe the growth of deep discount reflects the churn between branded discount and deep discount, and not interactions with premium brands. We remain quite pleased with the role L&M has played in PMUSA's portfolio over the past six years, growing share and increasing profitability without affecting Marlboro. In smokeless, USSTC is similarly focused on maximizing income while maintaining momentum on Copenhagen over time. USSTC delivered strong adjusted operating company's income growth despite slowing category volumes and one less shipping Monday during the quarter. Copenhagen, the fastest growing brand in four of the last five quarters, grew its share by 0.7 share points to 35%. Additionally, in early February, USSTC presented a compelling case supporting its MRTP filing for Copenhagen snuff to the FDA's Tobacco Product Scientific Advisory Committee that communicating accurate and scientifically grounded information to adult smokers about the relative risks of smokeless tobacco is important for harm reduction. The committee overwhelmingly agreed that our modified risk claim is fully supported by scientific evidence and voted accordingly. We'll continue to engage with FDA on this application. We also remain very excited about the opportunity to market PMI's ICOS Heat Not Burn product in the U.S. We are fully committed to this platform and have strong commercialization plans to support its launch. We're ready and continue to learn from the momentum of ICOS's success in overseas markets. As you are aware, it's been two years since PMI submitted the ICOS PMTA and recent comments from leadership at the Center for Tobacco Products suggests the decision is forthcoming this year. We believe the science is compelling and supportive of a market authorization, and we're ready and excited to help convert adult smokers to ICOs once that authorization is received. Turning now to eVapor. In December, we announced that our investment in Juul would allow us to participate meaningfully in the eVapor category. and also to support and even accelerate adult smoker transition to noncombustible alternative products. Over the past few years, as products in the market have improved, led by Juul, we've seen a significant reacceleration in the number of adult vapors in the category. Annual 12-month moving data shows an increase in the number of adult vapors from 9 million in 2016 to 13 million in February 2019. And when looking at three-month data ended in February, there were more than 15 million adult vapors compared to the 12 million in the year-earlier period. We believe this data reflects higher product satisfaction and conversion by adult smokers and is supportive of harm reduction potential of the category. In the first quarter, we estimate that eVapor category volume grew by approximately 40% year over year across open and closed systems and all trade classes. Juul reported to us that its shipment volume grew approximately 175% to over 175 million refill kit pods. And we estimate Juul now represents more than 40% of the overall eVapor category in the first quarter. Sequentially, the eVapor category and Juul's growth slowed in light of Juul's unilateral decision to stop shipping non-traditional flavored pods to retail in November. As we've previously noted, we accept any short-term slowdown resulting from actions to address youth eVapor use in an effort to preserve the long-term eVapor opportunity for adults. Internationally, Juul continues to see promising results and is making progress on its commercial expansion. Though still early days, let's update the two examples we first highlighted in our year-end call in January. In Canada, while distribution is limited, Juul reports that retail takeaway at the end of February grew to more than 80% dollar share in stores selling their products, from slightly more than 60% dollar share at the beginning of December. In the Sainsbury chain in the UK, Juul tells us that it remains the number one evapor brand in the chain, increasing its dollar share to more than 27% by the end of March, from 23% in late January. Juul now operates in nine countries outside of the U.S., having most recently launched in Spain with additional country launches expected by the end of 2019. By mid-March, Juul products were available in over 85,000 stores throughout Switzerland, Germany, France, and Italy. Juul also plans to test next-generation products in limited international markets this year, including a Bluetooth-enabled device. This device will test a variety of features, including access restrictions, at the user level. On the HSR review process for the JUUL transaction, we announced earlier this month that we received a request for additional information from the Federal Trade Commission related to the HSR notification we filed during the first quarter. We are cooperating with the FTC and will work to provide answers to the outstanding questions promptly. We continue to believe that our investment and the services we have agreed to provide JUUL will promote competition and have long-term benefits for adult smokers. Turning to the FDA, with the arrival of a new interim FDA commissioner, we are focused on continuing to work productively to with the staff at the Center for Tobacco Products. We are committed to a shared belief in a continuum of risk for tobacco products, and that adults who need or want nicotine should have access to nicotine through less harmful, non-combustible products. As of February, on a 12-month moving basis, 13 million adults have already chosen to use eVapor products, clearly suggesting that this vision can be realized. We know, however, that the epidemic of youth evaper usage threatens the opportunity for harm reduction for adult smokers. That's why we are fully engaged, along with Jewel, in thoughtful solutions and taking action. We believe the single most impactful step we can take today is to continue our advocacy for raising the minimum legal age to purchase all tobacco products to 21 at both the federal and state levels. In just a few short months, we're beginning to see the impact of the full force of our government affairs advocacy. Year to date, governors in six states have signed legislation to increase the legal age of purchase to 21, bringing the total number of states to 12. Two additional states have already passed legislation that awaits the governor's signature. With these additional bills, approximately 38% of the US population will be covered by a statewide legal age of purchase at 21. Nineteen additional states are actively considering similar legislation, and bipartisan legislation is being introduced at the federal level. This intensive effort has the endorsement of many in the public health sector and our full support. We expect the actions taken by Altria and Juul will take some time to result in a leveling off and ultimately reduction of the current youth usage trends, but we believe these actions are essential and that now is the time. In addition, during the first quarter, the FDA published draft guidance proposing a potential revision to its compliance policy for both evapor products and cigars. For flavored evapor products other than tobacco, mint, and menthol, it would move the deadline for filing premarket applications for these products from August 2022 to August 2021. It would also impose restrictions on sales of such tobacco products at in-person locations and online in order to reduce underage access. and it would take enforcement action against those that target underage users and or promote underage use of evapor and similar tobacco products. We believe the draft guidance for evapor products is an important step toward addressing youth evapor use. For cigars, the draft guidance could result in the removal of all flavored cigars from the market 30 days after issuance of final guidance, except for grandfathered products and products that have received authorization from the FDA to remain on the market. This draft guidance raises several concerns in terms of process and the lack of science and evidence supporting the proposed policy. We will detail our concerns in our comments, which will be available on Altria.com. In summary, this is a dynamic time period in a changing tobacco category. Consumer preferences and regulatory actions are driving rapid change. We believe that our diverse income streams with our evolved platform of strong core tobacco businesses and investments in Juul, Kronos, and AB InBev have positioned Altria best among our peers for long-term growth and leadership across a variety of future scenarios. Our 2019 plans are on track. We reaffirm our guidance to deliver full year 2019 adjusted diluted earnings per share of $4.15 to $4.27. This range represents a growth rate of 4% to 7% from a 2018 adjusted diluted EPS base of $3.99. I'll now turn it over to Billy to provide more detail on our first quarter results.