Altria Group Inc. (MO)
2013 Investor Day Conference Transcript
June 11, 2013 9:00 AM ET
Marty Barrington - Chairman and CEO
Dave Beran - President and COO
Howard Willard - Chief Financial Officer
Murray Garnick - SVP and Associate General Counsel, Altria Client Services
Jim Dillard - Senior Vice President, Regulatory Affairs
Bruce Gates - Senior Vice President, External Affairs, Altria Client Services
Billy Gifford - President and CEO, Philip Morris USA
Brian Quigley - President and CEO, U.S. Smokeless Tobacco Company
Vivien Azer - Citigroup
David Adelman - Morgan Stanley & Co. Inc.
Ann Gurkin - Davenport
Judy Hong - Goldman Sachs & Company, Inc.
Erik Bloomquist - Berenberg
Priya Ohri-Gupta Barclays Capital
Nik Modi - UBS
Good morning, everyone. I’m Marty Barrington, Chairman and CEO of Altria Group. On behalf of our management team, I’d like to welcome you here today and those listening on the webcast to our presentation this morning.
Before we begin, please review the Safe Harbor Statement in today’s presentation and the Forward-Looking and Cautionary Statements section in today’s press release for a description of the various factors that could cause our actual results to differ materially from projections included in today’s remarks.
Reconciliations and further explanations of the non-GAAP financial measures discussed today are available on altria.com.
Our focus this morning is on Altria’s plans to continue creating value for shareholders. We’ll start with an overview of Altria’s business model and strengths. We’ll then discuss our tobacco companies’ investments in premium brands, followed by a question-and-answer session. Then we’ll take a break and give those of you in the room a chance to explore the creative brand materials and technologies we’ve set up next door.
When we return, we’ll discuss the external environment, Altria’s financial strategies and cash returns to shareholders. And then we’ll finish our morning with closing remarks and another, excuse me, and another question-and-answer session followed by lunch.
You’ll have the opportunity to hear from and meet members of our management team. Most of you know Dave Beran, our President and Chief Operating Officer; Howard Willard, our Chief Financial Officer; and Murray Garnick, Senior Vice President and Associate General Counsel for Altria Client Services.
This morning you will also hear from Jim Dillard, Senior Vice President, Regulatory Affairs; and Bruce Gates, Senior Vice President, External Affairs both with Altria Client Services.
We also have with us Billy Gifford, President and CEO of Philip Morris USA; and Brian Quigley, President and CEO of U.S. Smokeless Tobacco Company. Everyone will be available throughout our time together today.
Each of these executives has significantly contributed to Altria’s results for shareholders over the years and each will play an important role as we work to continue Altria’s track record of success. Our management team is supported by talented employees who drive our business performance.
We believe that Altria offers a compelling investment proposition with the opportunity for strong total returns consisting of solid adjusted diluted earnings per share growth and a significant dividend.
Altria’s goal is to grow its adjusted diluted EPS at an average annual rate between 7% and 9% over time. We also have a goal to return approximately 80% of our adjusted diluted EPS to shareholders through dividends.
Altria’s strengths support our ability to achieve these goals and continue to create value for shareholders. These include the most diverse business model among our U.S. tobacco peers, leading premium tobacco brands, a systematic approach to innovation, including new products, well-developed capabilities to address legislation, regulation and litigation challenges, proven cost management and a strong balance sheet that supports excellent cash returns to shareholders, primarily through dividends. We’ll discuss each of these strengths this morning. I’ll begin with a discussion of our business model and innovation.
We believe that Altria’s diverse and successful business model provides the foundation for future growth. Our tobacco companies, Philip Morris USA, John Middleton and U.S. Smokeless Tobacco Company are the core of this model. These companies have grown income from smokeable and smokeless tobacco products by satisfying adult tobacco consumer preferences with premium brands.
In the smokeable products segment, PM USA and Middleton’s strategy is to maximize income while maintaining modest share momentum overtime on Marlboro and Black & Mild.
In the smokeless product segment, USSTC and PM USA seek to increase income by growing volume at or ahead of the category growth rate while maintaining modest share momentum on Copenhagen and Skoal combined. Our tobacco companies are complemented by growing alcohol assets that include our ownership of Ste. Michelle Wine Estates and our equity investment in SABMiller.
In the wine segment, Ste. Michelle’s goal is to grow income by expanding its share and distribution of premium wines. Altria also seeks to maximize the contribution of our equity investment in SABMiller to Altria’s total shareholder return.
The tobacco space in the United States is an attractive place to do business with an estimated combined profit pool of nearly $14 billion in 2012, which includes cigarettes, cigars, smokeless tobacco and other tobacco products. Cigarettes generated the majority of these profits, followed by smokeless tobacco products and machine-made large cigars.
The diversity of Altria’s tobacco businesses and the successful execution of their strategies helped Altria earn approximately 52% of the combined tobacco profit pool in 2012.
We estimate that the profit pool grew at a compounded annual rate of 4.5% from 2007 through 2012. And this growth happened during a time of economic challenge, the largest federal excise tax increase on tobacco products in history and new comprehensive regulation of tobacco products by the Food and Drug Administration.
There are approximately 56 million adult consumers across all tobacco product categories, according to government data. This number has declined modestly in recent years as declines in adult tobacco use have been partially offset by population growth.
Total tobacco volume declines have also been moderate as declines in cigarette volume have been partially offset by increases in smokeless tobacco products and machine-made large cigar volume. Total tobacco volume based on pounds decreased approximately 2% annually from 2009 through 2012.
Altria’s tobacco companies are well-positioned in the U.S. tobacco space. They have the leading positions in the largest and most profitable tobacco product categories. And in each of these categories, our companies compete with premium brands that enjoy strong equity and higher margins than most of their competitors.
Dave will update you shortly on how we are managing these brands to deliver income growth in our core businesses over the long-term. I’ll focus now on our companies’ efforts to develop innovative tobacco products for adult tobacco consumers.
Our tobacco companies have built their leadership positions over the years by evolving their product portfolios to meet the changing preferences of adult tobacco consumers. Our companies develop a deep understanding of adult tobacco consumers and their preferences and work to create superior products to meet them.
Of the estimated 56 million adult tobacco consumers in the United States, approximately 44 million are cigarette smokers and approximately 7.5 million consume smokeless tobacco. Approximately 50% of adult cigarette smokers say they are interested in trying innovative types of tobacco products according to our research.
USSTC and PM USA work to meet this interest by offering new tobacco forms from their leading brands. These offerings include pouches from Copenhagen and Skoal, pre-formed portions like Skoal ReadyCut and snus, and smokeless tobacco sticks from Skoal and Marlboro. Our smokeless tobacco product development is supported by the intellectual property we obtained through the UST acquisition.
Altria’s subsidiary Nu Mark focuses on responsibly developing and marketing innovative tobacco products for adult tobacco consumers. In 2012, the company introduced Verve discs, a mint-flavored, chewable tobacco product that contains tobacco-derived nicotine, in approximately 60 stores in Virginia.
Nu Mark used the Verve launch to gauge adult consumer acceptance of the product and we are pleased with the brand’s initial results. Nu Mark now plans to expand distribution of Verve discs to approximately 1,200 new stores in Virginia in the second half of 2013. The expansion plans include an improved product and enhanced marketing communications that incorporate the learnings we gained over the past year.
Adult smokers are also expressing more interest in e-cigarettes. According to our research, the e-vapor category is growing but off a small base. Category growth appears to be driven by increased awareness and trial, as well as expanded retail distribution. Although, there are over 200 brands available in many forms, sizes and taste blends, our research shows that adult smokers are aware of only a few brands.
Moreover, the existing products that they have tried often do not meet their desires. In our view, the category is in its early stages and time will tell how it will evolve. We’ve now spent a good deal of time studying the category and the business opportunity.
Altria’s market research and product development teams have been researching adult smoker preferences and Nu Mark has developed what we believe is a superior product. Accordingly, now is the appropriate time for Nu Mark to enter the category.
This August, Nu Mark plans to introduce MarkTen e-cigarettes into a lead market in Indiana. Nu Mark’s objective is to responsibly market and sell a premium product that delivers a superior sensorial experience to adult smokers and vapors.
There are opportunities to compete effectively by introducing superior products, building brand equity and navigating a changing regulatory environment. Nu Mark possesses significant capabilities that we believe will provide a competitive advantage as the category evolves.
MarkTen e-cigarettes are designed to offer adult smokers and vapors a familiar draw with an appealing taste. Its unique Four Draw technology is designed to give adult vapors a more consistent experience, puff-to-puff and day-to-day. Nu Mark believes its technology provides an experience that closely resembles the draw of a cigarette.
Unlike many other e-cigarettes, MarkTen e-cigarettes can be used either as a disposable or rechargeable device. To use the product as a rechargeable adult vapors just need to purchase replacement cartridges and an accessory kit that includes charging devices. The product will be available in two varieties, Classic and Menthol. Retailers will set the consumer pricing, but we believe that the device will sell for about $9.50.
Nu Mark plans a number of activities in the lead market to build MarkTen’s brand awareness and equity among adult smokers and vapors. FDA has stated its intention to regulate e-cigarettes and other tobacco products.
In addition, several states and localities have enacted or proposed legislation related to the sale, use or taxation of e-cigarettes, and Jim and Bruce will share our views on these proposals later this morning.
In addition to internal research and development, our companies are working with third parties to develop and commercialize innovative new products for adult tobacco consumers.
Last year, Altria Client Services entered into an agreement with Okono, an affiliate of the Danish company Fertin Pharma to develop innovative, non-combustible nicotine-containing products. Okono and another Altria subsidiary also formed a joint venture, Richmark to market and sell these kinds of products outside the United States and Canada.
This summer, Richmark plans to introduce Tju, chewing tobacco gum into a test market in Denmark. This product contains tobacco and is an alternative for adult cigarette smokers who wish to continue to enjoy tobacco, but in a smokeless form. It will initially be offered in two varieties, Summer Blend and Dark Blend.
Altria’s companies take a systematic approach to innovation, including the development of new products to meet consumers’ evolving preferences. This approach combines a deep understanding of adult tobacco consumers, product development expertise, intellectual property acquired through the UST acquisition, intellectual property rights owned jointly with Philip Morris International and partnerships with others. These efforts have contributed to our business results and we believe they position our companies well for the future.
In recent years, Altria’s tobacco companies have introduced or expanded cigarettes, cigars and smokeless tobacco products that have evolved their product portfolios, strengthened their brands and contributed to retail share gains. They support these products with initiatives that build their brand equity.
Products introduced by Altria’s tobacco companies in the last three years have outperformed those of their leading competitors in cigarettes, cigars and smokeless tobacco in terms of retail share.
We’re using the same adult consumer-focused approach to developing and marketing innovative new tobacco products and we expect our innovation strategies to contribute to Altria’s revenue and income growth in the future.
Dave will join us now to discuss our investments in our premium tobacco brands in more detail.
Thanks Marty. Our tobacco operating companies invest in premium brands in the largest and most profitable tobacco product categories. We believe that these investments position our companies to deliver superior business performance overtime creating long-term marketplace advantages.
Disciplined innovation is at the heart of our brand-building. We start by working hard to understand adult tobacco consumer preferences. We use what we learn to enhance our brands’ connections with them, both in segments where our brands are strong and where they are less developed and for us, brand innovation is broader than just developing products. It includes finding creative and engaging ways for our brands to connect with adult tobacco consumers.
Our companies are committed to marketing their products responsibly by taking steps designed to limit reach to unintended audiences. Each limits its one-to-one communications, which include direct mail, email, consumer websites and event marketing, to their age-verified tobacco consumers, 21 or older.
Marlboro is the most profitable cigarette brand in the U.S. and it’s the engine that, in large part, drives the business performance of our smokeable products segment. Therefore, we’re always working to improve Marlboro’s marketplace position with equity-building activities that position the brand for future success.
Marlboro’s iconic position as the brand men smoke for flavor rests on a foundation of innovation. In 1954, PM USA repositioned Marlboro with a number of groundbreaking innovations. A new Richmond Recipe formulation with a cork-tip filter, launched into a marketplace dominated by non-filtered cigarettes, a new pack design with a red roof and a flip-top box, launched into a marketplace largely made up of soft pack products, and a new positioning as a flavorful cigarette for men. These and many other innovations contributed to almost 60 years of retail share growth and Marlboro’s development into the largest cigarette brand in the U.S.
In 2012, Marlboro innovated again with its new architecture. This architecture provides a broad platform to communicate with adult smokers, while staying true to the brand’s essence as the most flavorful, masculine, premium cigarette. Each of the brand’s four flavor families, Red, Gold, Green and Black expresses Marlboro’s positioning and values in its own unique way, allowing Marlboro to expand the breadth of its equity-building offerings. The architecture has inspired new thinking about Marlboro and the brand has been busy connecting with adult smokers in innovative and exciting ways.
Let’s look at how the brand is doing this, starting with the recently expanded Marlboro Black family. Marlboro Black is a bold, modern take on Marlboro, inviting adult smokers to navigate the unknown where bold flavor is.
Marlboro Black reinforces this message by regularly sending direct mail to adult smokers on our mailing list. These communicate the flavor family’s core equity and include a coupon that an adult smoker can redeem at retail. When he enters the store to redeem the coupon, he’ll see that PM USA has reset the fixture, giving Marlboro Black its own home.
And when the consumer purchases a Marlboro Black product, let’s say a pack of Marlboro NXT, he’ll see the brand’s bold packaging and then experience its capsule technology that allows him to switch from non-menthol to menthol taste. The direct mail piece, as well as on-pack communications, also invites the consumer to the new Marlboro website.
Once on the site, he can participate in promotions like Marlboro Black’s capture the unknown sweepstakes, during which participants submitted over 80,000 photos of their own stories of bold adventure or he can engage in conversations with other adult smokers about the spirit of Marlboro Black, as communicated in the articles, interviews and videos.
The brand also goes on the road with its adult only facility, the Marlboro Black Lounge. Inside this mobile marketing unit, adult smokers have opportunities to interact with the brand and win prizes. They can also explore all four of Marlboro’s flavor families with the brand’s new interactive technologies. You can see some of these at the break and at lunch.
In 2012, the Marlboro Black Lounge hosted almost 200,000 adult smokers at events across the nation. Marlboro Black is off to a strong start. And while we are supporting Marlboro Black with a number of equity-building activities, we are doing just as much with Marlboro’s other flavor families.
Here are a few highlights. Marlboro Green embodies Marlboro’s flavor heritage in a way that brings spontaneity to a classic campaign. The brand brings Marlboro Green to life with its Flavor Makes the Night Campaign in direct mail, email, on-pack and on-line.
For example, Marlboro Green engages adult smokers with the flavor makers on Marlboro.com. This series highlights venues such as restaurants and bars where flavor makers create special experiences.
Adult smokers have posted thousands of comments on Marlboro.com, engaging in conversations with the Flavor Makers themselves and each other. Through its Flavor Makes the Night campaign, Marlboro Green interacts with adult smokers at different bars across the country.
These promotions build brand awareness and allow smokers to register for Marlboro’s mailing list. In addition, the flavor finder on the website directs adult smokers to those bars with Marlboro Green promotions.
Marlboro Gold features the Marlboro Man in a different moment, one of relaxation that can only be found in the majestic serenity of the American West. Marlboro Gold makes good on a promise of flavor and enjoyment unique to and truly worthy of, Marlboro Country. Its equity campaign is built on the tagline, Flavor is Golden.
Marlboro Gold’s communications showcase its unique personality. As part of its Team Marlboro promotion, over half a million adult smokers pledged to help reduce cigarette litter. And Marlboro Gold has provided them with over 400,000 portable litter devices.
Adult smokers can join other Team Marlboro projects as part of the Help Preserve the Land campaign. For example, team members are getting ready to explore and clean up Arizona’s scenic Verde River.
Marlboro Red is the foundation upon which the architecture rests. This family established Marlboro as the most flavorful, masculine cigarette brand. PM USA is strengthening Marlboro Red by re-grounding it in the American West and the values of the cowboy.
In 1964, Marlboro first invited adult smokers to come to where the flavor as, Come to Marlboro Country. And Marlboro Red keeps this timeless message at its core today.
Marlboro Red invites adult smokers to forge their own brand with the Stand for your Brand feature on Marlboro.com.
Over a million and a half adult smokers have their own brand and it becomes their signature when they create content on the website. Marlboro Red’s Rock the Ranch promotion invites adult smokers to experience 18,000 acres of adventure at the Marlboro ranch in Montana.
While each flavor family has created equity-building activities designed to highlight its unique personality, all the flavor families are part of one great brand, Marlboro. And PM USA designs promotions to reinforce this point.
The brand’s Wide Open Flavor promotion invited adult smokers to explore the American West and Marlboro. This promotion connected them with 80 locations across the West, capturing the essence of Marlboro’s four flavor families with videos and pictures.
During Wide Open Flavor, the brand generated 14 million adult smoker interactions. Brand equity is an important metric we use to evaluate brand health over the long term. Although it’s a bit early to evaluate the impact of the architecture and supporting activities on brand equity, we’re confident these efforts are improving the Marlboro brand.
Of course, Marlboro starts from a position of strength, as the brand continues to have excellent brand equity and demographics. According to a TNS brand equity study completed in March, Marlboro’s brand equity scores among adult smokers remain far higher than any other brand in the cigarette category.
Also, Marlboro’s equity score among smokers who are 21 to 29 is much higher than any other major cigarette brand and equals its overall equity score. Marlboro also has strong demographics as its share among 21 to 29 year old smokers exceeds both its overall share and those of the two largest competitive premium brands combined.
Turning to Black & Mild, it is the premium, machine-made, large cigar brand, positioned as the best any day cigar adults enjoy for its smooth taste and pleasant aroma. Black & Mild is innovating with a variety of new product offerings.
Over the last several years, the brand has strengthened its leadership position in the tipped cigarillo segment with additional varieties, including Royale, Jazz and seasonal blends. The brand is also competing in the untipped cigarillo category with varieties such as Black & Mild Classics, Sweets and Wine.
While the machine-made large cigar category continues to experience heightened competitive activity and Black & Mild’s retail share has declined as a result, Black & Mild is a great brand with strong brand equity scores, both overall and among 21 to 29-year-old cigar smokers. Black & Mild will remain focused on its strategy of maximizing income while maintaining modest share growth over the long term.
The investments we’ve made in our companies’ premium smokeable brands are paying off. In 2012, the smokeable products segment increased adjusted operating companies income 4.2% to $6.3 billion. And expanded adjusted operating companies income margins 0.9 percentage points from 40.3% to 41.2%. PM USA also grew Marlboro’s retail share 0.6 percentage points to 43.6% as measured by our new tracking service.
Turning to our smokeless tobacco brands, Copenhagen has been providing adult dippers moist smokeless tobacco satisfaction since 1822. Copenhagen’s strong equity is grounded in its core values of masculinity, heritage, authenticity and tradition. These values have deep roots in Copenhagen’s manufacturing process.
It takes four years to make a can of Copenhagen. And every can of Copenhagen is made from 100% American grown tobacco. While staying true to Copenhagen’s essence and values over time, the brand is innovating by profitably expanding its forms and taste profiles to appeal to more adult dippers.
Copenhagen snuff is the center of the brand with its classic packaging, including the fiberboard can and tin lid. The brand has a long history of leading in the natural segment with its Fine Cut Copenhagen Snuff, Copenhagen Long Cut Natural and Copenhagen Straight.
More recently, Copenhagen has offered additional products to reach adult dippers with different taste preferences. With the launch of Copenhagen Long Cut Wintergreen, positioned as the most flavorful wintergreen MST product, the brand entered the largest and fastest growing segment of the category.
Since 2010, Copenhagen Long Cut Wintergreen has delivered 10 consecutive quarters of share growth. Copenhagen Southern Blend also addresses different preferences. It has a mellow taste in a manageable long-cut form.
In 2012, the brand expanded Copenhagen Southern Blend to 27 states. And in February of this year, the brand began shipping Southern Blend to the Northeast. Copenhagen has been innovating in other ways too. The brand has used its Men of Copenhagen campaign as a creative way to reinforce the brand’s core values and engage adult dippers.
The campaign gives Men of Copenhagen from across the country the opportunity to join projects to improve their communities. For example, in 2012 the Men of Copenhagen restored a river front park in McKeesport, Pennsylvania.
Copenhagen also uses creative packaging to engage adult dippers and grow the franchise. With its Fresh Pull Pack, the brand communicates its core message, satisfaction since 1822, while incentivizing repurchase with money off the next purchase. Copenhagen uses new under-lid communications to reinforce its core equity, provide attractive offers and encourage adult dippers to visit the new Copenhagen website, FreshCope.com.
The brand’s website effectively connects with adult dippers online, including with mobile devices. It reinforces equity, executes promotions, delivers value and generates awareness about Copenhagen products. In the Barrel Room, adult dippers connect with Copenhagen’s legendary craftsmanship. And the website enables user-generated content, allowing Copenhagen adult dippers to share their own stories.
In 2012, the brand also revamped the Copenhagen workshop. This mobile marketing unit is used at events across the country. The workshop increases the number of connections between Copenhagen and adult dippers by allowing them to try Copenhagen products and purchase a can at a great price.
Skoal is the contemporary MST brand that provides a smooth smokeless tobacco experience. Skoal’s products offer great taste and forms that are easy to manage. While Copenhagen is the original MST brand, Skoal has historically been the innovation leader, helping expand the forms and blends of MST.
Skoal was the first to introduce Wintergreen in 1934, Pouches in 1983, and Mint in 1985. Today, adult dippers can find Skoal in every major MST form, including Fine Cut, Long Cut, Pouches and Snus. They can also find Skoal in many varieties such as Wintergreen, Mint, Straight and other blends.
This tradition continues. In 2012, the brand expanded Skoal ReadyCut, offering adult dippers preformed portions that provide great taste and are easier to control than conventional MST products.
Skoal ReadyCut is now available in 21 states in Mint, Wintergreen and Straight at a premium price. Skoal has evolved its traditional product portfolio as adult dipper taste preferences have changed. Now adult dippers can choose between the big, smooth flavor of Skoal X-TRA products and the balanced, smooth taste of Skoal Classic products.
In February this year, the brand began to refresh Skoal’s packaging to better reflect the brand’s contemporary premium qualities and to better communicate the attributes of Skoal X-TRA and Skoal Classic. Last month, the brand introduced a new retail look that features both a Skoal Classic Zone and a Skoal X-TRA Zone.
Skoal is also engaged in adult dippers on the web and at events. On Skoal’s updated website, adult dippers can view brand news and explore Skoal offerings in the Line Up section. Inside the Skoal Zone, which the brand takes on the road, adult dippers can try Skoal products, compete in interactive games and take home some new gear, compliments of the brand.
USSTC’s investments in Copenhagen and Skoal have delivered strong results. These premium brands have the highest brand equity scores in the MST category. In 2012, the smokeless products segment grew adjusted operating companies income by 7% to $959 million and grew adjusted operating company’s income margins by 1.8 percentage points to 60.8%.
Copenhagen and Skoal grew their combined domestic smokeless products shipment volume by 6.2% for the full-year of 2012 and grew their combined retail share by 1.5 percentage points during the same period, as measured by our new tracking service.
Turning to the wine segment, Ste. Michelle has complemented our tobacco operating companies’ performance with strong income growth. Ste. Michelle’s strategy is to grow income by expanding its share and distribution of premium wines. Currently, it is the third largest premium wine producer in the U.S., and is among the fastest growing of the Top 10 premium wine producers, according to the Nielsen Company.
Ste. Michelle’s estates include Chateau Ste. Michelle, Columbia Crest, 14 Hands and Stag’s Leap Wine Cellars. Also, Ste. Michelle imports and markets Antinori, Champagne Nicolas Feuillatte and Villa Maria Estate products in the U.S.
In 2012, 14 Hands broke the million case mark and was named Leaders Choice - Wine Brand of the Year by Market Watch magazine. 14 Hands was also the wine sponsor of the Kentucky Derby and was the featured wine at various events throughout Derby week. Ste. Michelle’s strategies enabled it to grow its adjusted operating company’s income by 9.5% for the full year of 2012.
In summary, our operating companies are focused on investing in premium brands. Each uses disciplined innovation to strengthen their premium brands. These investments are delivering positive results and we believe they position our companies for future growth.
Now, Marty and I will take your questions.
Okay. One note before we get started as a courtesy to see to those both in the room and on the webcast. If you could please wait for our microphone before asking your question, we appreciate that. Thank you. And let’s begin who would like to start first. Vivien
Vivien Azer - Citigroup
Thanks. Vivien Azer, Citigroup. I wanted to talk a little bit more a value expectations for the e-vapor category in terms of the size of the pi, the potential impact on traditional cigarettes volume and whether you have a margin target in mind once you get profit distribution?
Okay. Let me take a whack at those. It’s early days obviously in the category. So almost anything we talk about with e-vapor, we have an understanding I guess. I think the question really is you’ve seen the publish reports, including some of your own about what the size of the category is today. I think the open question is what's the category going to be tomorrow. And because it's so early, I think it's hard to know that.
What we do know is that there are some adult smokers that were interested in innovation, our research tells us that. And you see really, kind of, for the first time adult cigarette smokers really trying these products. So it’s hard to know. I think it's also early on margin, the tobacco space generally enjoys nice margins as you just saw from Dave’s presentation and we would aspire to have a good margins in any business we operate there.
But you know, there are so many unknowns right now about what’s going to be the excise tax structure if any, how many consumers are actually going to migrate to the product, what’s going to be the regulatory situation. So we're mindful of margin but I’d be misleading, if I told you that I had a number for you today. We aspire to have that margins I can tell you that much. That was two, what’s was you third, I’m sorry.
Vivien Azer - Citigroup
The potential impact on traditional cigarettes volume
Vivien Azer - Citigroup
I think you answered that.
I do, yeah. I think it's just how many really switch.
Vivien Azer - Citigroup
I get it, one follow up, in terms of the consumer work that you’ve done around the interest in e-cigarettes. Are there any stand-up in terms of demographic, it’s skewed little bit younger more urban, more educated?
It’s just heard to read right now. We have done some work in that regard but I think it's early and rather than to guess at those numbers. I think it's fair to say that there is some widespread interest in the product among a certain cohort of adult cigarette smokers. Okay. Thank you. Who is next?
I have one here. Who is the target consumer for MarkTen. Is there only gear towards smokers or also non-tobacco users. And how important will it be to you that you would be able to make a differentiated health claim or risk claim on this product?
Okay. So, our target audience for MarkTen is adult cigarette smokers and adult vapors. And we’re not making a health claim with MarkTen and in fact, we’ll have a warning on it which is appropriate for the category. We just have to see over time what FDA has to says about these products.
But would you see as a benefit if you could make a health claim at some point in the future assuming the FDA would led you do that?
Well, I won’t talk about these e-vapor products particularly in that regard because we’re not making a claim about it. But I think we’ve talked at other times about our desire, I mean this is one of the reasons for why we supported FDA. We think that harm reduction would be a good public policy for the FDA to pursue. If manufacturers could bring products to market that do reduce harm and if FDA could approve claims in that regard that are accurate and they are non-misleading, but that tells adult tobacco consumers that there is some relative risk. We support that policy in any products that would meet that test we would support them too. You bet. Why don’t we go over this way, David?
David Adelman - Morgan Stanley & Co. Inc.
Marty, two questions, first on Marlboro’s demographics, in the past when you’ve shown those graphics, you’ve had actual numbers, here it’s hard for an outsider to detect exactly. In general could you talk about Marlboro's demographic profile today, with young adult smokers versus when you ran those analyses and have third-party assist the brand actually we’ve say two years ago? That’s my first question.
Dave, why don’t you take that one?
Yeah. We look at Marlboro’s both the brand and equity, that’s the TNS study. What we've seen overtime is that the brand Marlboro has remained, okay, basically has remained very strong with not a lot of movement, okay, both in its equity status and reason for that it's been around for a substantial period of times 60 years. So, remains strong and its equity scores among 21 to 29 age smokers’ remains about equal to its overall share, so not a lot of movement but remains high.
David Adelman - Morgan Stanley & Co. Inc.
Okay. And then, secondly, on the different topic, could you talk about your approach to price and mix management within the smokeless tobacco category because in the recent past, although you have taken wholesale price increases, revenue growth pretty much attract volume growth because of the nature of the new products and their price points? Is that sort of what you had in vision two or three years ago, you wouldn't be getting net pricing or you underperforming what you would have hope or is that sort of just the reflection of the programs you are putting into the market?
Just for clarity, you’re talking about smokeless.
David Adelman - Morgan Stanley & Co. Inc.
On smokeless, yeah.
But, do you want to start Dave, answer that one.
Yeah. When we look at the smokeless category, first we start with our overall strategy which is to grow Copenhagen and Skoal combined at or greater than the overall category, so modest share growth in the category that’s growing. And if we do that and we continue to invest in those two brands, we should get income growth that exceeds the category growth of that segment and mix, you described mix, we describe it as looking at the consumer of those brands to the friends of the consumer.
So overtime whether it’s Skoal Xtra or Copenhagen Wintergreen versus Fine Cut or Skoal Classic. I am less concerned on what products they choose. I am more concern that we have products out there that they find appealing and more satisfying than competitive products, and if we do that then income should follow.
And I guess, the only thing I would add to that is, obviously margin enhancement proves, I think its strategy is on track for us. Maybe I’ll switch to another side of the room. Ann?
Ann Gurkin - Davenport
Thank you. I wanted to return to the e-cigarettes topic if I may. I wanted to know if you chair your in place on consumer trial and retention and conversion in that category, and what’s your thought are on that topic.
Ann Gurkin - Davenport
And then you highlighted activities you have planned around MarkTen, but can you elaborate a little bit on how to build awareness behind MarkTen and how to reach out to the consumer?
And then third when you launch in Indiana, how do you get on the shelf, like do you take something off or can you just comment on, where you place that product on the shelf?
Yeah. Let me take the first two and then I’ll ask Dave to comment on our distribution approach. There -- we’ve talked about this before I think there is obviously very high awareness of e-cigarettes. There is some considerable trial but conversion I think everybody agrees as well.
So that’s going to be a function of the products, technology evolving. We like very much for example our Four Draw technology, one of the insights that we have we believe is that the draw of the product is a significant contributor to the experience from sensorial point of view and we worked very hard on trying to get that draw to be closer to what someone is interested in such product might like.
So ultimately I think you’ve got have a superior product and then we'll go to work in the same way on our branding and our equity campaigns to try to communicate that to the brand the same way. But I think it's early there in in terms of people converting.
But that's our business, so we are in the business of trying to provide superior brand of products to adult tobacco consumers and so we want get in. And also I would tell you we’re the market leader.
We intend to act like a market leader and there are some things that need to be sorted out in the category. There is regulatory issues to be sorted out. There is excise tax issues to be sorted out. And we want to act like the market leader and be at the table as those issues are sorted out for the consumer. Dave, do you want to say word about the approach in Indiana to distribution?
Yeah. Well, I’ll first starts with AGDC, Altria Group Distribution Company and over the past four, five years, that group as had a great deal of experience and whether it selling in expanded space in the MST. It’s selling in the concept of resetting more of those fixtures from the Flavor Families concept, so they'll take the same approach.
They are in most those stores on a monthly basis, sometimes twice a month. And so each store depending on its set up or require probably something that's not completely unique but a little bit different than maybe some other store. So they know how to do that and they will be doing that over the next couple months as we speak.
Thank you. Judy?
Judy Hong - Goldman Sachs & Company, Inc.
Marty, you showed a chart that total tobacco volumes been declining about 2% and I think that was in pound term. I’m wondering if you think about it on the cigarette equivalent term if that number would be comparable. And as some of this other tobacco categories whether its smokeless growing at 5%, 6% to growth growing at 2% and now you’ve got e-cigarette category that’s exploded. Do you think that the underlying cigarette category decline is going to be worse going forward from 3% to 4%? And so just wanted to get that dynamic total tobacco consumption and than within and how do you think about cigarette consumption?
Yeah. Well, I mean, cigarette volumes have been going down now since 1982, right, and if you look at them overtime, they’ve been going down about 3% to 4% overtime. And so I think that’s the best measure if you will of what cigarette volumes have been doing. Of course, it’s not a prediction for the future.
But I think I mentioned during the first quarter that we didn’t see anything including e-cigarettes by the way that we thought was going to be a significant step change in terms of cigarette volumes.
What you do see in terms of total tobacco volumes as we explained, as you see people that are moving. They are moving within the tobacco space and so some people use our cigarettes, some cigars, some smokers, I suppose, if the e-vapor category turns out to be what something and maybe you’ll have that as well. But it’s really moving and then of course you have population growth underneath that for adults to participate in the category. So that’s how we think about it. We don’t see any big step function change in that at least as of now.
Judy Hong - Goldman Sachs & Company, Inc.
And then just then somewhat related to that, when you think about the total tobacco profit posing going forward, I think historically if that -- it’s about 4.5% in the last four or five years, how do you think about that profit growth algorithm in the context of the growth in some of these other category as well. And then just in terms of how you would replicate your margin structure, not just in e-cigarette but just broader categories. Obviously there are tax differences and MST differences but just kind of thinking about the underlying margin structures and how does that impact the overall Altria margins going forward?
Well, we start with trying to have strong operating companies, that have premium brands that can command premium prices in the marketplace and have strong margins. I think the best example is the smokeless business. So you see there the operating margins that Dave just showed us were about 60% there. And so that's always been our way we invest in premium brands. They have equity to command premium pricing and I point out that they both -- they've been able to do that by and large through some pretty difficult economic times.
For emerging categories like e-vapor products the margin structures are going to have to be first established before we can talk about margin enhancement. And I just think it's too early to speculate on what that would be. But I can tell you we’re interested obviously in having a good manufacturer’s margin on those and other innovative products of the kind we pointed out this morning. Did that help you? Okay. Let me just try to be fair about going over here maybe we love to dance.
Thanks. Two questions back on this cigarette side of business. I apologies I kind of fitted in and out over the past 15 years of tracking the company. But the slide that shows that the kind of main purpose for the smokeable products has a language of maximizing income, while maintaining modest share momentum to distinguish it from the kind of strategicals of the smokeless category and the other division.
And I just wanted to know question one, is that formulation, that phrasing, we all kind of try to pick up all these words very precisely. Is that new or at least from our standard relatively new in the last two, three years?
And the second question just related to that in fact is that as Marlboro goes from being a brand to a portfolio of brands to address the fax that many in the community feel that the demographic issues associated with and part of the responses has been making it into a portfolio of brands.
We see the outcome of that portfolio brands currently kind of color coordinated in descriptors. But how much more thoughts or how radical has the thought been in terms of making it into a portfolio. Would you consider even in effect moving forward with the colors and the descriptors that extent at that the word Marlboro begins to recede. It becomes synaptic direction. That is how -- what's the range of opportunity for taking mobile from a single brand to a wide range in portfolio of brands.
Okay. Thanks for your question. Maybe I’ll start with the first part with, Dave. I’ll ask you to handle second. That articulation actually has been relatively constant that you identify. We do want to maximize income in the smokeable segment. But as Dave pointed out in his remarks, Marlboro is the driver of that profitability by and large.
And so we want to be tentative to making sure that Marlboro continues to be a strong brand that can come in those premium prices and demand those margins. So that has been relatively constant for many years. I don't think I would want you to take way down if there's anything new there.
And if I could just follow-up that we still consider the brand Marlboro one rate brand not for that we have four flavor families or four product families, that have really allowed the brands teams at our agency to kind of explore a different communication vehicles. But if you look at the history there was a chart that showed the 60-year history of Marlboro and very soon I think within a decade, Marlboro Red, Marlboro Green, Marlboro Gold was in the second decade. So it reached within 20 years of the creation of Marlboro it already, okay, started to satisfy different consumer preferences through different products. We have basically over the last year and a half, basically more freedom to our brand people and the agency to think about those four distinct flavor families under the umbrella of what we think is one great brand Marlboro that would be our approach going forward.
Looks like we have time for perhaps one more before the break and we’ll have another Q&A, maybe Michael upfront, we’ll try this see how the clock goes.
Just looking at the brand equity score comparisons in the agency split that you gave, the Marlboro has the advantage versus the unnamed competitors there. But if the gap is not as big as the market share advantage that you have? Can you explain what some of the drivers are that keeps your market share above that the gap bigger there then just in the equity scores?
Yeah. I guess what I would say about all these metric is just to provide some context before we talk and Dave may want to talk about the TNS score in particular. But I think it's useful to remember that, the way we look at Marlboro’s strength is through a variety of metrics, right. We’re looking at its scale. It’s bigger than the next 10 brands combined. The next 10 brands combined.
We’re looking at its ability to command premium pricing, price gap hasn’t hardly moved including to the worst economic period we’ve been through in decades, right, at about 35%. We do look at the demographics. We do look at the brand equity scores. We have qualitative feedback from Marlboro smokers and adult competitive smokers.
So I know it's attempting to try to zoom in on one metric and try to extract, perhaps, more insight than it suggests, that’s how we look at it, that’s not the discount for question that you are asking which I understand is just that when we look at it, Michael, we look at it through a variety of lens just to make sure that Marlboro is headed in the direction it needs to continue to head in.
Do you want to say more about that Dave?
That’s basically and the both that the equity component, it’s actually made up of numerous, numerous questions, such as brand awareness. What do you think about the brand, quality, so it’s a lot of different components that then get ratioed up to one number. So, but I would second, I’m already had said, we look at that as but one feature of lot’s of different elements around the strength of the brand.
Okay. That’s helpful. And then lastly just one quick question on the e-cigarette rollout, do you have a timeline for an expected national launch?
No. I think we’re not going to make any announcements in that regard today. We’re pleased to be able to announce our significant step forward in Indiana and what we will do obviously is learn our way in, we'll talk to the consumer and find out how we're doing and if we have announcement more we’ll make it at that time.
So thanks for your question. Thank you all for your questions. There is plenty of time for Q&A. I promise we’ll be around, but I do want to keep us on schedule for the webcast purposes. So we’ll take a break now and we will be back at 10.30 sharp. Thank you.
Good morning, everyone, and welcome back. I’m Jim Dillard. I’m responsible for leading the Altria Regulatory Affairs Department and I’ve been with the Altria family of companies for four and a half years. Before joining Altria in the acquisition, I spent seven years at UST, where I was Senior Vice President of Manufacturing, Science and Technology.
Prior to joining the tobacco industry, I held various positions at the Food and Drug Administration for over 14 years, including Director of the Division of Cardiovascular and Respiratory Devices.
My current role allows me to combine my FDA and tobacco experience to help Altria address federal tobacco regulation for our businesses and their adult tobacco consumers. We have structured our Regulatory Affairs team into four key areas, regulatory advocacy and engagement, quality compliance, regulatory sciences and regulatory reporting.
In the broadest terms, we think of our regulatory work in two primary areas, compliance and engagement. Early on in the establishing of the regulatory affairs function for Altria, we developed core principles for interacting with the agency. Our aim is to be informative, science and evidence-based, balanced and constructive.
We also seek to provide strong support for our positions by drawing on our companies’ deep knowledge of tobacco product development, manufacturing, marketing and sales and distribution.
Finally, we advocate for accurate and non-misleading product communications to adult tobacco consumers. We believe we’re making progress in establishing a positive long-term relationship with FDA.
We want the agency to expect thorough and complete analysis from Altria and we hope to be in a position over time to increase our interactions and engagements with FDA on specific regulatory issues and the underlying science.
FDA regulation is a marathon not a sprint, so we are taking a long-term and methodical approach to the work that we do. For example, we have submitted over 70 papers to the agency covering a range of important issues, we participated in 30 meetings with FDA and presented multiple times at the Tobacco Products Scientific Advisory Committee.
We also make appropriate FDA submissions available on our website. In fact, we encourage you to visit altria.com, specifically the Federal Regulation of Tobacco section of the site. You’ll find these regulatory submissions there searchable by subject and by year.
Some of our tobacco operating companies also hosted FDA at their facilities to share information on how they manufacture tobacco products. Over the past four years, the principal focus for FDA and tobacco product manufacturers has been on implementing the statutory requirements of the Family Smoking Prevention and Tobacco Control Act.
In recent public comments, FDA has described its near-term priorities, emphasizing decisions on substantial equivalence, deeming of other tobacco products and of course, menthol.
While the timing of FDA action on these topics is unclear, these priorities are consistent with our expectation and with Marty’s remarks CAGNY in February. Given FDA’s stated focus on these priorities, let’s discuss each one of them briefly.
With respect to substantial equivalence, we’ve had on-going scientific engagement with FDA on our submissions. We have a dedicated team working to timely respond to all FDA information requests. We have regular on-going dialogue with the Office of Science as they review the substantial equivalence submissions. We expect FDA to make additional progress on this topic in 2013.
Regarding the deeming regulation, the Act authorizes FDA to issue regulations asserting jurisdiction over other tobacco products and FDA has stated that it intends to regulate cigars, e-cigarettes and other tobacco products.
While we expect FDA to issue proposed deeming regulation soon, it is important to consider these proposals in the context of the broader vetting process for proposed regulations like these.
As this organizational chart illustrates, we expect that deeming regulation will be reviewed by several parts of the agency. First, we’d expect draft regulations to be reviewed by multiple departments within the Center for Tobacco Products, including the Office of Science, the Office of Policy, the Office of Regulation and of course, by the CTP Director, Mr. Zeller.
Once the CTP’s reviews have been completed, we’d expect the proposed regulation to be reviewed at the agency level by FDA’s Office of the Chief Scientist and the Office of the Commissioner. And after that, we’d expect review by the Department of Health and Human Services and finally, the Office of Management and Budget. All of this and potentially more likely is happening on an issue as complicated as extending FDA regulatory authority to new classes of tobacco products.
Once published, we will carefully evaluate it, assess the potential business implications and share our perspective with FDA through the public comment process. In the meantime, we have been working very closely with John Middleton and Nu Mark preparing them for eventual regulation. Importantly, we expect that FDA will not issue a final regulation until after interested parties have had a chance to participate in the notice-and-comment rule-making process.
As Marty shared, Nu Mark is entering the e-vapor market and expanding its lead market for Verve discs. We have shared our perspective with FDA regarding appropriate regulation of these types of products and at the principle level, we believe FDA regulation of these products should be appropriate for the category, permit continued access for adult cigarette smokers interested in alternatives to smoking while limiting reach to unintended audiences, provide for accurate non-misleading product communications to adult tobacco consumers, encourage research and monitoring, establish product evaluation guidelines and good manufacturing practices that enable consistent product performance and reduce variability, and provide a reasonable transition period to comply with the regulations.
Let’s turn to Modified Risk Tobacco Products or as we called them MRTPs. As you may know, FDA issued draft guidance for MRTP applications in March of 2012. We have encouraged the agency to focus on harm reduction and acknowledge a continuum of risk. The law expressly recognizes the potential role that Modified Risk Tobacco Products may play in reducing the harm caused by tobacco use.
In recent comments, FDA has expressed interest in this topic, recognizing that different products may well present different risks to individual users. They also raised important questions related to population harm and the role that this will play in the agency’s analysis of any MRTP applications by the industry. FDA encourages the industry to submit MRTP applications.
We again have shared our perspectives and proposed principles on MRTPs with the agency. We continue to believe that Congress created the MRTP regulatory pathway so that FDA could have broad tools available to reduce tobacco-related harm.
FDA has the potential to significantly advance its mission of promoting and protecting public health by successfully implementing a regulatory framework for MRTPs and applications.
Let me briefly touch on menthol. As you may know, once the TPSAC completed its work on menthol two years ago, the CTP began to review the available science related to the impact of menthol in cigarettes on public health. It then submitted its independent review of the science to an external peer review. We submitted two substantial sets of comments on the available science and the impact of unintended consequences.
Our continued analysis of the science and evidence related to menthol affirms our perspective that menthol added to cigarettes does not increase the inherent risks of cigarette smoking.
Any future action taken by FDA to regulate the sale or distribution of menthol cigarettes or establish a tobacco product standard for menthol cigarettes will require rulemaking that includes public notice and the opportunity for public comment. FDA is also required to consider other issues, including illicit trade, contraband and counterfeit.
To sum up, Altria supported the enactment of federal legislation granting FDA regulatory authority over tobacco products. We believe that FDA regulation can play a significant role in reducing the harm caused by tobacco products. This is a goal that we share with the public health community and society, and we believe it is good for our company and the industry as a whole.
We have built significant regulatory capabilities to both comply with the Act and continue to engage and share science-based information with FDA and other key stakeholders about the regulatory issues important to our businesses.
Now, let me turn the podium over to Bruce Gates who will discuss External Affairs. Bruce?
Thank you, Jim. Good morning and thank you for the opportunity to speak with you today. As Jim mentioned, I’m Bruce Gates and my role at Altria Client Services is to lead our External Affairs efforts, which includes our Government Affairs and Corporate Affairs functions.
Among other things, we provide legislative advocacy and communications services to our operating companies and to Altria Group and we maintain a lobbying presence at the federal, state and local levels. We also work with Jim and his regulatory affairs team to support our engagement with the FDA.
An important component of Altria’s mission is to align with society by actively participating in resolving societal concerns relevant to our businesses. To support this goal, we seek input about our business practices from a broad range of stakeholders. Our engagement with them helps inform our business practices, assists in identifying emerging issues and improves our stakeholders’ understanding of our companies.
This engagement has informed our support of programs to help reduce underage tobacco use, our advocacy for reasonable regulation that can reduce the harm associated with our products and our support for legislation to help combat illegal trade in tobacco products.
There are times, however, when legislation or regulation is proposed that would have a negative impact on our business. In these instances, we advocate our positions by engaging responsibly with government officials, our business partners, consumers, employees and many other stakeholders.
I’d like to focus on one of these issues taxes to illustrate how we approach public policy issues. Tax increases, both excise and income present risks to our company and maintaining appropriate tax policy and rates is an important objective for our businesses.
Altria’s strong business performance in the face of recent economic and external challenges speaks in part to the value of our effective engagement in the legislative and political processes.
Today, tobacco taxes are high by almost any measure. When combined, the federal and state excise taxes on a pack of cigarettes amount to $2.43 on a weighted average basis. All in, payments to governments comprise about 55% of the price of a pack of cigarettes.
Not only are tobacco excise taxes high but they are regressive and unfairly burden tobacco consumers and when they are too high or increased dramatically, they can create significant financial incentives for criminals to engage in illicit activity that undermines tax revenues and hurts law-abiding businesses.
Tobacco consumers should not be asked to disproportionately bear the cost of large-scale government spending programs asserted to benefit many. As you know, the administration recently proposed a near doubling of the federal cigarette excise tax and a similar increase for other tobacco products, all to pay for a broad-based federal program. We oppose this increase and will closely monitor this issue.
High excise tax rates and large tax increases also encourage smuggling, contraband activity and counterfeiting. Ultimately, these activities deny the government revenue and deny income to the law-abiding members of the distribution chain.
The U.S. Alcohol and Tobacco Tax and Trade Bureau estimates that the federal revenue losses alone from illicit cigarette trade could be $5 billion annually. Some studies show that here in New York state where a pack of cigarettes may carry as much as $8 in taxes and fees, more than half of cigarettes consumed are brought in through illegal channels or from consumers buying their cigarettes out of state.
An important emerging issue is if or how to tax new forms of nicotine-containing products like those we have discussed this morning. We think that initially governments would be wise to avoid taxing products like these altogether until we’ve seen where the consumers ultimately land and to allow regulators fair opportunity to better understand how these products might fit into an effective harm reduction strategy.
From 2010 through 2012, we saw a relative moderation in the number of large increases in state excise taxes on tobacco products. Over that two-year period, the year-end weighted average state cigarette excise tax increased at a compounded annual rate of 2% as compared to 10% from 2004 to 2010.
Last year, we engaged in 16 states where increases were proposed, of those only two were successful. As of July 1st, the weighted average state excise tax will increase approximately $0.03 due to the $1.60 per pack increase in Minnesota.
The weighted average state excise tax as of that date will be about $1.45, $0.04 higher than at the end of 2012 based on increases enacted to date. We are opposing large increases proposed in several states where legislatures remain in session.
To conclude on excise taxes, when we think that government is over-reaching, we vigorously defend our consumers. A recent example was our participation with a broad coalition of tobacco companies, taxpayers, small businesses, law enforcement and labor that successfully opposed a tobacco tax increase that was on the ballot last year in California.
We also encourage our consumers to participate in the legislative process. Our companies launched Citizens for Tobacco Rights, a website that offers information, tools and resources to help them get involved in tobacco issues.
Now, I’d like to spend a few minutes on federal income taxes. As a high dividend-paying company, we understand the importance of maintaining a low federal personal income tax rate on dividends.
In 2002 and 2003, we advocated to lower the dividend tax rate and bring it into parity with the capital gains rate. Then again last year, as the lower rate was set to expire, we worked with a coalition of like-minded organizations in support of keeping the tax rate as low as possible.
Our engagement included advocating with policy makers and activating our employees, retirees and other shareholders to weigh in with Congress and the administration. We are pleased that Congress and the President agreed on a permanent change to the tax code maintaining a lower tax rate for dividends than on ordinary income and parity between the tax treatment of dividends and capital gains.
Finally, a word on corporate income tax. We believe that America’s corporate tax rates are too high, the code too complex and the entire system not competitive. For these reasons in 2011, we helped form the RATE coalition to Reform America’s Tax Equitably.
Now less than two years later, we are one of 30 members representing 30 million employees advocating for sound and equitable reforms to the tax code. It has been more than a quarter of a century since comprehensive tax reform was last enacted.
We were pleased that both presidential candidates advocated for lower corporate rates during the campaign and we will continue to actively engage with Congress on this important issue.
To close, our companies have developed a comprehensive approach to understanding and proactively addressing many of these risks. We have also built significant capabilities and expertise to responsibly advocate on issues of importance to our businesses and to our shareholders.
Thank you for your time. Murray will now take us through a litigation update.
Thanks Bruce. We have continued to achieve substantial success in managing the tobacco and health litigation, notwithstanding significant challenges. A comprehensive discussion of the tobacco-related litigation can be found in Altria’s 2013 first quarter Form 10-Q filing.
This morning I will touch on two categories of tobacco litigation, lights class actions and individual cases, including Engle progeny cases. Finally, I will briefly update the current status of non-participating manufacturer proceedings.
With respect to the lights class actions, the overwhelming majority of federal and state courts have refused to certify these cases. However, state courts in California, Missouri and Massachusetts have certified three lights cases.
In California, the Brown class action trial is currently underway before the state court without a jury. In Missouri, the Larsen case is scheduled to be retried in January 2014 and in Massachusetts the Aspinall case is active but does not have a trial date. Although outcomes of these cases remain uncertain, we believe we have substantial defenses in all of them.
Other lights cases are pending in federal and state courts, but courts in those cases have yet to decide whether these should be certified as class actions. In federal court, no lights case is currently certified as a class action and no class certification in federal court has ever withstood appeal.
In the Miles/Price case, the plaintiffs continue to try to reopen the judgment that dismissed their claims and reinstate the original verdict that was vacated by the Illinois Supreme Court. Most recently, plaintiffs’ petition was dismissed for the second time by the trial court and plaintiffs are appealing that dismissal.
With respect to individual cases outside of Florida, we continue to see a clear downward trend. In 2012, only two new individual personal injury cases were served on PM USA, while 10 such cases were dismissed. Since 2011, other than retrials or trials of derivative claims, PM USA tried four individual cases in New York, Massachusetts and Alaska winning all four.
Regarding the Engle progeny cases, events in 2012 and the first half of 2013 demonstrate that these are challenging cases but that PM USA is aggressively defending itself and has strong legal and factual challenges to these suits.
By way of background, the original Engle case was a class action brought by smokers in Florida that resulted in a punitive damages verdict against the industry in 2000. On appeal, the Florida Supreme Court vacated the punitive damages award and decertified the class.
At the same time, however, the court allowed class members to file individual suits by January 2008, in which they could use certain general jury findings regarding company conduct. Exactly how these findings could be used, however, has been and continues to be a critical legal issue of constitutional magnitude that cuts across all of these cases.
Although earlier this year the Florida Supreme Court in Douglas rejected our due process challenge, we will shortly be asking the U.S. Supreme Court to review the decision. The due process issue is also currently before the Eleventh Circuit Court of Appeals in two appeals brought by R.J. Reynolds Tobacco Company. We look forward to the Eleventh Circuit’s decision and the possible opportunity to present our arguments to the U.S. Supreme Court.
In the meantime, in the federal and state trial courts, we received defense wins in approximately half the Engle progeny cases tried to verdict. Furthermore, in the last year, state appellate courts reversed several compensatory and punitive damages awards on a variety of state law grounds.
PM USA will continue to defend these cases vigorously and appeal any loss, though it is possible that we will have to pay some judgments this year depending on if and when the U.S. Supreme Court accepts review.
We also have recently finished a trial in West Virginia in a unique case that was a consolidation of hundreds of individual personal injury actions filed against the major cigarette companies. After over 15 years of litigation, the jury rejected virtually all of plaintiffs’ claims, including for punitive damages.
The plaintiffs prevailed only on the narrow and unique claim that ventilated filter cigarettes between 1964 and July 1, 1969 should have included instructions, such as how to hold the cigarette without covering up the ventilation holes.
To the extent any plaintiff chooses to prosecute such a claim, he or she would have to prove a trial that the absence of such instructions somehow led to his or her injuries. Obviously, we would have substantial defenses in such a lawsuit.
To sum up, we have had success in managing litigation, although we continue to face significant challenges as we have for many years. Our goals remain to protect the interests of our shareholders by vigorously defending these claims.
Finally, let me bring you up to date on the status of the NPM adjustment. Pursuant to the settlement of the 2003 to 2012 NPM adjustment disputes with certain states, PM USA received a credit of $483 million against its April 2013 Master Settlement Agreement payment.
In late May, two additional states joined the settlement and as a result, PM USA expects to receive another $36 million credit against its MSA payment obligations. A number of states that have not joined the settlement have actions pending in their state courts to vacate or modify the stipulated award.
The arbitration with the states that did not join the settlement concluded in late May and we are awaiting the panel’s decision as to the 2003 diligent enforcement claims of those states. Proceedings to determine state diligent enforcement claims for 2004 and subsequent years have not yet been scheduled.
Now, I’ll turn the presentation over to Howard.
Thanks Murray. Good morning everyone. My remarks this morning will focus on our four strategies that we believe will generate strong returns for our shareholders for the long-term. Generating operating income growth from our businesses, focusing on controlling costs, maintaining a strong balance sheet, and delivering excellent cash returns to shareholders, primarily through dividends.
Let’s start in the smokeable products segment. PM USA and Middleton’s objective is to maximize income while maintaining modest share momentum on Marlboro and Black & Mild over time. And we have a track record of delivering against this objective.
From 2008 through 2012, the smokeable products segment grew revenues net of excise taxes per thousand units at a compounded annual rate of 5.5%, grew adjusted operating companies income at a compounded annual rate of 4.7% to $6.3 billion, and expanded adjusted operating companies income margins from 33.8% to 41.2%.
Pricing has been and will continue to be an important contributor to income growth in the smokeable products segment. From 2008 through 2012, the smokeable products segment led its principal competitors in revenue growth, excluding excise taxes on a per thousand basis. And, in the first quarter of 2013, the segment grew the same metric by 4.5%.
At the same time the PM USA and Middleton realized this net pricing. We have also been very mindful of managing costs as controllable costs per thousand were essentially flat over that same 2008 to 2012 period.
Our smokeable products segment has performed very well in a challenging environment and has consistently grown its income, which helped support our strong returns to shareholders over the last five years.
Let’s move to our smokeless products segment, where USSTC and PM USA’s goal is to increase income by growing volume at or ahead of the category growth rate while maintaining modest share momentum on Copenhagen and Skoal combined. From 2009, the year we acquired USSTC, through 2012, the smokeless products segment delivered excellent results against these objectives.
Copenhagen and Skoal grew their combined volume at a compounded annual rate of 7.6%, which is over two percentage points higher than the category. Copenhagen and Skoal’s combined retail share was up approximately three percentage points. USSTC and PM USA grew their adjusted operating companies’ income in the smokeless products segment at a compounded annual rate of 14.9%. And adjusted operating companies income margins were up 11.3 percentage points.
Turning to our premium wine business, Ste. Michelle grew its adjusted operating company’s income at a compounded annual rate of 12.5% from 2009 through 2012. Our operating companies generate a significant amount of cash. Their strong performance has helped grow our operating cash flow from continuing operations from $3.2 billion in 2008 to $3.9 billion in 2012.
Cost management is also an important part of the algorithm to deliver strong profit growth, particularly in the smokeable products business where cigarette volumes continue to decline. We have been very successful in reducing our costs over the past five years.
This cost reduction was as a result of the multiyear $1.5 billion cost reduction program that was finished in the third quarter of 2011. After completing that program, we launched another cost reduction initiative to achieve an additional $400 million in annualized cost savings versus previously planned spending by the end of 2013.
This program remains on track. Although this program ends this year, cost management remains an important part of our culture and our continuing efforts to grow shareholder value. Let’s briefly touch on capital expenditures. We currently project our future internal uses of cash to be relatively modest.
We anticipate capital expenditures across the Altria family of companies to be less than 2% of revenues net of excise taxes over the next several years. For this year, we anticipate capital expenditures will be in the range of $125 million to $150 million.
Altria’s strong balance sheet is the third element that helps sustain our ability to reward shareholders. A strong balance sheet secures the cash flow generated by our operating companies, protects Altria’s investment grade credit rating and supports Altria’s approximately 80% dividend payout ratio target.
Our investment grade credit rating is key to our capital structure because it allows us to competitively access the capital markets. It has allowed us to issue over $6 billion of senior notes over the past three years at attractive rates.
Altria’s credit rating provides us access to the commercial paper market to cover short-term cash needs, such as during months immediately preceding and following MSA, tax and dividend payments that occur each April. We also have a revolving credit facility of $3 billion that backstops our commercial paper borrowings.
In the third quarter of 2012, Altria completed a tender offer that repurchased high-coupon debt and replaced it with new lower cost debt. The key benefits of the refinancing included the ability to reduce our 2018 and 2019 debt maturity towers, lower future interest expense and reduce our weighted average coupon rate.
Last month, we issued $1 billion of senior notes in 10-year and 30-year maturities with a weighted average coupon rate of 3.96%. These and other actions decreased our weighted average coupon rate from 9.1% at the end of 2009 to 7.0% as of May 31, 2013.
From now through the end of the first quarter of 2014, we will have approximately $2 billion of debt coming due with associated annual interest payments of approximately $160 million. Our decision to refinance or retire this debt as it comes due depends on the conditions in the capital markets, interest rates, Altria’s business needs and other factors.
Our debt-to-EBITDA ratio of approximately 1.7 to 1 as of March 31, 2013 is well within our credit agreement debt covenants of not more than 3 to 1. In January of this year, Altria made a voluntary $350 million contribution to its pension plans, increasing our funding position to approximately 82% on a Projected Benefit Obligation basis.
Altria’s economic interest in SABMiller strengthens our balance sheet, provides income diversification and helps grow our EPS and dividend, while helping to sustain our investment grade credit rating. This position allows us to participate in the estimated $32 billion global beer profit pool, where SABMiller has an estimated 20% share.
The market value of Altria’s interest has increased nicely from $3.4 billion in July 2002 to nearly $21.8 billion as of May 31, 2013. The dividend income that Altria has received from our equity investment in SABMiller has grown from $112 million in 2003 to $402 million in 2012, a compounded annual growth rate of 15.3%.
This asset has a low tax basis of under $500 million. And any sale would be taxed at our corporate tax rate of approximately 35%. We regularly evaluate our economic interest in SABMiller and currently believe maintaining the investment is in the best interests of our shareholders.
Altria’s income growth, cost control and strong balance sheet enable us to return a large amount of cash to shareholders, primarily through dividends. Altria has a long history of dividend payments and dividend increases, having increased its dividend 46 times in the last 44 years. Future dividend payments remain subject to the discretion of Altria’s Board of Directors.
Since the spin-off of PMI in early 2008 through May 31, 2013, Altria has paid shareholders $15.3 billion in dividends and increased its dividend six times for a compounded annual growth rate of 8.7%. In August 2012, Altria increased its dividend by 7.3% to an annualized rate of $1.76 per share. A strong and growing dividend is an important part of why we believe that Altria is an attractive investment in any environment.
Finally, Altria also has repurchased stock when we have concluded that it is the best use of cash to maximize shareholder value. Since the PMI spin-off through March 31, 2013, Altria has repurchased approximately $3.7 billion of shares.
In 2012, Altria repurchased shares worth $1.1 billion and completed our $1.5 billion program in the first quarter of 2013. In April 2013, we announced a new $300 million share repurchase program that we expect to complete by the end of this year. The timing of share repurchases depends upon marketplace conditions and other factors.
To sum up, we are focused on strategies that have consistently delivered strong returns for shareholders. Together, these strategies allow us to maximize the value of our assets while positioning the company for long-term growth.
Altria has revised its guidance for 2013 full-year reported diluted EPS from a range of $2.49 to $2.55 to a range of $2.50 to $2.56 to reflect the impact of an additional $36 million credit to be applied against PM USA’s MSA obligations as a result of two more states joining the previously disclosed settlement of the NPM adjustment disputes for 2003 to 2012.
Altria reaffirms that it expects its 2013 full-year adjusted diluted EPS to increase by 6% to 9% to a range of $2.35 to $2.41 from an adjusted diluted base of $2.21 per share in 2012.
Thank you. And now I will turn it over to Marty for closing remarks.
Okay. Thanks Howard. And thank you all for listening this morning. Altria is a great company with diverse strengths. We have leading businesses driven by premium brands. We have broad capabilities that help us drive innovation and manage external challenges. And we have committed employees who work every day to successfully execute our strategies.
Altria’s strengths and the successful execution of its strategies have delivered excellent total returns to shareholders. From the end of 2007 to the end of 2012, Altria’s total shareholder return was 84.2%, outperforming the S&P 500’s total return for the same period of 8.6% and the S&P Food, Beverage and Tobacco Index’s return of 54.9%.
These strong returns have been driven by Altria’s consistent delivery of solid annual adjusted diluted EPS growth and its dividend. Altria’s goal is to grow its adjusted diluted EPS at an average annual rate of 7% to 9% over time.
From 2007 through 2012, Altria grew its adjusted diluted EPS at a compounded annual rate of 7.9% as compared with the S&P 500’s operating EPS growth of 3.2%, which excludes corporate and unusual items in a manner similar to our adjusted diluted EPS measure.
Our dividend payout ratio of approximately 80% of adjusted diluted EPS was the highest in the S&P’s Food, Beverage and Tobacco Index and was among the highest in the S&P 500 in 2012. Our dividend yield of 4.9% as of May 31 exceeds the 2.1% yield of both the S&P 500 and 10-year Treasuries.
We’re proud of this track record. And we believe that the strengths we outlined today position us to create shareholder value over the long term.
So I now invite Dave to rejoin us and we’ll be happy to take any additional questions. If you please direct your questions to me, I will try to get them to the right person and facilitate our conversation. Who would like to begin? We have one there, David, please. Okay, we’ll come back to you. Promise.
Hi. How are you? So I just want to ask Howard in relation to share repurchase. You have obviously very strong cash flow this year and you have some benefit from the NPM settlement, if you will, from a cash flow standpoint. $300 million for the remainder of the year would seem every easily accomplished for the company. What would keep you from buying stock more otherwise you could extend this -- for the Board approved more share repurchase through the year. But $300 million at this point seems quite low relative to your cash flow?
Yeah. I think as you pointed out we announced $300 million program. And I think we’re pleased with that right now. And we haven’t made any further decisions to increase that. I would point out that we have some debt coming due later this year in the first quarter of next year. And so we’re kind of balancing what our cash needs are going to be going forward.
David, let’s go back and pick up Eric’s question. Thank you.
Erik Bloomquist - Berenberg
Thanks. Erik Bloomquist, Berenberg. Two questions, one is with respect to the regulatory environment and the evolution of the Tobacco harm-reduction approach. I was wondering if you discuss what you see as the markers in development of that and what we can expect in terms of the adoption of that approach viable to regulators but also folks involved in tobacco control?
Maybe I’ll begin and then I’ll toss it over to Jim. I think at this most simple level. What one marker will be when manufacturers bring products to the FDA and seek their approval. And that's how we see it which is we’re in the business trying to develop products for adult tobacco consumer. So we’re working very hard in that regard.
And I think another marker is when the agency has those and what it does with respect to those applications when they have them. It’s a complex situation. It’s emerging. I mean we’ll see over time, but I remind everyone that in the United States, this is probably the only tobacco control regime that has expressly in its statute this notion of harm reduction and the idea that it could advance public health by reviewing products that are claimed with appropriate science and evidence to reduce harm from tobacco use. Jim, do you want to comment?
Yeah, I think I agree with everything you said Marty. The only other thing that I would add and maybe this is the marker that you’re looking for but I take it as a very positive effect that tobacco harm reduction continues to be elucidated in the published scientific literature. The agency continues to hold meetings some on the appropriate nature of who is going to do this type of work.
So the fact that we continue to make progress and it’s important center and it’s being discussed by the agency and very recently Mr. Zeller, the new Center Director, also mentioned that modified-risk tobacco products were on his agenda. So I think all of that is leading to a very positive outlook for that particular harm reduction agenda.
Do you have another question?
Erik Bloomquist - Berenberg
Yeah. Sorry, just a follow-up then. It struck me that the requirements around the population effect in evaluating MRTP is quite a robust hurdle. Could you comment on that and how you see the industry and Altria specifically able to satisfy that quite on this requirement?
Jim, why don’t you start. Maybe I’ll pitch in.
Sure. I think broadly about population effects, it is the newest part of the statute. Within the other regulated products industry it’s the safety and effectiveness standards. The population effect is the new part to the tobacco control standard. And I think we’re all working through what that means to us currently as we speak.
The agency has taken a shot at it in terms of putting forward modified-risk tobacco product guidance document. We’ve had an opportunity to comment on that guidance document. Those comments are on our website. I could see us depending on the next step of that particular guidance document what that might entail for us, we would provide subsequent comments.
But I think we're in that time where the industry and the agency are working very closely to try to figure out what exactly that population standard is going to mean. And what is the data requirements for satisfying those both within MRTP context as well as section 910 new product context as well.
I would just supplement that to say that another way of thinking about this perhaps would be that the agency would adopt an approach where they actually do test markets for lack of a better phrase. You could imagine that rather than getting sort of caught in this didactic of, you must know before we launch a product versus why don’t you let us launch a product and then surveil and make sure that there aren’t these negative population effects.
That one could imagine a scenario in which a market was chosen to roll out a product with a belief that it will be harm reducing that those population effects are control for. But with a robust surveillance program to find out whether that prove to be true as opposed to. For example, approving the product for national launch. So it’s another idea that's been kicked around. I'm sure that and other ideas will be discussed this week or following.
Okay. Maybe just a follow-on to that on next-generation products. Can you talk a little bit about your thoughts on that and potential opportunities. Do you continue to have the rights to platform one and partial rights I believe to platform two in terms of what Philip Morris is discussed. Is it something that you guys consider still an opportunity for you to introduce here in the States?
Well, I won’t comment on our internal plans about perhaps other products that maybe down the road beyond what we’ve spoken about today. But if I take the thrust of your question which is are we interested in a broad range of innovative products that we’re trying to develop that are satisfactory to adult tobacco consumers that may produce less harm you bet. We’re working really hard on that. We have folks at our Center for Research and Technology working on it very hard.
Okay. And then my second question is on the lines of innovation. As a company in the last couple of years, the innovation level has increased across all your different businesses, different products which is good. And I’d like to hear from you how you are balancing the increased levels in innovation and how you’re prioritizing these opportunities maybe Howard from you a little bit in terms of resources, cash. And then also making sure you balance that with maintaining focus on your core.
Yeah. I think that's an excellent question and I can tell you at the top level the way we talk about it internally and we have done quite a lot of work to make sure our organization understands this which is maximize the core and innovate to the future. Maximize the core and innovate to the future that’s how great companies do it. And we never take our eye off the ball about our core businesses which I think Dave did such a good job of laying out and Howard showed you the financial results from them.
So we understand that we are the stewards of those businesses. And we pay a great deal of attention to them every day to make sure that they won responsibly and that we’re returning returns to shareholders. At the same time, no business or industry remain static. And you have to be prepared to take wise bets forward in a financially disciplined way, in a responsible way so as to move to your future.
And I think that’s how our organization works on that and that’s a balance. The balance is the right word. I mean, we use a variety of techniques, allocation of resources, looking at potential scenarios. You heard Jim and Bruce talk about engaging with people who will be important drivers of how that world emerges but that’s how we think about it.
We have this terrific business. We continue to run it as best we can but we are trying to open up our minds, our product development, our brands, our regulatory affair, strategies to the possibilities of the new. And I think that’s what that balance is that we’re trying to strike. I mean so we’ll see. Maybe I’ll do ladies first David with Judy and I’ll come right to you.
Judy Hong - Goldman Sachs & Company, Inc.
So two questions, first, just on the cost savings. As you just come to the end of the program, the current program, how are you thinking about the future program? Is it going to be just really more of an ongoing productivity initiatives or are there any restructuring that you can talk about today just thinking about the big buckets of cost savings opportunity?
And then I guess just remind us in terms of how you are thinking about SABMiller because obviously every year we have, I think this discussion about what’s the right timing and what’s sort of the economic value that it brings to the table. So when you think about the criterion evaluating whether it’s right to keep the business, does the criteria change -- what are the criterias, number one and does that change as that part of your business gets too big or depending on your value of the SABMiller stake or what any other factors that go into that equation?
Okay. Good questions both. Just to keep things interesting on first, the order, Howard why don’t you talk about SABMiller and then Dave I’ll move to you on how we think about cost generally.
Sure. I think with regard to SABMiller, as you pointed out, we evaluate that every year. I would say there’s some common criteria but we’re also evaluating it fresh each year. And really we’re asking ourselves do we think that it’s going to provide greater value to shareholders in holding on to it or in doing something different. And we review that with management, we review that with our board. And I think we again this year have concluded that for now we continue to believe that holding on to that position continues to make sense from a shareholder value perspective.
Dave, you want to talk about cost?
Yes. From a cost side, let me step back for a second. The first two programs, the 1.5 and the 1.2, 1.5, 1.4 over the last five years. That was basically the result of external events happening and also combination of some internal events we spun of -- perhaps spun of PM moved the headquarters to Richmond and basically restructure our business model. So that basically addressed the first program.
The second program was basically a remnant that was left over after the doubling of the federal excise tax that took place in 2009 which had a one-time impact to the size of cigarette business. So it required us to think differently about our business.
Ongoing, we’re always looking to reduce costs especially in the cigarette business where volume, industry wide continues to come down. We like to stay ahead of that and even in our other businesses that are growing with the industry -- the industry volume is growing, what we’re trying to do there is change business processes to get efficiencies that will then retreat to margin improvement. So as we look at the future, it's basically re-examining our processes, how can we do things better that will result in margin expansion.
I’d just like to supplement that with one last thing which doesn’t get a lot of air time but it's worthy of mentioning which is the business model itself. When you look at AGDC which is our sales company or you look at Altria Client Services which deliver services of the sort that you heard about from the panelist up here right now. This is very efficient. This is very efficient.
So you move from having the Philip Morris USA sales force basically distributing cigarettes to now having the AGDC sales force which distributes all the products you saw this morning and is now at least in Indiana about to take on yet another one. So the model has really, really refined to that. They do an excellent job. And we’re also especially on the services side, we’re able to deploy those resources to where the growth opportunities are and it allows us to control our headcount and our cost in a pretty efficient way.
So I think if we add all that up that’s how we think about it. There may not be these big chunks anymore but everybody comes to work every day, thinking about how we can make the model form a little bit tighter to watch our cost. So let’s go to David now. Thank you.
David Adelman - Morgan Stanley & Co. Inc.
Thank you. Two questions Marty. First on MarkTen and e-cigarettes, I’m going to make the assumption you’re not going to advertise the product on television. And the follow up to that premise is do you think you’re putting yourself at a significant competitive disadvantage?
But we haven’t said today we gave a lot of information out about MarkTen today but you’re right to point out we didn’t layout the marketing campaign. And the reason is that’s been finalized now. So we know where we’re going and what the product is and the price and all.
Here’s how we’re thinking about that as we work through those issues. And I think Dave had a slide on this in his presentation. Our target audience is adult smokers and adult vapors. And we will have robust marketing campaigns, communication campaigns, product information campaigns so that they are aware of MarkTen.
At the same time, we do want to be mindful of taking steps not to extend our reach to audiences that are not the target of those effects. I think that over the several years that we've been doing this, David, we’ve demonstrated our ability to be quite successful without putting ourselves at any kind of a competitive disadvantage with that approach. And that approach is just fundamental to the way, we believe tobacco product should be marketed.
And I believe in the long run, it has emerged significantly to shareholders advantage to have us in the industry largely to be viewed that way. So stay tuned for more. I know it’s a matter of some acute interest about exactly how we’re going to do it. But the executions that I've seen so far leave me no doubt that we’ll be successful in reaching the people we want to reach with our communication platform.
David Adelman - Morgan Stanley & Co. Inc.
Thank you for that.
David Adelman - Morgan Stanley & Co. Inc.
And then secondly, I wanted to ask about cigarette pricing. Last year, particularly in the middle of the year there was a lot of concern in the investment community as your price realization moderated at PM USA. And the fourth quarter was better, it was even better in the first quarter. And I am curious, Marty, is that a function of the fact that volumes have been a bit weaker. So is it offsetting lever or is it more reflection of a variety of other dynamics?
I just think it flows from the fundamental strategy. We’re pursuing both Dave and Howard and I we’ve all spoken on this which is we’re trying to maximize income in this multiple segment and pricing is and continues to be an important part of that algorithm. To be sure, there are other elements. We talked about some of them cost management for sure, but pricing look the volumes go down, the Master Settlement Agreement payments go up. This is just the math of the dynamic. And so we have a desire to maximize our income and the cost increases are -- rather the price increases are a part of that. Dave, anything you want to add to that?
We look at it first and foremost maximize income, moderate should be minimum on Marlboro. And price is about one. It’s important the price is about one of those components. And we look at over the long term in one quarter in one year, one component might have a higher weight than the other but it’s actually looking at all five components of the value equation, over the long term to go about maximize income.
Who else has a question? I have a question over here Mike to your left?
Priya Ohri-Gupta Barclays Capital
Priya Ohri-Gupta from Barclays. Thank you for taking the question.
Priya Ohri-Gupta Barclays Capital
I was hoping that you could talk a little bit more about your philosophy around that issuance. How do you think about the tradeoff between refinancing versus paying down debt? And then how does that flow over to your share repurchase activity from a debt-funded basis? And then secondly, could you also just talk about further managing your interest expense line, do you have a targeted amount of maturities in any given year that you look to manage to and do you have an interest rate target?
Howard, it sounds like to you.
Sure. I think from with regard to kind of managing our debt, I don’t think this formulae as you may have laid out there. I think it starts with a commitment to our current investment grade credit rating. We think that’s served us well and I think we continue to reinforce that.
And then I think with regard to what we do when we have maturities or considering other actions, I think we tend to make those decisions in the moment based on, again this overall broad strategy. So you’ve seen us take some actions over the last couple of years and certainly with some maturities coming up we’ll be making some decisions in the back half of this year.
Are there questions? Nik?
Nik Modi - UBS
Yeah, the question is on since the TPSAC came out with its report on menthol, can you just share kind of your views on some of the incremental science that’s come out. And I guess this question is for Jim but -- kind of what your assessment is of that because I know there’ve been quite a bit of study that has been done since TPSAC?
Yeah, excellent question. We’ve actually been tracking it very closely and the science has emerged, has been either in line with I would say or even stronger supporting the conclusions that we and others put in front of the FDA on that question, would you agree Jim?
I would agree. The only other thing I would just mention is maybe a little bit on the process on menthol too. A lot has happened. I’ve gotten questions about is it odd that menthol seems to be going through this process at the FDA. And the FDA I think is taking a very measured approach to looking at the science. I think they have taken the TPSAC report, the industry reports as well as other information on menthol. And I think they are doing a full sum and thorough job of looking at all the data associated with menthol and it’s a large amount of information.
So I think that on top of our ability to review that data I agree with the conclusions that Marty came out with they are supported with the data that’s been going on and we also know there's additional data is likely to come from the government as we move into the future through studies like the past studies and some other NIH-funded studies as well.
Are there other questions? We have one in the front row, Mike?
Yeah. Two questions. With the Tju launch in Denmark that possibly is a more niche type of product, but if it did well, would you consider brining that here and the converse if you have something like success with MarkTen, is that something you would consider taking internationally?
And then second on PMCC, I know on the cash flow and financials does not split separately anymore but what kind of activities should we expect from that going forward? There was a good amount of sales last year, but what would that look like down the road?
Okay. Howard, do you want to start with PMCC and then I’ll pick up the innovator.
Sure. On PMCC, we’ve been unwinding that business for some time and I think what you should expect to continue is to see a decrease in contribution from PMCC over time. Although there will continue to be asset sales as we unwind that business.
I think the biggest element of that was we had a dispute with the IRS that has now been resolved and I think it should be a relatively smooth unwinding there and it’s gotten to be smaller and smaller part of our portfolio. So there shouldn't be a lot of surprises from PMCC going forward.
The answer on Tju which is of course part of a joint venture as I’ve described, it is if we met success there in that test market or in Denmark we certainly of course would want to leverage that success elsewhere, so we’ll see how that test turns out.
I think the same holds true for any new technology that we might deploy that we own the rights to which is if we could prove it out to adult cigarette smokers in the United States, and particularly if there were positive signals from the FDA on that you could imagine that would be of interest in other parts of the world and we will certainly look at that in that regard. Are there other questions? Yes, Vivien?
Vivien Azer - Citigroup
Hi. My question has to do with the Marlboro positioning. Dave in your comments you indicated that the strategy around reinforcing, excuse me, masculine any of the Marlboro brand and while smoking incidence in the U.S. is much higher for men than it is for women. There’re probably still 20 million female smokers in United States. So I’m curious with respect to Marlboro Black piece of it. Can you give us some color on how’s that skews male versus female versus the broader Marlboro portfolio?
Hi. Yes. When we look at the total brand, given its size in the marketplace, there is one can assume and it’s true that Marlboro not only the leading -- has the leading share among men has a leading share among women and when we look at the various flavor families. And Marlboro Black is the most recent introduction into the Marlboro family of flavors.
The jury is still out on the long-term view but the brand is actually or that flavor family is actually gathering up pretty good demographics both among men and women but at this point it’s skewing more male, but we look at things over the long-term. So that’s a great question not only today but it’s a great question really three to four to five years out, okay
Vivien Azer - Citigroup
And just a follow up on that from an age profile perspective, is Black and/or [NXT] skewing higher with 21 to 29?
The -- once again when we look at the demographics, we are -- look at Marlboro Black as adding to the overall share and it has a good strength among smokers 21 to 29 at this point but there again we’re looking three to four years out.
Go ahead. Okay, Mike.
Thank you. Once the FDA assess the FDA approval process should we expect to see more from I’d call breakthrough innovation in the U.S. cigarette market or is it going to be just more new flavor blends that kind of thing. Does the U.S. smoker care for products that are more innovative than just new brands?
Well, we maybe have two elements of your question. One is what do adult cigarette smokers in particular want which is a consumer preference and separate that out from the SE process itself with substantial equivalence process itself. I’ll ask Jim to comment on the insights that he has into substantial equivalence.
Just like we talk about innovation with respect to the new kinds of products, we continue to look at innovation in the core business of course and that means different packaging, it means different taste profiles, basically the way we think about it is we can look at the space for these products whether it’d be cigarettes, smokeless or cigars and if we can find a space, where there is an unmet need or is underserved or we’re under serving our franchise, we can bring products there to try to see if the consumer reacts to them.
What’s new these days of courses is that you have to take that process now to the FDA so that they can review it from substantial equivalence point of view. But, yes, we continue to look as hard as we ever did about innovating within the core business as we do with new. Jim with that maybe I’ll ask you to comment on that process.
Sure. I’ll talk a little bit about the process. I think we’ve heard from the center on a number of occasions that they believe they are making progress. They believe that they are going to be coming to some conclusions in the very near future. Mr. Zeller’s talked a number of times about that and our experience would be that it feels like that in fact is true.
There are a lot of interactions on substantial equivalence. I think they’ve heated up as well over the last two or three months. So at least from an internal perspective, we feel like progress has been made. I think Marty mentioned the CAGNY we expected there to be continual progress in 2013. And so I think from all indications both from what the center is talking about and what it feels like they seem to be making progress. So we’re encouraged by that.
I'm intrigued by your advocacy for the corporate tax reform and what motivated and what has been your appraisal of your effectiveness on that going forward to that platform both on corporate income tax rates and also the tax rate on dividends?
Okay. Good question. Howard maybe you should start with the corporate tax rate that we pay and Bruce can talk about and he can self-assess himself about how well he is doing.
Sure. I think I’ll let Bruce talk more broadly about corporate tax rates in the U.S. compared to internationally, but I think there are competitiveness issues. But the other issue in the U.S. is that corporations pay a pretty broad range of different tax rates. We tend to be at the higher end of that range at about 35% and so as we look at corporate tax reforms, we think there is an opportunity to make companies in the U.S. more competitive and we also think there is an opportunity for us to reduce our tax rate with a lot of the different types of reforms that are being considered.
Yeah. I would add that we recently became distinguished as the highest corporate tax rate in the OECD countries. So there is a serious competitiveness issue that’s recognized by unfortunately by members of both parties, leaders in both parties, both Chairman of the relevant tax writing committees and Congress have recognized the need for corporate reform. The trick is getting done. As I mentioned in my remarks, it was obviously helpful that both presidential candidates put a stake in the ground on corporate reform and getting there in a reasonable timeframe will be threat.
Are there other questions? Okay. I just want to say one last time. We really appreciate all of you taking the time to be with us today whether you are here in the room or those on web. Thank you again for your interest in Altria Group and for those of you who are here, the reward is lunch which is in the next room. We are adjourned.
- Consumer Discretionary