Altria Group, Inc.

Good day and welcome to the Altria Group 2019 Third Quarter 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. 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 Mr. Mack Livingston. Vice President of Investor Relations for Altria Client Services. Please go ahead, sir.

Thanks, Pasha. 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 third quarter and first nine months business results. Earlier today, we issued a press release providing these results. We're also including slides to accompany our remarks and And all 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. Share repurchases also depend 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. With that, I'll turn the call over to Howard.

Thanks, Mac, and good morning, everyone. We are in the midst of a remarkable transformation within the tobacco industry. Once predictable, the industry has become increasingly dynamic and complex. And while this evolution may pose short-term challenges, we believe tobacco harm reduction is a significant opportunity for the industry and adult tobacco consumers. We believe that in the next decade, noncombustible products can surpass combustibles as the preferred choice among adult tobacco consumers. We intend to lead this historic transformation with our unmatched portfolio of noncombustible products and investments. Before moving to our strong third quarter performance, I'd like to provide you with our perspective on Altria's strategy and the key noncombustible platforms. Over the last two years, we believe we've built a business platform with the ability to deliver strong long-term results across a variety of future industry scenarios. We understood that no single product would likely satisfy all adult smokers looking for alternatives, and that the regulatory environment for noncombustible products would continue to evolve. We assessed our portfolio and believe that we have addressed gaps with investments in evapor and oral nicotine pouches, as well as an adjacent investment in cannabis. Today, we believe we have the strongest portfolio across multiple tobacco platforms and are well positioned for future growth in a rapidly evolving U.S. tobacco industry. Turning to the key noncombustible platforms, the eVapor category faces a critical inflection point. We must address underage use while also preserving options for the more than 20 million adult smokers who are interested in less harmful tobacco products. We continue to believe that raising the legal minimum age to purchase all tobacco products to 21 at the federal and state levels is the most effective action to reverse the rise in youth vaping. Today, more than 50% of the U.S. population is governed by Tobacco 21 laws. And while there is strong momentum behind this change, more activity is required from the federal government and remaining states to enact Tobacco 21 laws nationally. We also urge swift action from the FDA and other public health authorities to take the appropriate actions regarding flavored eVapor products and to identify the sources of the recent vaping injuries. We believe that these actions could reset the course for the eVapor category and preserve its long-term potential for harm reduction. We are also excited about the opportunity that heated tobacco presents to adult smokers. Based on third-party research, approximately 40% of U.S. adult smokers have tried but ultimately rejected eVapor products. We believe heated tobacco could be an appealing alternative for these adult smokers. Unlike eVapor products, these systems contain real tobacco and offer a sensorial experience closer to that of traditional cigarettes. The IQOS heated tobacco system is the first and only heated tobacco product that's received premarket authorization from the FDA, and it also has a pending MRTP application. We believe that heated tobacco systems, and IQOS specifically, are well positioned to meet the preferences of adult smokers who are looking for, but have not found, a satisfying alternative to cigarettes. Finally, we believe that oral tobacco can provide a compelling alternative for adult smokers. In moist smokeless tobacco, we filed a modified risk application with the FDA for Copenhagen snuff, based on decades of available science. Additionally, we have invested in the rapidly growing oral nicotine pouch segment, which offers adult tobacco consumers convenient nicotine satisfaction. Ultimately, the adult tobacco consumer and the regulatory framework will dictate which categories grow and at what pace. We believe our broad portfolio, investments, and leading capabilities position us to win in multiple future scenarios. Turning the third quarter performance, Altria continued to deliver excellent results driven by our core tobacco businesses. We grew adjusted diluted earnings per share over 10% in the third quarter, with both of our core tobacco segments delivering double-digit adjusted operating companies' income growth, expanding their adjusted operating companies' income margins, and maintaining momentum on their leading premium brands. The smokable product segment delivered another remarkable quarter, growing its third quarter adjusted operating companies' income 12.6%, and increasing its year-to-date adjusted operating company's income growth to 8.1%. Higher pricing and the impact of our cost reduction efforts more than offset lower cigarette volumes to drive income growth in both the third quarter and the first nine months. TMUSA is pleased with Marlboro's performance with eight consecutive quarters of stability since the end of 2017. In discount, L&M is performing in line with expectations, and we are pleased with its increased profitability over time. We believe discount category dynamics continue to primarily reflect a churn between branded discount and deep discount offerings. Overall discount category retail share was flat sequentially in the quarter at 24.2% and remains in line with historical share levels. We estimate that U.S. cigarette industry volumes declined by 5.5% in the third quarter and first nine months when adjusted for trade inventory movements, calendar differences, and other factors. We continue to believe that increased adult smoker movement to e-vapor and high levels of exclusive e-vapor category usage were the primary drivers of the accelerated decline rate over the past year. Based on our 12-month moving data, we estimate there are now 12.6 million adult vapors 21 plus as of September 2019, up from 10.3 million at the end of 2018. Importantly, that growth trend coincides with a trend toward more exclusive usage in the category. According to our adult consumer tracking data, we estimate that 6 million adults 21 plus vape and do not smoke as of September 2019, which is the highest number of exclusive users since our study began in 2014. Adult tobacco consumer movement across tobacco spaces remains highly dynamic, and we will continue to monitor these trends. Over the past 12 months, U.S. cigarette industry volumes declined by an estimated 5.5% when adjusted for trade inventory movements calendar differences, and other factors. We reaffirm our full-year 2019 U.S. cigarette industry adjusted volume decline estimate of 5% to 6%. We also maintain our 4% to 6% adjusted decline rate estimates through 2023 until more information is known about how adult tobacco consumers will respond to eVapor category dynamics. including regulation and legislative developments. Turning to our smokeless product segment results, USSTC is successfully executing against its strategy of maximizing income while maintaining momentum on Copenhagen over time. The smokeless product segment continued its strong 2019 performance, growing its adjusted operating company's income by 10.2% in the third quarter, and 9.7% for the first nine months of 2019. Copenhagen's category-leading retail share was 24.7% for the third quarter, up one-tenth sequentially and up two-tenths versus the year-ago quarter. USSTC's smokeless volumes decreased an estimated 3% in the first nine months of the year when adjusted for trade inventory movements and calendar differences. In the last six months, smokeless industry volume decreased by an estimated 1.5%. We believe these declines reflect increasing adult tobacco consumer interest in both eVapor products and oral nicotine pouches. In eVapor, we participate in the category through our 35% economic investment in Juul. We made the investment based on our belief that Juul's product development strength, early signs of brand equity, and potential to convert adult smokers set it apart from all other eVapor products in the market. We also believe that the investment would enhance Altria's growing portfolio of noncombustible product offerings. Given the dramatic shifts in the current eVapor regulatory and marketplace environments, we have revised our transaction assumptions. In preparing our financials this quarter, we performed evaluation analysis on our dual investment which considered multiple regulatory and marketplace scenarios. In aggregate, we're now projecting lower evapor category volumes in the U.S. versus our original estimates, which resulted in a third-quarter non-cash impairment charge of $4.5 billion related to our dual investment. Also factoring into this determination were other changes to our original assumptions, For example, we expect it may take longer for Juul to realize the strong margin performance that we previously communicated. We've also revised our estimates of Juul's international business due to recent market developments. Despite this impairment charge, we remain committed to Juul's success. We are pleased with the recent decisions by Juul to change leadership, and we are optimistic about Juul's focus and prioritization in key areas such as establishing industry-leading responsible practices and pursuing regulatory authorization of their products. Finally, regarding antitrust clearance, we've certified substantial compliance with the FTC's second request, and we expect a resolution in the first quarter of next year. Turning to heated tobacco, PMUSA is executing a robust marketing strategy for ICOS in the Atlanta lead market. The first U.S. Icos store opened in September and has since been supplemented by additional retail touchpoints, including a mobile pop-up unit and Icos Corners located within select stores. We've also recently opened a second Icos Boutique in the Mall of Georgia. Of course, responsible marketing is the foundation for all our consumer interactions. Icos is intended only for adult smokers and Icos Boutique entrants must be 21 or older. The performance of ICOS in Atlanta and other lead markets will be an important input to our future commercialization plan for the brand. The primary goals of the lead markets are to determine how best to communicate with adult smokers and how to scale our efforts. PMI's MRTP application for ICOS remains pending with the FDA and we are optimistic about the prospects of ICOS receiving this modified risk authorization. Additionally, we are encouraged that the FDA's draft PMTA rules include a special pathway for technological changes to previously authorized products, which could support bringing newer versions of the ICOS device to market. Finally, we are excited to announce that ICOs will be expanding to Richmond, Virginia beginning next month with an ICO store opening in the Carytown district. Altria has a sizable employee base in Richmond and deep connections with the community that could accelerate early adoption of ICOs. We also anticipate distributing heat sticks to approximately 150 retail outlets within the area and deploying a similar marketing strategy as the Atlanta lead market. We are pleased to expand ICOS availability as an alternative to adult smokers and look forward to sharing more details in the future. In oral nicotine pouches, we are pleased to announce that the on transaction closed during the third quarter. Now that the transaction is complete, we'd like to update you on our plans to pursue leadership in this new and fast-growing category. We are focused on engaging adult tobacco consumers through both traditional retail and digital experiences. We launched a premium branded website for Ahn where age-restricted adult tobacco consumers can explore the brand and will soon be able to purchase the product online. We expect to begin production of Ahn in our Richmond Manufacturing Center beginning first quarter next year. In 2020, we are targeting annualized capacity of 50 million cans by mid-year and 75 million cans by year end, with additional capacity available if necessary. In addition, our strong regulatory affairs team is preparing PMTAs for the ON portfolio for the May 2020 deadline. As a reminder, Altria owns 80% of the Helix Innovations joint venture that will commercialize ON globally. Onn has a product portfolio consisting of 35 unique SKUs, seven flavor varieties across five nicotine strengths. We believe the breadth of nicotine strengths and flavors is a tremendous competitive advantage, as both adult smokers and dippers can find satisfying options within the Onn portfolio. As I mentioned at the beginning of the call, we continue to believe the evolution of the tobacco industry represents a significant opportunity for Altria. We've marked major milestones in our transformation journey this year, including launching ICOS and completing the on-transaction. We believe that with current adult smoker trends and e-vapor disruption, it's an opportune time to expand the availability of these options. We believe that incremental investment behind our noncombustible portfolio will best position Altria for long-term industry leadership. In light of these considerations, we are replacing our long-term adjusted diluted EPS growth aspiration of 7% to 9% with a compounded annual adjusted diluted EPS growth objective of 5% to 8% for the years 2020 through 2022. We believe this new growth objective provides us the flexibility to make investments in noncombustible offerings for the long term, generate sustainable income growth in our core tobacco businesses, and return cash to shareholders through a strong dividend. We also expect to maintain our dividend payout ratio target of approximately 80% of adjusted diluted EPS during this period. We will provide specific full-year 2020 adjusted diluted EPS guidance in January. when we announce our fourth quarter 2019 results. Turning to 2019 earnings, we reaffirm our guidance for full year adjusted diluted EPS to be in a range of $4.19 to $4.27, representing a growth rate of 5% to 7% from an adjusted diluted EPS base of $3.99 in 2018. Altria's 2019 success to date can be attributed to our resilient core tobacco businesses and our talented employees. Our employee base has embraced industry disruption with focus and dedication. Our business results show what I see every day, that our people propel our success, and I thank them for that. I'll now turn it over to Billy to provide more detail on our performance and other investments.