Altria Group, Inc.

Good day, and welcome to the Altria Group 2020 First Quarter Earnings Conference Call. Today's call is scheduled to last about one hour, including remarks by Altria's management in the question and answer session. 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, Nicole. Good morning, and thank you for joining us. This morning, Billy Gifford, Altria's CEO, will discuss Altria's first quarter business results. Sal Mancuso, our CFO, and Murray Garnick, Executive Vice President and General Counsel, will join Billy in our Q&A session. Earlier today, we issued a press release providing our results. The release, presentation, and quarterly metrics are all 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 2019. 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. We're also conducting today's call from our respective remote location. As such, there may be brief delays or small technical issues during the call. We thank you in advance for your understanding. With that, I'll turn the call over to Billy.

Thanks, Mac, and good morning, everyone. To begin, I'd like to thank you for joining us this morning, and I hope that you and your families are safe and healthy. The past two months have been challenging and have changed the way we live and work. Yet our exceptional organization has risen to the challenge and demonstrated compassion, grit, and resilience. Over the past two months, I've connected with our teams and their families, children, and sometimes four-legged friends who have popped up on the video frame. I'm more than impressed by the dedication and resourcefulness of our employees who are balancing significant work responsibilities with many personal commitments. We'll get through this challenging time together and grow stronger as a team because of it. I'd also like to thank Howard for his leadership and dedication to Altria for nearly 30 years, and we wish him well in his retirement. It is truly an honor to lead this great company, and I believe we have a very bright future ahead of us. The first quarter brought out the best in Altria's employees, as we navigated the dynamic tobacco environment and the unprecedented effects of the COVID-19 pandemic. I've been fortunate to work here for over 25 years, and in that time, I've learned that we rise together as a company to face our challenges. We've approached the challenges of COVID-19 by focusing on the health and welfare of our employees, maintaining business continuity, and supporting our communities. In addition to implementing remote working and social distancing protocols, our teams are working tirelessly with critical businesses and trade partners to limit disruptions to our supply chains and distribution systems. As you know, last month we temporarily suspended operations at our Richmond Manufacturing Center after two of our employees tested positive for COVID-19. We've since reopened the manufacturing center under enhanced safety protocols. And currently, all of our manufacturing facilities are producing products for our adult consumers. We're also focused on supporting the communities where we live and work. We committed an initial $1 million to support COVID-19 relief efforts for our employee and grower communities. Many of our valued nonprofit partners have been hard hit by COVID-19 with disruptions to critical programs and funding streams. To help them through this time, we're providing additional flexibility with the use of grant and sponsorship dollars to support general operating needs. We're also accelerating some payments and relaxing reporting requirements considering their stretched capacity. Additionally, we've also donated supplies and we're running an employee giving campaign to support five nonprofit organizations on the front lines of the pandemic. Today, our employees have donated more than $100,000 to this campaign. Like many other companies, we're tackling the challenges of COVID-19 with our key stakeholders in mind, and of course, that includes our investor base. Given the unprecedented circumstances, some investors may be less interested in our recent results and more focused on our outlook. But we believe it's important to discuss some of the first quarter dynamics to set the context for the balance of the year. To start, first quarter adjusted diluted EPS grew by 18.5%, driven by excellent performance from our core tobacco businesses with double-digit adjusted OCI growth in both the smokable and oral products segments. In February, we announced our new 10-year vision to responsibly lead the transition of adult smokers to a noncombustible future. And we discussed the strategies that will drive our vision forward related to corporate responsibility, our product portfolio, and science-based policy. Today, we'll focus our remarks on our product portfolio strategies. Let's begin with our combustible product strategy, which is to maximize profitability while appropriately balancing investments in Marlboro with funding the growth of noncombustible products. The smokable product segment delivered outstanding first quarter results, growing its adjusted OCI by more than 20% and expanding its adjusted OCI margins to 55.3 percentage points. Higher pricing and higher volume more than offset higher resolution expenses to drive profit growth in the quarter. The segment also delivered strong quarterly net pricing of 9.2%, due in part to its continued use of revenue growth management. Our reported domestic cigarette shipment volume increased by 6.1% in the first quarter due to several factors, including increases in trade inventories, one extra shipping day, and consumer pantry loading due to COVID-19. When adjusted for the traditional factors of trade inventories, calendar differences, and other factors, our domestic cigarette volume decreased by 3.5%. However, we believe that our preliminary estimates of consumer pantry loading should be an adjusting factor to reported volumes due to its high likelihood of near-term volume payback. When adjusted for these traditional factors, and the estimated consumer pantry loading, our domestic cigarette volume decreased by 5%. We estimate that US cigarette volumes declined by 2% in the first quarter when adjusted for trade inventory movements, calendar differences, and other factors. With the additional adjustment for consumer pantry loading due to COVID-19, we estimate that industry volumes declined by 3.5% in the quarter. To estimate the impact of consumer pantry loading, we analyzed shipments to retail and retail sales data and compared them against recent and historical trends. During the first few weeks of March, we observed stable retail foot traffic and elevated tobacco expenditures per transaction. However, in late March, retail foot traffic decreased significantly as stay-at-home orders were enacted but tobacco expenditures remained high. As we said before, it's difficult to identify trends based on short time periods. This is especially true in such a fluid environment. We'll continue to monitor marketplace dynamics and we'll update our estimates next quarter as more data becomes available. We maintain our full year 2020 adjusted industry decline rate estimate of 4% to 6% And we'll continue to monitor additional factors, including e-vapor regulatory developments and the impact of the federal Tobacco 21 law. Marble's first quarter retail share of the total cigarette category was 42.8%, down 0.5% versus the prior year, but its share of premium cigarettes remained flat versus the prior year at 56.9%. Over the last several months, we've observed an increase in the number of age 50 and older smokers in the cigarette category. We believe these smokers have previously switched to eVapor products, but recently returned to cigarettes due to negative publicity and regulatory and legislative developments in the eVapor category. Based on our adult smoker demographics, smokers over the age of 50 have a greater propensity to purchase discount cigarettes than younger adult smokers. In the first quarter, gross shipment volumes to retail moderated for the premium and branded discount segments, declining by 1.5% and 3.8%, respectively. However, we observed a significant increase in deep discount volumes, as its growth rate nearly doubled from the prior quarter to 14.4%. We believe this rapid rise in deep discount volumes is partially due to the influx of older adult smokers returning to the cigarette category and contributed to Marlboro's first quarter retail share performance. We're continuing to strategically prioritize investments in Marlboro and have focused our resources on maintaining its leadership position within the premium segment of the category. We believe investments behind our leading WALTI programs, such as Marlboro Rewards, and product expansions like Marble Bold Ice with its innovative resell pack, best position the brand within the premium segment and maximize its long-term profit potential. Looking at the discount segment, we saw a retail share increase of eight-tenths versus the prior year, primarily driven by the deep discount segment. We're continuing to monitor the dynamics within the discount segment, including interaction with premium brands, and the impacts of adult smoker movement across tobacco categories. PMUSA continues to profitably compete in the branded discount segment. In addition to its L&M brand, PMUSA recently refreshed Chesterfield to serve as a complimentary discount offering focused on adult smokers age 40 and older. In cigars, Middleton's reported volume increased 13.1% in the first quarter, outpacing the machine-made large cigar category. We believe Middleton is the best-positioned cigar manufacturer to navigate the FDA framework. The company has already received premarket authorization for nearly 90% of current volume and expects to submit the remainder of its substantial equivalent applications by the new deadline of September 9th. Let's now turn to the second product portfolio strategy in our new vision. Over the next 10 years, we will develop and expand our portfolio of FDA-authorized noncombustible products and actively convert adult smokers to them. Currently, we're focused on the three most popular noncombustible platforms, old tobacco, evapor, and heated tobacco. We believe oral tobacco will play a significant role in adult tobacco consumer transition from cigarettes and that our unmatched portfolio will play a leading role in that transition. Our product offerings within the Copenhagen, Skoll, and Orn brands provide adult tobacco consumers with a wide range of satisfying flavors and strengths within both the MST and oral nicotine pouch categories. Our oil tobacco product segment performed exceptionally well in the first quarter, growing its adjusted OCI by over 13% and expanding its adjusted OCI margins to 73 percentage points. As a reminder, the oil tobacco segment includes our MST, SNUs, and oil nicotine pouch products. Higher pricing and higher volume more than offset investments in ORN to drive OCI growth for the quarter. We estimate that U.S. oral tobacco industry volumes increased 6% over the last six months as the rapid growth in oral nicotine pouches more than offset volume declines in MST and SNUs. When adjusted for estimated retail and consumer pantry loading due to COVID-19, we estimate that U.S. oral tobacco industry volumes increased by 5% over the past six months. First quarter retail share for the oil tobacco segment was 50.4%, and Copenhagen continues to be the market leader with a 32.4% retail share. Segment share declined by 2.8 share points due to the continuing mix shift between oil nicotine pouches and traditional MST. We remain pleased with Copenhagen's increased profitability and the performance within the MST category. ONN was sold in over 28,000 stores at the end of the first quarter, including the top five convenience store chains by volume. The newly redesigned ONN cans are now available for purchase, and we're enhancing its retail visibility through premium fixture space in most stores. We believe ONN is a compelling proposition for both adult dippers and smokers. Although it's early days, we're encouraged by the momentum that ON is building at retail, and we're continuing to test several go-to-market approaches. For example, here are the results of promotional programs that we recently ran in two large convenience store chains in different states. In both chains, ON sales volume accelerated during the promotional period, and more importantly, maintained much of that momentum throughout the first quarter. Today, we believe the pace at which adult tobacco consumers are adopting ON is related to the duration of ZEN's time in market. For example, in Colorado, we expected a competitive environment as ZEN has been available since 2016. But we're quite pleased that ON has doubled its velocity within the chain in just a few short months. In North Carolina, where ZEN has only been sold for 12 months, We observed faster adoption of OARN and continued momentum after the promotional period. We're preparing a strong PMTA submission to the FDA for the OARN portfolio, and we expect to file our application in May. We're encouraged by the results of our research studies and believe that our package of scientific evidence demonstrates that the marketing of OARN is appropriate for the protection of public health. After finalizing the PMTA submission, our regulatory and science teams will pursue plans for a modified risk application for Olin. Turning to eVapor, the category continues to remain dynamic in light of ongoing regulatory and legislative developments. In the first quarter, total eVapor estimated volumes declined by 12% sequentially and 10% versus the prior year. We believe the e-vapor volume decline is partially due to the ENDS guidance issued by the FDA in January, which banned all non-tobacco or menthol-flavored pod products. With our minority investment in Juul, the U.S. Federal Trade Commission recently announced its decision to file an administrative complaint challenging the transaction. The FTC alleges that our minority investment is anti-competitive, due to our decision to close the Newmark Operating Company in the fourth quarter of 2018. We intend to vigorously defend the investment. In the meantime, we're continuing to provide regulatory affairs services to Juul, including support for their PMTA following. In heated tobacco, we remain excited about the opportunity to introduce ICOs to U.S. adult smokers. Unfortunately, the COVID-19 outbreak has caused us to adjust our ICO's commercialization plans. We've had to temporary close our Atlanta and Richmond stores and pause our interactive marketing efforts to limit person-to-person contact. We'll be guided by public health authorities as to when we'll reopen the stores and resume our interactive marketing approach. In the meantime, we're continuing our digital marketing efforts to generate awareness and drive product education through their ICO's website. Also, heat sticks remain available for sale in more than 500 retail stores across Atlanta and Richmond, and we believe we currently have sufficient on-hand inventories. Additionally, we pushed back the Charlotte launch due to COVID-19 concerns. Our Charlotte expansion will include several enhancements from earlier launches, including a more disruptive retail look and a greater emphasis on flexible marketing units such as pop-ups and pods. We believe our enhanced retail fixtures will aid awareness as both the Icos brand and its proposition of real tobacco, no ash, and less odor will be prominently displayed at the point of purchase. We're encouraged that Philip Morris International has recently submitted a supplemental PMTA for ICOS-3. This enhanced device has a more modern look and charges faster than the currently authorized 2.4 version. PMI's MRTP application for ICOS-2.4 remains pending with the FDA, and we continue to be optimistic about its authorization. Let's now discuss the performance of our adjacent alcohol and cannabis assets. The first quarter was challenging for our alcohol assets as both St. Michelle and our equity investment in AB InBev underperformed versus the prior year. In wine, St. Michelle is experiencing headwinds due to evolving adult consumer preferences and increased uncertainty in the demand for its products. These dynamics have been further negatively impacted by the COVID-19 pandemic. As a result, St. Michelle recorded first quarter charges of $392 million, consisting of a write-down of excess wine inventory and an estimated loss on non-cancelable future grade commitments. We treated these charges as special items, and they were excluded from underlying results. St. Michelle's first quarter adjusted OCI decreased more than 13% due to lower shipment volume, including lower on-premise sales due to COVID-19. In Beer, first quarter adjusted equity earnings from ABI were $190 million, down nearly 24%, representing Altria's share of ABI's fourth quarter 2019 results. As described in our press release, these results now exclude our share of ABI's mark-to-market activity relating to certain financial instruments associated with its share-based compensation program. These amounts were previously included in our adjusted results, but beginning this quarter, we'll be treating them as special items and they'll be excluded from our adjusted earnings. We've recast our prior period results to reflect this change. Turning to cannabis, Kronos recently disclosed the results of its audit committee review of certain revenue transactions, which resulted in a financial restatement of the first three quarters of 2019. As a major shareholder, we expect Kronos to consistently maintain adequate internal controls and financial reporting processes. Although these restatements were immaterial to us, we take these matters seriously and believe that Kronos is implementing the appropriate remedial changes. In the first quarter, we recorded an adjusted loss of $25 million related to our Kronos investment, which primarily represents our share of Kronos' fourth quarter 2019 results. We continue to believe that Kronos' asset-light strategy is prudent given the evolving nature of the global cannabis market. Finally, let's discuss capital allocation and guidance. As the quarter progress, we develop liquidity strategies to manage through the impacts of COVID-19. We're fortunate that our businesses are highly cash generative and convert income to cash at over 90%. However, we believe it was prudent to take additional actions to preserve financial flexibility in this environment. In the first quarter, we halted share repurchases and fully drew down our $3 billion revolving credit facility as a precautionary measure. This week, the Board rescinded our existing share repurchase program, which had a $500 million balance, to further strengthen our liquidity position. After funding today's dividend, we have approximately $2 billion of cash on hand. And for the coming quarters, we expect to maintain a higher cash balance than normal to manage through potential disruptions. Due to the uncertainties related to the impact of the COVID-19 pandemic and the economic recovery scenarios, we're withdrawing our 2020 full-year adjusted diluted EPS guidance. Let's walk through the factors that led us to that decision. As you know, ABI has withdrawn its 2020 financial forecast due to the impacts of COVID-19. ABI is a significant contributor to our earnings, and we believe there would be misalignment to provide our financial forecast without greater clarity on ABI's expected performance. From a macroeconomic perspective, we anticipate a recessionary backdrop and increased financial pressure on adult tobacco consumers. We've observed a rise in unemployment rates that we expect to persist throughout the year. There's also a wide range of economist predictions for the peak level of unemployment and economic recovery. For our adult tobacco consumers, we expect an increase in down trading within both the cigarette and MST categories. The degree of down trading will depend on several factors, including the depth and duration of higher unemployment. and the severity of COVID-19 impacts, with potential offsetting factors of lower gas prices, increased unemployment benefits, and government stimulus payments. For our tobacco businesses, we believe we have the right tools to help navigate through a difficult and uncertain time as we manage the business for long-term success. Due to the combination of these factors, we decided to withdraw our EPS guidance until the COVID-19 situation stabilizes. We're continuing to monitor the impact of the virus, and we expect to reestablish guidance at the appropriate time. As a result of withdrawing guidance for 2020, we've also withdrawn our three-year compounded annual adjusted diluted growth objective. Please reference our earnings release and our Form 10-Q that we filed today for additional disclosures related to the business impact of COVID-19. Turning to dividends, we understand that our dividend is important to our investors and it remains a top priority for us. Our objective continues to be a dividend payout ratio target of approximately 80% of adjusted diluted EPS. Since we have withdrawn our four-year EPS guidance due to the impacts of COVID-19, we wanted to provide investors with a greater transparency on how we will approach the dividend this year. For 2020, we expect to recommend a quarterly dividend rate to our board that reflects, among other things, our strong cash generation and the strength of our balance sheet. That concludes our remarks, and we will be happy to take your questions. Operator, do we have any questions?