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.

Thanks Howard, and good morning everyone. Although our recent investments have been the subject of significant focus, our smokable and smokeless tobacco businesses still deliver most of our earnings. Despite headwinds in the first quarter, these businesses are performing well, and we expect them to deliver strong income growth into the future. Here are some highlights from the quarter. In the smokable product segment, adjusted OCI was essentially flat, at nearly $2 billion, and adjusted OCI margins increased 3.6 percentage points to 53.3%. Adjusted OCI results were driven by lower cigarette volume offset by higher pricing, lower promotional investments, and lower cost. Turning to Marlboro, the brand's retail share declined two-tenths of a percentage point year over year. However, it remains unchanged sequentially from its fourth quarter 2018 share. Several initiatives are helping Marlboro stay strong and relevant. First, PMUSA introduced the reseal pack technology last year, representing our most significant cigarette packaging innovation since the flip-top box. The consumer response to the introduction was overwhelmingly positive, and the brand continues to expand this innovation. PMUSA is excited to announce plans to expand Marble Smooth Ice, a fresh, crisp, menthol cigarette in the resale pack nationally, with distribution to over 110,000 stores beginning this month. Similarly, Marble Rewards continues to exceed our expectations, bringing new adult smokers, 21 plus, to Marble.com and increasing digital engagement. In only two and a half months, more than 1.6 million adult smokers 21 plus enrolled in the program and entered over 30 million pack codes. We've seen a nearly 140% increase in new registrants to Marble.com in the first quarter. We're encouraged that Marble smokers are reinvesting their rewards points back into the brand as mobile coupons remain the number one redeemed item. In the super premium tobacco and water segment, Nat Sherman continues to perform well following the regional expansion of Nats across the Western U.S. in mid-2018. In the first quarter, Nats represented 3 tenths of a sharepoint of the cigarette category in states selling the product. Based on these strong results, Nats is expanding nationally to the remaining 37 states this month. In the smokeless product segment, USSTC generated adjusted OCI growth of 7.9% in the first quarter, as higher pricing and lower cost were partially offset by lower volumes. We continue to believe that smokeless industry volume is being affected by adult tobacco consumer movement between tobacco categories and higher pricing. Copenhagen continues to be the growth engine behind the success of USSTC. In the first quarter, Copenhagen grew 0.7 retail share points to 35%. Next month, USSTC will open the original Snuff Shop, a premium flagship store in the heart of downtown Nashville. The store is designed to reinforce Copenhagen's leading equity among adult dippers, and it's 100% American craftsmanship positioning. Turning to our alcohol assets, in wine, St. Michelle's adjusted OCI decreased $2 million, primarily due to higher cost and higher promotional investments, partially offset by higher shipment volume. In beer, adjusted earnings from our equity investment in AB InBev were $200 million in the first quarter, which reflects Altria's share of AB InBev's fourth quarter results. And of course, we continue to reward shareholders through dividends and share repurchases. We remain fully committed to our dividend payout ratio target of approximately 80% of adjusted diluted EPS. We repurchased 2.7 million shares in the first quarter at an average share price of $56.34 for a total cost of $151 million. This leaves $195 million remaining in the current $2 billion repurchase program, which we expect to complete by the end of the second quarter. We were also active in the credit markets in the quarter. We issued $16.3 billion in debt in the European and U.S. markets at a combined weighted average coupon of approximately 4.1%. We subsequently used these proceeds to repay the term loan we use to fund the JUUL investment and to fund the Kronos investment. The balance will be used for other general corporate purposes, which may include future debt maturities. Finally, our cost reduction program remains on track to deliver approximately $575 million in annualized cost savings by the end of 2019. As a reminder, the program includes savings from workforce reductions, third-party spending reductions, and closure of our Newmark operations. In the first quarter, savings were primarily driven by workforce reductions, most of which occurred at the end of February, as well as discontinuation of eVapor operations. We continue to expect the remaining savings from this program to ramp up throughout the year and to achieve full run rate by year end. I'd also like to provide color on reported earnings. Since we will be recording Kronos-related financial instruments at fair value each quarter, there may be significant reported earnings volatility permanently driven by quarterly adjustments related to movement in Kronos' stock price. Any fair value adjustments is non-cash and will be reported as a special item. With that, we'll wrap up, and Howard and I will be happy to take your questions. While the calls are being compiled, I'll remind you that today's earnings release and our non-GAAP reconciliations are available on Altria.com. We posted our usual quarterly metrics, which include pricing, inventory, and other housekeeping items. With that, I'll open the question and answer period. Operator, do we have any questions?

Before we do that, Operator, Paige has just reported out to me that I misspoke on one number that I'll correct now. I think I explained that by mid-March, dual products were available in a number of stores in Switzerland, Germany, France, and Italy, and that number of stores is 8,500 stores. So with that, operator, do we have any questions?

Thank you. Once again, if you would like to ask a question, please press the star key followed by the number one on your touchtone phone at this time. Investors, analysts, and media representatives are now invited to participate in the question and answer session. We will take questions from the investment community first. Our first question comes from the line of Chris Grohe of Steeple.

Hi, good morning. Good morning, Chris. Hi. I want to ask around the volume performance in the cigarette category this quarter. You talked about sequential weakness through the quarter, obviously gas prices being a main driver of that. Can you talk about where it ended the quarter, and do you see that continue into the second quarter? I'm just trying to get a sense of the performance you expect as we kind of move here in the interim in 2019.

Yeah, I won't comment on the second quarter performance, but – It did step up a little bit in March, and ultimately the total quarterly performance was down 5%. But, of course, we've taken all that into account as we've looked at our estimate for the full year, and we continue to believe full year decline is likely to be 4% to 5%.

And that 4% to 5% decline rate is a category growth rate. Obviously, a lot of your market share weakness in the quarter occurred in the discount segment. Marlboro's performing well. Would that persistence of that performance for L&M cause you to lose market share for the year? Is that part of your expectation for 2019?

I don't know that we're at all troubled by the discount performance in the first quarter. As we stated, there's been a trend for quite some time for some modest share churn between branded discount and the deep discount products. We are focused on programs within L&M to moderate that. But I don't feel like we feel like that puts our plans for the year at all at risk. And it is a continuation of a moderate trend. And I pointed out, I think in the past, that if you go back five years on L&M, It is still modestly ahead in its share, and it's had significant profit improvement. I think we're quite pleased there. As you point out, our primary focus in the cigarette category is on Marlboro. I think that we're pleased with the performance of the Marlboro brand. We're pleased with the stability of the premium category. And I think that causes us to not be interested in getting too active in spending a lot of money in discount.

Okay. Thank you for that. And just a quick follow-up, if I could, on menthol. You indicated that your market share was down a little bit in menthol in the quarter, which I found surprising. You've had a lot of new products there as well. Is that category any more competitive or anything unique that would have caused your market share performance to not be up in the quarter? And any color you have there would be helpful. Thank you.

Yeah, thanks for the question, Chris. I think it's important to remember over a short-term period, things will fluctuate. There was nothing there from a competitive standpoint that would show that we have concern about. Of course, the tobacco category is always competitive, but if I put it in a band, I'd put it kind of in the midpoint of a band, and so nothing of concern.

Okay, thank you.

Your next question comes from the line of Pamela Kaufman of Morgan's Family.

Good morning. Thanks for the question. I just wanted to follow up on Chris's question on volumes in the quarter and better understand why wholesalers are depleting inventory levels to this degree. You mentioned that this is something that you expect to reverse throughout the year, but is this a reflection at all on their view of the health of the category and how transitory is this dynamic?

Yeah, I think when you think about wholesale inventory, it's always important to put it over a long period of time. You'll see fluctuations in a short period, and what we refer to is that they tend to balance out over the longer period. I think when you think about wholesale inventory and trade inventories in total, you'll see a number of different reasons why the inventories fluctuate based on how they manage their inventories. Sometimes it's seasonality. Sometimes it's when their year end occurs. And the other is around price increases. And so when you look at the price increase that took place, our price increase this year, it took place earlier in the quarter than last year. And so you'll typically see that wholesale inventory tends to deload after a price increase. Well, because it happened earlier this year, they were able to, what we anticipate is that they were able to deload their inventory all within the quarter, where last year it lapped first and second quarter.

Thank you. And also, just wanted to hear a little bit more about your perspective on the leadership changes at the FDA and Do you believe that any of these changes impact the FDA's goals on menthol or nicotine reduction or perhaps impact timing for ICOS approval?

Sure. Yeah, I don't think we've gotten any indication that directly as a result of a leadership change that there's going to be significant change in the issues and the view of FDA on those issues. You know, I think that the nicotine issue and the menthol issue, I think, from my expectation, are expected to be resolved and with us for quite some time, a period of years. And so I think we're in early days on that, and I wouldn't expect this change is going to have a big change there. I would be surprised, given where we are in the ICOS application process, which is I think we're near the end, there were any changes that occurred there. And then I think that, I think, and this is favorable in my view, I think there's been pretty clear communication that under the new acting FDA commissioner, there's going to continue to be a focus on driving down youth use of eBay for products. And I think that's a positive.

Thanks. And sorry, last question. What... Have you started to offer any of the services to JUUL as part of your services agreement? And can you elaborate at all on the nature of the questions related to the antitrust review?

Sure. With regard to the services that we provide JUUL, we are in the early stages of that, although we did provide some in the first quarter. I think you'll see that pick up pace more in the second and third quarter of this year. Probably the service that is most highly visible that we offered in the first quarter, we had established innovative tobacco product space in a number of retailers across the country that we were going to use for our Mark 10 eVapor products. Typically, that is space that is visible by the consumer, oftentimes includes the header position. And we transferred that space that we were going to use for Mark 10 over to Juul. And already in March, there were thousands of stores that were converting that space to the Juul product. And I would expect that will continue into the second quarter. With regard to questions around HSR, I don't know that, there's any specific questions that I would call out. I just think that as is typical in these cases, we addressed a number of questions in the first round. They had some follow-up questions, and that just means that we end up in a longer period of time for them to make their decision. As I indicated in the remarks, we continue to be confident about its ultimate approval. Thank you.

Our next question comes from the line of Michael Lavery of Piper Jaffray.

Good morning. Thank you.

Hi, Michael.

As you expand smooth ice and nets nationally, can you give us a sense of what those are replacing on the back bar? And with, Julie, you just touched on the Mark 10 swap outs, obviously, but are there any cases where that may replace anything other than Mark 10 space?

Yeah, from a standpoint of the first two, Marble Smooth Ice and Nats, they really aren't replacing anything on the back bar. We have a great sales force that knows what's relevant to the consumers in their area, and so they really work with the retailers in our display space to display those brands that those consumers are interested in. As far as the innovative space, it's really limited to the removal of our brands in the marketplace in eVapor and the replacement of that by Juul. in those stores where they bought that space from us.

Okay. Well, thank you. And a little bit related, how much have you seen, if any, the momentum and vapor have an impact on trade inventories? Now, especially with your relationship with Juul, do you have some better visibility on their sort of situation in the store and how that may or may not be influencing retail trade inventories?

I think when you think about it, Michael, across inventories, they really do look at it through time and think about the various categories individually. I think we have seen a benefit to out-of-stocks on Juul product with some of our services we provided. So I would say better inventory practices in the eVapor space related to Juul, but no material impact on the other categories.

Okay. Thank you. And then just one more. We saw the canopy acreage deal, obviously, recently, and your stake with Kronos is significant and could flip above 50% with the warrants. Do you work with them on strategic evaluation of opportunities in the U.S., and is the acreage playbook one that you might see replicated with them as a partner?

Sure. As you know, we recently closed the deal with Kronos, and through our board representation, we are significantly exposed to their ideas and obviously provide them with ideas on how to further grow their business in the future. I think you are right to point out the fact that the cannabis space is quite lively these days with a variety of companies that are making strategic moves. And we've obviously been thinking quite proactively on our own and are now thinking with Kronos which strategic moves make sense over the next year. I don't have anything to talk about today, but our intention in making the investment into Kronos and capitalizing them quite competitively versus the other cannabis companies in the space was really designed to enable them to make the kind of moves that are necessary to build out a leadership position. And I imagine over the next year or two, we'll have more to say about that.

Okay, great. Thank you very much.

Your next question comes from the line of Owen Bennett of Jefferies.

Morning, guys. Hope all well. Just a couple of related questions on Juul and the services you're providing there. So whether it be the shelf space, or as I understand what you were saying previously about advertising the Juul inside your Marlborough packs. I was just wondering, firstly, could you talk about the dynamics you're seeing between Marlborough and Juul now? Have you seen any increased rates of switching? And then secondly, if ICOS does get approved, How will you make the decision between switching more of the smokers to ICOS or switching them over to Juul? Thank you.

Sure. You know, I think we have not detected any specific impact of Juul on smokers. On Marlboro, I would say that Juul's growth continues to be more broadly from the cigarette category generally, and we haven't seen any specific impact on our brands. And then I would say that with regard to Icos versus Juul, I think we ultimately believe that the consumer is going to decide which product most appeals to them. It would not surprise me if some consumers actually engage in trial of both products and then ultimately make a choice between the two or whether or not they want to stay within the cigarette category. And I think our real focus... in providing assistance to Juul and also in representing the Icos brand once it's approved by FDA is to make sure that consumers are aware of the products and the product benefits, that the products are distributed in stores where adult cigarette consumers shop, that they're aware of the brand, that it's in stock. to make promotional offers on it. And then I think ultimately the consumers are going to make their product choice.

Okay. Thank you very much.

Thank you.

Our next question comes from the line of Bonnie Herzog of Wells Fargo. All right.

Thank you.

Good morning.

Hi, Bonnie.

Hi. I guess my first question is more of a big picture one. I guess I want to ask, can your model work? Meaning, Can you guys still hit your EPS guidance in the context of an environment where, you know, SIG volumes are decelerating faster? Just really want to hear from you what gives you the confidence in this. You know, I'm thinking about this in the context of the key headwinds, you know, such that you do own a stake in Juul, but you aren't yet seeing the benefits of that, and you might not until next year. Pricing's going up, you know, to offset the greater volume pressure, but, you know, is this pricing really sticking? And then finally, you know, SIG volumes realistically could decline more rapidly. So I guess in the context of all of that, is it realistic to assume that you're going to be able to deliver on your EPS guidance? And then more importantly, your long-term algorithm. Thanks.

Sure. I think to start off, we continue to strongly believe that we can deliver on our EPS guidance this year of 4% to 7% EPS growth. and we continue to be confident of our ability to deliver over the long term against our 7% to 9% adjusted EPS growth. And I think we communicated on the call here our expectation for the range of industry cigarette volume declines. I think you're asking a hypothetical question, which is related to, well, if it turns out that there are conditions in the marketplace that cause our estimate for category declines to be lower than actually occurs, do we still feel confident in our seven to nine percent EPS growth? And I have to say that while we continue to believe that our estimate is our best view on what the next five years will bring, if there is further movement around in the category that drives cigarette volume declines higher, I still have confidence that we can deliver against our 7% to 9% EPS growth over the long term. You are right to point out that in this year, we don't have an income stream of any significance coming from Juul, but given the growth we expect in the eVapor category and the growth we expect from Juul this year, I would expect that by next year and the year after, if in fact there is any acceleration in the cigarette category decline rate, that we will have an income offset to any impact that would have on us related to income coming from Juul. That was part of the logic of the investment, because while we think we have a pretty good handle on what's going to happen over the next five years, if there was any variation in that, we felt strongly that we wanted to have a position in the leading, fast-growing, and in the near future, highly profitable eVapor player in the U.S. And I have to tell you, I also believe that we have a very resilient profit generator in the cigarette and smokeless businesses that we have. and we have a number of additional levers to pull to help drive EPS growth. So we continue to be – frankly, we continue to believe that the year, the next five years, is unfolding much the way we expected when we put together our analysis three or four months ago. And if there were – Changes in the future, we feel like our platform gives us a number of options to continue to deliver both our 7% to 9% long-term EPS growth and 80% of that cash back to the shareholders in the form of dividends.

Okay, that's really helpful, Howard. I appreciate the color in that. And I do want to just clarify something about the Juul closing and when you could see the equity income flowing through the P&L. Just to be clear, I mean, is there any potential that that could happen this calendar year? Is it really going to be a 2020 event?

So, Bonnie, the equity income will really be triggered by HSR approval. Right. That is when our shares move from economic or non-voting to voting. And remember, we talked about with Juul we would be on a one-quarter lag, similar to the way we are with AB InBev. So taking that into consideration, it will depend on when HSR approval comes through.

Understood, but then that's what I'm curious about. Is there any update on the timing of when that is expected?

Yeah, I think it's hard to predict how long this HSR process might take. And I think that given that it's going to be some time that we'll be interacting with them to answer questions, and given the fact that we're going to be on a one-quarter lag, I think there's a question as to whether that would start to flow this year or whether it's likely to flow in early next year. But we'll certainly keep you up to date on our discussions with the FTC.

And then just to be clear, so your guidance assumes none of that flows in this year?

Yes, that was our original assumptions. And we communicated that at the beginning of the year, that our guidance for this year really didn't include any material income contribution from either Kronos or Juul. And that was the assumption in our guidance. And, of course, it turns out that because of the regulatory action, that's highly likely to be the outcome.

Okay. Then maybe one final question from me, if I may, just on your margins. You know, your smokeable margins expanded really sharply in the quarter. So hoping you could just drill down a little bit further on some of the key buckets because I think this does highlight some of the levers you have to pull. I mean, I guess I'm assuming the earlier and larger than expected price increase was probably one of the key drivers there. And you already touched on, you know, some of the service agreement payments, which I think also could be a nice boost to margins. But are there any other considerations and maybe – thinking about that as the year progresses, especially as you realize more of the cost savings that you've highlighted. Thanks.

Yeah, I think you touched on the two most important, especially in a short-term period like a quarter. But certainly as we progress through the year and the cost reductions ramp up, the savings associated with those, certainly cost will be a factor as well. Okay.

Thank you. Thank you. Thank you, Bonnie.

Your next question comes from the line of Vivian Azar of Cowan. Thank you, good morning.

Hi, Vivian.

So I wanted to double back to your industry volume expectations, please. Very helpful disclosure on slide six as you unpack the drivers. I'm looking specifically at the additional cross-category movement and the evolution of that drag, which is 40 basis points in 18, but 50 basis points on a trillion 12-month basis, which would, if my math is right, imply that the first quarter drag was actually much more meaningful, 70 to 80 basis points. Am I thinking about that math right?

I think you are, but I wouldn't go to such a short-term period, Vivian. You remember as we were progressing through 18, eVapor was ramping up throughout the year. And so whenever you take off in a trailing 12 months, Whenever you take off the first three months, of course, all of those months that it's increasing through carry a heavier weight. But I think the logic you're applying to it is correct.

So that's fair, Billy. But with that in mind, then, you know, given that that more meaningful impact coincided with an actual, you know, sequential softening in Jules' results, given the elimination of novel flavors in brick and mortar retail. How are you guys thinking about that for the full year? Because to my mind, it does call into question a little bit the achievability of even the minus four for the category.

I tried to follow exactly what you were saying there, Vivian. I think when you think about it, this trailing 12 months is really just designed to kind of say, look, we need a long period of data to be able to break it down to these specific buckets. And when you take off those first three months, which would have been the first quarter of the previous year, when volume is ramping through the year, as we talked about previously, the 15% to 20% evapor growth, across that five-year period on a CAGR, of course it's going to grow faster in the earlier period because the base is growing. So just math would say that from a CAGR standpoint, it'll slow down in the later years just because the base is growing. We feel like with the 4% to 5%, it's important to remember you've got to look over it in a long period. I think sometimes we tend to get wrapped up in the quarter. So just for instance, last year, right, first quarter quarter, cigarette industry volume was down 5.5%, and we ended the year at 4.5%. So sometimes we take a quarter and try to project it out as if that's the exact way the whole year is going to play out versus allowing time to pass.

Okay, that's fair. So then can you articulate what is embedded in the 4% to 5% outlook for the full year? Is it a 50 basis point drag from cross-category movement, or is it worse than that?

Remember, Vivian, when we put out a range, each one of these is going to have a magnitude of range around it, and so we are trying to provide and be as transparent as we can in the four to five. I'd hate to start now saying let's take the pieces and give guidance on the pieces. I'd rather stick to the four to five percent, but know that each of these pieces have a range around them that are incorporated in the total four to five percent that we're providing.

Okay, that's fair. Thank you very much.

Thank you.

Our next question comes from the line of Steve Powers of Deutsche Bank.

Hey, guys, good morning. Hi, Steve. Hey, so I guess to pick up on some of the prior questions related to the FDA and the FTC, obviously there were some public concerns put forth by the FDA and the FDA commissioner following the announcement of your transaction with Juul. Could you expand at all on how your more recent conversations with the FDA have gone with respect to Juul? And then do those discussions have any impact at all on how the FTC may be reviewing your filing for HSR approval?

Sure. You know, I think based on our dialogue with our advisors, I think the FTC tends to make a decision based on its own analysis and and applies against the rules that it's focused on discharging. So I don't find that there's a whole lot of influence from one agency to the other. And I think ultimately we're going to answer the questions for the FTC and we expect them to act based on the rules that they normally use. With regard to our dialogue with FDA, I would say that Most of the dialogue we've had with FDA and most of the interaction with FDA around JUUL, really starting in October, has really been focused on FDA's concern about youth usage of eVapor products and their encouragement of us in JUUL to take actions that might help reduce youth usage of eVapor products. And I have to tell you that we feel like We've taken significant actions, and frankly, that Jewel and I have been on the leading edge of really proactively addressing that issue. In the case of Jewel, they removed their flavored products from mainstream retail outlets, and you saw some impact, I think, of that action in the first quarter because there was a sequential slowdown in growth overall of the category. And I think that that is going to take, I think, some of the pressure off on youth usage of the products just because the category slowdown is likely to have an impact there. And I think in the short run, it is prudent to take steps, even though they may impact adult cigarette smokers, if that can really help have a positive impact on driving down youth rates. And then we also talked about what I think has been quite a gratifying pickup in the pace of moving the minimum age to purchase to 21. When we first had a dialogue with the FDA in October of last year, we expressed to them that we were committed to raising the minimum age to purchase to 21 at the federal level. We continue to always believe that federal activity on something like that makes it easier for retailers to manage that and enforce that. But following further communication from the FDA, we concluded that doing it at both the federal and state level was going to get quicker action. And that was accurate. We've already had a number of bills passed. And then I'm also pleased to see that not only is it moving in a number of states, but it's now moving at the federal level. So I have to tell you, I'm quite gratified that we could see significantly more action in significantly more population centers in the U.S. towards raising that age to 21. And we think that's probably the most important thing combined with effective enforcement to drive down youth usage of e-vapor products and really all tobacco products.

Great. Thank you. And then secondly, I wanted to pick up on Smokeless if I could. At least versus our expectations, the price and the margin realization in that business this quarter was frankly exceptional. So anything to call out there versus your own internal expectations? And then related, I guess, any update on how you're seeing that industry segment evolve in terms of its interplay with eVapor? Thanks so much.

Yeah, I can't think of anything that I would call out. I would agree with you. It was certainly an exceptional quarter for that segment and specifically our business. I think we tried to highlight in the remarks that Copenhagen is the growth engine there. The dippers really like Copenhagen. and they want to engage with that brand, and we're doing everything to reinforce that with them.

I might point out that while it was certainly a good first quarter for Smokeless, the profit growth is quite similar to the full-year performance last year, and so I think that that's a business that's able to generate that kind of profit growth on a pretty regular basis. I think with regard to interaction between Smokeless and eVapor, I think the relationship is a little bit complicated in that you will recall five or six years ago, you had an eVapor category that was not growing much at all, and you had a smokeless category that was growing in volume terms 5% a year. I think that was really driven by the fact that at that time, smokeless was the primary place that a lot of cigarette smokers were moving when looking to an alternative to cigarettes. I think the step down in the growth in the smokeless category is not so much driven by smokeless consumers switching cigarettes, to eVapor. It's driven by the fact that a lot of the cigarette smokers that were switching to smokeless and driving its growth have stopped switching to smokeless, and they're more attracted to eVapor. And that has resulted in the last two or three years of a category that's more flat to slightly down. And at least until we see some change in cigarette smoker interest in eVapor, I think we think this is probably the range the smokeless category will be in. although you're right to point out the fact that even with that kind of volume performance, it has nice profit growth.

All right, great. Thanks again, guys.

Our next question comes from the line of Gaurav Jain of Barclays.

Hi, good morning. Thank you. So there's a lot of investor interest in the modern oral category, the nicotine pouch without tobacco category. And here, you know, Zinn has gained a lot of share and is expanding nationally. BAT is also planning its own launch. How are you planning to pursue this opportunity?

Sure. You are right to point that out. While the modern oral category is small in the U.S. today, it has certainly generated a lot of interest, and I know there's further product expansion that is planned. While we are the leader in the smokeless tobacco category, we do not currently have a product in the market that participates in that modern world. But the potential there is not lost on us, and that's an area that we've got some work underway. I don't have anything to share with you today, but I do think if you think over the next five or ten years, that could be an interesting sector.

Again, considering you cannot introduce new products because of deeming regulations, how exactly will you go about pursuing that opportunity?

Sure. I'm not going to comment further on that.

Okay, sure. So my next question is on cigars. So can you just share what percentage of your cigar business will be impacted by the proposed flavor cigar ban, if it were to go ahead? Was some part of your portfolio grandfathered, and on some others you have SE applications and you have marketing orders as well? So any estimate of what part of your portfolio might be impacted?

Yeah, I don't have a specific answer for you as far as a percentage. I think if you think about a lot of our products, similar to the way we treated cigarettes and smokeless, a significant amount of our SKUs currently in the marketplace are not grandfathered, meaning we had made changes. However, they're considered more of the transitional products. So we're evaluating that based on the proposed rules, and you can certainly see all the remarks we made related to the current proposed rule. And so we'll have to see how, if the FDA moves forward and how they move forward in any changes to the rule, and then we'll have a more specific percentage for you.

I think there's really a need for a bit more clarity from FDA on exactly which cigars would be impacted by the action they proposed in the preliminary rule. And I expect that based on the high volume of comments they're going to get, they'll provide that greater clarity as they think about moving on to the final rule.

Sure. Thank you. And my last question is on Juul and ICOS. So there's a theory that Juul works in high nicotine markets like the US and Icos works in low nicotine markets like Japan. Now you have interest in both these products and you are going to invest capital behind Icos. So how do you view this theory?

Yeah, I would not subscribe to the theory that Juul is a better fit for some markets and that Icos is a better fit for others. I have to tell you that we believe that both Juul and Icos can generate quite nice consumer interest here in the U.S. And I also believe that the Icos product is quite satisfying on both a nicotine and a taste basis for a large number of consumers that smoke traditional U.S. cigarettes. I think that the The difference between a consumer picking a Juul or an Icos is more likely to be related to other factors that differentiate the products, whether it's the form factor, whether it's the taste. And I think ultimately there's room for both products to be quite successful here in the U.S.

Okay. Well, thanks a lot. Thank you.

Your next question comes from the line of Nick Modi of RBC.

Yeah, good morning, everyone. So just a question on price realization, Billy Howard, maybe if you can give some context. I mean, it's been a lot higher over the last few quarters than I think has been normally the case. And so I guess there's kind of two pieces to this. One is, should we be thinking about price realization being a bigger part of the contributor to the algorithm going forward? or is it that the loyalty rewards program that you guys are launching nationally is helping you kind of become more efficient with your promotional spend? Any clarity you can give on that would be helpful.

Sure. You are right that if you go back over the last five years, price realization has typically been between 4% and 6%. And I wouldn't draw any conclusion for the year based on the first quarter, but certainly last year it was on the higher – higher end and above that range. You know, I think that part of the way I might explain that is I don't know that we have, we have not, we don't have a specific target in any given year on price realization. But we are guided by the fact that we're trying to maximize profitability in our cigarette business. And beyond list price, in a favorable economic environment with much better tools for tuning the effectiveness of our promotions. I think we are getting better and better every year at how to effectively spend our promotional dollars to effectively get it to the consumers that need it, and frankly, to trim it with consumers that don't. And we're getting more precise at doing that on a per packing basis, at below the state level, and certainly on a one-to-one basis. So you have not only list prices, but you have promotional efficiency. And then, of course, you're also pointing out that with a program like Marlboro Rewards, where we're strengthening the equity, and maybe without using price as a tool, increasing consumer loyalty, I think that gives us more flexibility on driving profitability across the brand. So I would say that the tools we have to manage the profitability of that brand have gotten much more sophisticated over the last three or four years.

Great, and then I guess one final question for me is can you recount how volumes kind of behaved or moved when you had several retailers kind of exit the cigarette category? Because we're having similar situations occur across certain retailers right now, and so maybe you could just give us kind of a case study on what happened, I think, when CVS exited the cigarette or tobacco category a couple years ago.

yes I can certainly do that you know what we found was that there was really no disruption in product availability for consumers and I think it's really driven by the fact that most tobacco consumers already have a number of places that they shop where they can purchase their tobacco products and if they have a primary place that ultimately stops providing those tobacco products, they very easily shift to either another store they're already going to or to a store down the street or around the corner. And what we found in the last phase was that, and I know it's the same in this period, It is not like the availability of tobacco products is such that if you have a chain that pulls out, somebody's got to drive a great distance. The availability is quite significant, and people just adjust. I will say the benefit is that you may be aware that convenience stores have been growing their share of of tobacco sales quite nicely up until a couple of years ago when some of that growth in the convenience store trade slowed down a bit, I think partially through the advent of dollar stores. And frankly, as some trade classes and some retailers have pulled out, it's actually brought a bit of a return to growing share to the retailers that are committed to the category. And I know that it's a benefit for them.

Great. Thanks, Howard.

Thank you.

Your next question comes from the line of Judy Hong of Goldman Sachs. Hi, Judy. Thank you. Hi.

Good morning. So I guess I want to go back to the industry volume question, Howard. And I guess I'm just trying to kind of reconcile a couple of things. One is, you know, on one hand, you sound pretty comfortable with the long-term consumption decline staying within this 4% to 5%. On the other hand, you did take this year's down, albeit a little bit, after one quarter. So do you think this is just a lot of volatility and just predicting this industry volume decline now with a lot of vapor issue and the pricing strategy that may be evolving? And if that's the case, I mean, how do you sort of get comfortable with that 4% to 5% long-term decline forecast for the industry?

Sure. Based on the data we have available to us today, we're comfortable with our 4% to 5% forecast for this year and over the next five years. But you are right to point out that there are a number of other variables that are influencing the decline rate of the cigarette category today compared to three or four years ago. And frankly, that is why we took the step at the end of last year in providing you with both guidance and more detail on how we get to that guidance for the decline rate. Because it is a, I believe it's going to be a noisier environment for measuring that. And I think our commitment to our investors is, that as we get new information, we will apply that to our forecast methodology and to the approaches that we've used to forecast. And if there's any adjustments, we will make them. I will raise one that I don't think causes us to need to make an adjustment over the long-term decline rate forecast we made of 4% to 5%. But if we get more experience with it and if we continue to make progress, it could be something we'll be discussing probably next year, which is the impact of the increased age purchase to 21. And if, as I hope we will, we end up with a federal statute that essentially raises it nationwide, there is 2% of cigarette volume today that is – in that legal age to 20 segment. I don't think there's evidence yet that we're going to get to a uniform national standard that ought to be factored in. But if we make progress on that, I do imagine we'll be talking about what impact that might have. And we don't have a lot of experience with that. I don't think that it's going to suddenly just happen in one quarter, but it could be an influence over two years or three years. And, you know, I think as we learn about that, we would obviously make any adjustments. I have to tell you that 4% to 5% decline over a period of five years gives us a lot of opportunity to absorb that. But it is clearly a time when there are more variables and they're moving around a bit more.

Yep. Got it. Appreciate that. My last question is on fuel performance. So, sequentially, obviously – some flowing just given the flavor restrictions. Can you just put that performance in the context of what you expected to see post the restrictions took place? Do you think this is a bit of just a temporary situation? And do you or Jewel have any kind of a forecast for how this plays out for the full year 2019, just from a Jewel's wine and growth perspective?

Yeah, I don't think that... The results we got in the first quarter were much of a surprise to us. I think that the withdrawal of flavors, I think we knew was going to have an impact. And frankly, I think that we do think that it's likely to have some help on driving down youth vaping, so I think we thought that impact was worth it. Frankly, I wasn't surprised by the results, and I think I was quite pleased by the fact that the JUUL in the first quarter, even though the category growth slowed down, that it held share, and I think it's performing quite nicely.

Got it. Okay. Thank you.

Thank you.

Your next question comes from the line of Adam Spielman of Citi.

Thank you. Good morning. Hi, Adam. Hi. So a lot of my questions have been asked already, and I think you already just mentioned, just to clarify something I think you said right at the end of Judith's question and answer session, that in the first quarter on slide 18, you've got dual growing sequentially 3%, and I think you said it held strad, so that implies the whole e-vapor category. was growing only about 3% in Q1. Is that correct?

Yeah, I think you're referring to our chart, right?

Yes. And what I'm really trying to get at is you've given us a sequential growth for Juul, and thank you for that, but if you looked at the category, when I say category, eVapor overall, would it show the same pattern roughly or not? How would that look?

I think the – if you're referring to chart 18 where we show you from first quarter 2018 to first quarter 2019, and we've got the volume for the overall eVapor category, and we've colored in Jules' performance, the sequential quarterly growth numbers are actually for the total eVapor category.

Oh, I misunderstood that.

Yeah, the category overall – On a year-over-year basis, it's had quite nice growth, but it has slowed down. You'll notice the slowdown really started in the fourth quarter, which is when flavors were first withdrawn, and then it slowed down even more in the first quarter. And we didn't provide a specific number on Juul, but as you can see from the chart, Juul continued to perform quite nicely and really represented on a year-over-year basis the growth of the category.

And just to be clear, the .44 refers to the whole category, not to Juul? That's correct. Okay, sorry, I misunderstood it. Okay, thank you. That's very clear. I may have missed this, but am I right? Because under the service agreement, you will be able to access your database or mark it somehow through your database and put inserts and onsites into your packs. Do you have any sense of when that's going to begin? Because my impression is it hasn't yet. Yes.

I think the way I would phrase it is that Juul, like the other operating companies at Altria, can provide offers to consumers that are on the adult tobacco consumer database. The actual planning of those offers and the sequencing of them across our companies, including Juul, and the execution of them, comes through ALTRIA personnel that are in our marketing services organization. But you are right that that marketing services organization has added Joule to the roster of companies that can procure those services from them. And it is both direct mail communication, and it's also on certs. You are also right that there's been relatively light activity in the first quarter, and I would expect to see more activity in quarters two, three, and four. and that will be both direct mail drops and inserts in the product. And, of course, we always manage, particularly with regard to the database, we always manage the sequencing and the amount of mail that we send to consumers on the database. So Juul will be sequenced in with offers from our other tobacco brands.

That's very, very helpful. And just one final question. Do you actually – do you tell you what their plans and expectations are for going forward? Or is it simply they report to you what they've done after the quarter ends?

Yeah, I would say through our board observer – Our board observer has access to the communications that they share with the board members. And then at quarter end, our investor relations group has a relationship with Juul where they discuss Juul's performance for the quarter, and they discuss what information we will share. So we do not have kind of a real-time sharing relationship. That's great. That's driven by the fact that we haven't gotten HSR approval, and it probably wouldn't be appropriate.

Yeah, so that's very clear. So the follow-up question on that is, is it right to believe that the Jules board expects Jules volume to accelerate in the rest of 2019?

Yeah, I don't know that I would comment on that. Fair enough. Okay.

Thank you. I thought I'd try. Okay. Thank you very much. That's all very helpful. Thanks, Adam.

Thank you. At this time, I would like to turn the call back over to Ms. Paige Magnus for closing comments.

Thank you all for joining our call this morning, and if you have any follow-up questions, please call us at Investor Relations.

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