Morning, everyone, and thank you for joining us in Richmond or on
the webcast. For those of
you I have not met, I'm Bill Marshall, Vice President of Investor Relations. We have a great day planned for you, which we've already started with our brand experience. In a moment, you'll hear from our leaders who will discuss both today's success and our vision for the future of our company. For those of you joining us in person, you'll continue to have the chance to meet and speak with many of our talented employees and see some of our state of the art operations. A number of our executives are joining us here today.
This is a snapshot of those who are speaking or representing our brands. We'll begin with prepared remarks, but we are planning to break for several Q and A sessions throughout the day. So you will have plenty of opportunities to ask any questions you may have. Many of you are familiar with our story. Today, we want you to truly experience Altria and get a glimpse of how we operate every single day.
But before we start, we have a few of the usual reminders. Our remarks today contain certain forward looking statements and reference non GAAP financial measures. Please direct your attention to the forward looking cautionary statements 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 and on the Altria Investor app. Future dividend payments and share repurchases remain subject to the discretion of Altria's Board of Directors.
The timing of share repurchases depends on marketplace conditions and other factors. With that, it's my pleasure to turn it over to Marty Barrington.
Welcome everybody to Altria's 2017 Investor Day. We are absolutely thrilled to have you at our manufacturing center in Richmond and to showcase some of the extraordinary capability that has driven Altria to decades of market leadership and that we believe will continue to drive our leadership for decades to come. I also want to welcome all of those who are listening by the webcast. My role as we begin is to provide you with a framework for the conversation we're going to have with the talented members of our team. My principal focus will be on how Altria's companies, which have led the U.
S. Tobacco industry on the combustible side of the business for decades, simultaneously have been preparing to win in the emerging opportunity to provide adult tobacco consumers with non combustible nicotine containing products that are authorized by the U. S. Food and Drug Administration. We strongly believe that businesses that are great over the long term like ours both maximize today's business while preparing for tomorrow's and Altria has been doing just that.
We're all familiar with how Altria's companies have been the undisputed market leaders in the U. S. Tobacco industry for decades. So we won't dwell on what you already know that we have the best products and brands including Marlboro and Copenhagen, that these brands enjoy the highest equity in their categories, that Marlboro at more than 43 retail share points is by far the largest and the most profitable brand in the cigarette category for over 40 years and that Marlboro is the share leader in all 50 states. Or that Copenhagen at nearly 34 retail share points is the largest brand in the moist smokeless tobacco category and that Copenhagen combined with Skol gives USSTC more than 50% retail share of the category or that our manufacturing capability is state of the art as you'll see for yourself today.
For our sales capability, our sales organization, Altria Group Distribution Company, covers more than 240,000 retail locations in America, ensuring that our tobacco companies brands are well presented merchandised to adult tobacco consumers in a compelling and responsible way and that our trade programs align our important trade partners with our commercial objectives. AGDC's efforts result in broad distribution of our tobacco companies offerings in the marketplace with extraordinary speed and quality of execution. For example, when USSTC launched Copenhagen Mint, AGDC achieved 90% distribution of the product by week 3. And AGDC can distribute a pack of cigarettes anywhere in the United States for less than a third of the cost of a postage stamp. According to our 2016 annual survey of retail customers, AGDC's sales force was recognized for the 3rd year in a row as best in class within the industry.
Its overall satisfaction score of 89% was significantly higher than the other leading tobacco manufacturers. It's also undisputed that Altria has combined all of these advantages to build the most profitable U. S. Tobacco business. In 2016, the smokeable product segment contributed $8,000,000,000 in adjusted operating company's income with adjusted OCI margins of more than 48%.
The segment now has further growth potential with the inclusion of Nat Sherman, which Altria acquired in January of 2017. The Smokeless Products segment contributed $1,200,000,000 in adjusted OCI with adjusted OCI margins of more than 64%. These businesses plus the substantial combined income from our wine and beer assets have propelled Altria to the U. S. Tobacco industry's leading financial metrics.
And I know that all of you will remember what this has meant for shareholders. From 2,007 to 2016, we increased our adjusted earnings per share from $1.51 to $3.03 compounded annual growth rate of 8%. Over the same period, we increased our dividend from 1 point $1.6 to $2.44 a compounded annual growth rate of 8.6 percent and in August, we increased our dividend by an additional 8.2 percent to $2.64 From 2011 through 2016, we returned more than $28,000,000,000 in cash to shareholders in the form of dividends and share repurchases. For reference, dollars 28,000,000,000 is larger than the market caps of each of Kellogg, Doctor Pepper Snapple and Clorox. In 5 of those 6 years, Altria's annual total shareholder return was more than 20%.
So that's been our success in our core businesses. What's equally important though to understand is how Altria has at the same time been preparing to win on a new axis of competition, innovative reduced risk products. So let's turn to that. We began this journey more than 15 years ago when we made the bold decision to pursue federal legislation to grant the FDA jurisdiction over tobacco. It was legislation that was required to establish the possibility of bringing innovative reduced risk products to market.
Today, we have a national framework that sets the rules and provides the means to pursue innovative reduced risk products, it's the Tobacco Control Act. But that wasn't always so and some seem to have forgotten how we got here. It was because of Altria's leadership and only Altria alone in the industry. Why? Because we wanted to bring innovative reduced risk products to adult smokers that were less harmful than conventional combustible cigarettes.
We believe that consumers were entitled to receive accurate and scientifically grounded communications about them, including communications about their lower risk relative to cigarette smoking. And we understood that the only way that could ever happen was through comprehensive federal legislation. Many criticized us for leading on this issue, but we stayed the course. Other tobacco companies lobbied and fought against us long and hard And it took nearly a decade of investment and hard work by us along with others who supported this approach. But it finally happened in 2,009 when the act became law and with the act came the first key element to support the pursuit of innovative reduced risk products that was the legal and the regulatory structure.
The act isn't perfect, of course, comprehensive federal legislation rarely is. Its benefits come with some challenges, like the authority to issue product standards, including for nicotine and the substantial equivalence process and we'll be discussing our views on both these topics later. But in short, of course, Altria is ready for the introduction of innovative reduced risk products. After all, we helped make it possible. 2nd, to win in this new environment, we immediately set out to acquire top talent for best in class regulatory and product development capability.
We established a highly capable regulatory affairs group led by Jim Dillard, a former FDA leader with nearly 15 years of experience with the agency and deep tobacco experience. His team working with research and development, the law department and our operating companies has led us through the transition and more than 8 years of FDA regulation. More recently, we've expanded Murray Garnock's responsibilities beyond his General Counsel role to include regulatory affairs, while Jim focuses even more on product development and regulatory science. This year, we're celebrating the 10th anniversary of our $350,000,000 Center For Research and Technology. It's just miles from here up 95.
We built it to house our team of more than 400 scientists, physicians, product developers, engineers, regulatory experts and others who are developing innovative products, pursuing their regulatory authorization and constructively engaging with the FDA on policy. It also contains our consumer opinion center where our teams interact with adult tobacco consumers for real time feedback to inform product development. We continue to supplement this team with numerous experts, including experts with FDA experience to advance our harm reduction goals and Jim is going to speak to all this in a bit. We firmly believe that Altria has assembled the best talent, skills and capability in the industry, equip them with the resources they need and set them in the right direction to introduce new FDA authorized reduced risk products as the next leg of our commercial success. So we'll be clear, we aspire to be the U.
S. Leader in authorized non combustible reduced risk products. 3rd, Altria has relentlessly and effectively advocated for tobacco regulatory policy that recognizes the continuum of risk that promotes innovative products for consumers and that permits manufacturers to communicate truthful information to consumers about these products. As we've already discussed, we've been advocating this since before the act was passed. And while it's now well understood by policymakers that nicotine itself is not the problem, but rather its delivery by combustion, This was not always so.
It required science and evidence based proof, highly effective argumentation and much engagement to win the day. And that is exactly what our deep, experienced and talented external and government affairs, regulatory and law teams have been doing. For example, as early as 2,009, we provided the FDA with a comprehensive science and evidence based analysis advocating that the FDA regulate tobacco products based on the continuum of risk. And since that time, we've engaged extensively with the agency and others through scientific and public health conferences such as the Food and Drug Law Institute Annual Conference and the ENDS Conference to advance our views and to encourage others to support this approach. We thus were very gratified and not surprised in the least to hear the FDA announce in July that this is now official policy.
4th, Altria's companies have been steadily building compelling platforms of non combustible nicotine containing products with the potential for reduced harm. It's a portfolio approach and portfolio is an important word. Not all consumers want the same experience and that's certainly true in the tobacco category. So it's important to provide them with product choice. It's also true that too many initiatives can dilute focus.
So we have been concentrating on 3 platforms within our innovative products portfolio, which are the 3 that presently hold the most promise for U. S. Adult tobacco consumers and you see them here on this slide, smokeless tobacco and oral nicotine containing products, e vapor and heated tobacco. The first platform is in fact the largest and most profitable non combustible tobacco product in the world, smokeless products. We acquired USSTC in 2,009 in significant part because we saw cigarette smokers moving to that product and that's a trend that has continued.
Indeed, about 6,000,000 US adults now use smokeless tobacco, many of them former cigarette smokers. From a scientific perspective, based on decades of epidemiology, it is now accepted by most public health researchers that smokeless tobacco, while not safe, is a far less risky way to use nicotine than cigarette smoking. There's no combustion. We have been preparing our application to the FDA for a modified risk tobacco product designation for Copenhagen snuff and we're pleased to announce this morning that we expect to file that application during the Q1 of 2018. And Brian Quigley is going to explain more about this in a bit.
This platform also includes other oral tobacco and nicotine products, including snus and our Verve Discs and Chews. We intend to file a pre market tobacco application for Verve Discs and Chews by the end of 2018. It is also important to remember that smokeless products business is highly commercially successful as we reverse the very significant downward decline in market share its leading premium brands were experiencing before we acquired them. We've already discussed USSTC's profitability more than $1,000,000,000 and its margins, so we won't repeat that. Clearly, USSTC's tremendous success in smokeless products is a testament to our ability to build profitable businesses other than combustible cigarettes and to grow brands other than Marlboro.
Our second non combustible platform is e vapor. Since its start only in 2013, Newmark has built a leading e vapor business in the U. S, principally with the Mark 10 brand. There are about 27,000,000 vapers in the world and about 10,000,000 of them are American consumers. In fact, the U.
S. Is the largest e vapor market in the world. Many of these vapers are former cigarette smokers. The category is benefiting from improved technology that is providing these adult tobacco consumers with the enhanced flavor, convenience and satisfaction they seek. Vapor is another non combustible nicotine containing product that does not produce many of the dangerous compounds that combustible cigarettes do.
In the UK, the Royal College of Physicians is encouraging UK smokers to migrate to e vapor, estimating that e vapor products are likely 95% less harmful to health than smoking conventional combustible cigarettes and many other public health authorities agree. So our evapor platform provides another choice for cigarette smokers seeking an alternative nicotine experience. Mark 10 now is available in about 65,000 retail locations and has a substantial online business. It has a national share of 13.5% in mainstream channels, In major chain accounts where it's been selling for the full Q3, it's even higher at 27%. We have been preparing PMTA and MRTP applications to submit to the FDA for MARC 10.
We expect to file PMTAs by the end of 2018 with MRTP applications to follow. We're also developing other e vapor products based on evolving technology and consumer insights to enhance Newmark's portfolio, which Jody Begley is going to describe to us. All of this is being done with the aim to secure FDA approval of these products with claims where appropriate. The 3rd non combustible platform is of course heated tobacco. Through our agreements with Philip Morris International, we have the exclusive right to commercialize the IQOS platform and heat sticks in the United States once authorized by the FDA.
And our dedicated team has been working on our commercialization plans. I know that all of you are familiar with the technology and the encouraging results that PMI has had in international markets, so we won't review that now. But it's important to understand that IQOS and HeatSticks represent an important step forward in the technology of nicotine containing products with the potential for less risk and we're very excited to have that platform in our innovative products portfolio. IQOS is a unique product protected by intellectual property and will provide significant first mover advantage to Altria with the world's leading heated tobacco product. We'll work hard to maximize the number of U.
S. Adult smokers who convert to IQOS and Sarah Nachmus will provide more detail about our exciting plans for IQOS shortly. So I'll close this section by briefly mentioning 2 other long term efforts that we've had underway. The first is that we've been continuously preparing our organization by streamlining and simplifying, by relentlessly pursuing better diversity and inclusion and by encouraging and embracing innovation. Together, this program of cultural adaptation, we call it Unleash Our Potential, has prepared our very talented employees to be ready for the next wave of our competition and success.
You'll see and hear more about that today as you walk our halls and talk with our people. And finally, there's our enormous financial engine. We have maximized our core business that provides us with, among other things, significant free cash flow, an average of more than $4,500,000,000 per year for the past 3 years. We also have a strong balance sheet, which we've improved so as to be able to make the necessary investments for this next chapter of our success. Winning long term in this dynamic may be appropriate.
With the free cash flow we generate and a strong balance sheet, we have plenty of both firepower and flexibility to maintain our dividend payout ratio target of approximately 80% of adjusted diluted EPS and to make the necessary investments. We've been investing for years and now with the FDA's new direction on innovative products, we're prepared to make any further investments we need to win. So back to our framework. Altria remains the undisputed leader in the U. S.
Tobacco industry with the best products, brands, manufacturing, sales capability and strongest financial performance. Our decades of thought leadership and compelling advocacy to promote harm reduction has created both the enabling legislation and the regulatory policy that now accepts harm reduction and innovation as the way forward for adult tobacco consumers. Anticipating that environment, we have been building a portfolio of the leading platforms of non combustible nicotine containing products for adult tobacco consumers as well as preparing the scientific case for obtaining regulatory authorizations for them. Indeed, we believe the breadth and quality and focus of our non combustible product portfolio is second to none. We have been adapting our organization to win in this dynamic environment.
Our structures are more streamlined and more consumer facing than ever before. Our people are highly capable, embrace the new opportunity and we're eager to continue our winning ways. And we have an extraordinary financial engine to support all these efforts. So with all that, it should be apparent that we applaud the policy change toward innovation and harm reduction that the FDA announced in July. In fact, we believe the FDA has articulated a compelling vision for the future of innovative products.
We welcome that future and embrace the challenge. And because we have been preparing for it for years, we are ready to compete and to win and to sustain the leadership that we cherish, but have never once taken for granted. Thanks for your attention. I'm going to turn it over to Howard.
Thanks, Marty, and good morning, everyone. To build on Marty's remarks, we believe we are at an important moment of change and opportunity for the industry and for our business. Let's spend a few minutes framing that. According to data from FDA's PATH study, over half of adult smokers would consider using a tobacco product if it had a reduced harm claim. This equates to about 22,000,000 adult smokers who are interested in less harmful tobacco products.
Successfully converting a significant portion of these adult smokers to our company's non combustible products represents a significant opportunity for both harm reduction and our business. For years, adult smokers have been trying alternatives to cigarettes, looking for products that provide a similar sensory experience and nicotine satisfaction, but with fewer social frictions and potentially less harm. Our research shows that over the past 10 years, the percentage of adult tobacco consumers who exclusively use cigarettes has declined, while exclusive use of non combustible products has nearly tripled. Still the vast majority, nearly 3 quarters solely use combustible tobacco products. This is true despite many trying alternative products.
So while some adult smokers have completely converted to non combustible products over time, others have either returned to cigarettes or continue to use both. We believe this is in part because the existing products don't fully satisfy their expectations. We also think it's due to confusion about the health risks associated with various tobacco products. For example, according to the PATH study, 88% of adult tobacco consumers believe smokeless tobacco is as or more harmful than combustible cigarettes. And 45% of adult tobacco consumers believe e vapor is as harmful or more harmful than combustible cigarettes.
And according to our research, the percentage of adult smokers who believe e vapor is as or more harmful than combustible cigarettes has nearly doubled in the past 4 years. This is a major barrier to harm reduction. We believe that a large number of adult smokers are ready to embrace non combustible products, particularly if equipped with accurate, science based information about their risk. As today's products improve, tomorrow's products become available and the FDA authorizes manufacturers to communicate accurate risk information, adult smoker conversion will surely accelerate. This will be a win for adult tobacco consumers, for public health and for our long term commercial success.
In the FDA's July 28th announcement, the agency acknowledged the continuum of risk for tobacco products and distinguished between the harm associated with combustible versus non combustible products. We are encouraged by this and by its stated goal to encourage innovative and less harmful and satisfying non combustible products for adults who need or want nicotine. As Marty said, we aspire to be the U. S. Leader in authorized non combustible reduced risk products.
We aim to achieve this goal by offering adult tobacco consumers a portfolio of the leading non combustible products and brands that deliver on 3 important expectations superior sensory experiences and nicotine satisfaction, reduced health risks and accurate risk information, and the avoidance of social frictions associated with combustible cigarettes, such as smoke odor, ash and social isolation.
We'll discuss our progress on each
of our 3 platforms shortly. Of course, we can only compete in the marketplace with products authorized by the FDA, and we can only communicate reduced harm claims if the FDA permits it. We've been doing a substantial amount of work to prepare numerous regulatory applications for submission. This slide depicts our 5 year regulatory filing plan. We'll discuss several of these submissions in greater detail this morning, but we wanted to first give you a sense of the breadth of our efforts.
Of course, much can change over 5 years, so we may modify this plan as appropriate along the way. Our significant investments in regulatory science have laid the groundwork for these submissions and much of the foundational research is already underway. For more on our regulatory science, I'll turn it over to Jim.
Thank you, Howard, and good morning. In order to deliver the PMTA and MRTP applications Howard just discussed, we need substantial scientific support for each of these products. Our framework for tobacco harm reduction guides the science our talented team is generating each day to meet the FDA standards. As you can see, we start with the product itself to assess any reduction of harmful or potentially harmful constituents. We conduct numerous toxicology and clinical studies to assess an individual adult tobacco consumer's actual exposure and health risk.
And we conduct both primary studies and secondary research and data analysis to assess and model potential population impact over time. We've been building this science base and publishing for years. And so far this year, we've conducted over a dozen clinical studies, hundreds of thousands of analytical tests and many consumer perception and behavior surveys, all aimed at demonstrating with rigor the evidence needed for future marketing authorizations by the FDA. This work is made possible by our world class research, development and regulatory affairs organizations, which comprise over 400 employees dedicated to product research and regulatory sciences. We have the top talent that we need.
We've recruited from around the world and they include nearly 195 PhDs, approximately 75 engineers across multiple needed disciplines. They represent 16 different countries and speak 32 different languages, all working together under one roof and laser focused on advancing Altria's harm reduction aspiration. Over the past 10 years, these employees received over 6 60 patents and have published nearly 225 publications. Much of this work, as you heard from Marty and Howard, occurs at our 450,000 Square Foot Center For Research and Technology or as we call it, CRT. We designed the CRT for functionality, collaboration and flexibility to meet evolving needs.
The end result is truly a world class facility. It has nearly 150,000 square feet of purpose designed lab space and the leading equipment which enables us to design new products from start to finish. From biotechnology capabilities within the tobacco seed to on-site prototype testing with adult tobacco consumers and our consumer opinion center, all supported with state of the art tools and instrumentation. And the CRT is located within the Virginia Biotechnology Research Park. It's a community of nearly 70 private companies, nonprofits and research institutes focused on life sciences and innovation.
This provides our employees ready access to a wealth of external experts and So before So before I turn it over to Brian Quigley to discuss the Smokeless Products segment, let's take a glimpse inside the CRT and hear directly from some of these employees.
Well, I've been here almost for 15 years now. And Altria was always committed and we're going to have reduction. But I think now we came to the tipping point.
For years, this company has advocated for the Food and Drug Administration to regulate tobacco products along a continuum of risk. So one of the best pieces of news from the July announcement from FDA was its official acknowledgment really for the first time of a continuum of risk and the need to regulate along that continuum of risk, recognizing differences between tobacco products.
And so now we have the right framework to really move harm reduced products forward for approval and truthful and accurate communication to consumers.
This is truly an exciting period for us as a company and as an industry. There are close to 40,000,000 adult smokers and they're looking for options.
We have approached this challenge right at the root. In other words, we're looking at the tobacco plant and how can we modify the plant.
With some of the molecular techniques, we can actually look in and molecularly see what the farmer has been looking at for 200 years.
When we think of the opportunities we have for the types of products we can develop, this is exciting. Product innovation is our future and we have developed a top notch team of regulatory affairs and regulatory engagement people to make sure that we're ready for our future.
I forget sometimes exactly the caliber of the people that I work with on a day to day basis because it is an incredibly talented organization. It's really a range of folks who each bring to the table something very different.
Scientists and engineers from all over the world who are extremely enthusiastic and passionate about what they're doing. It's like a symphony. It's like a big symphony.
For the first time, you have all three key ideas coming together. The idea of having the right consumer insights, the idea of having the product technologies and the science that we need, and then finally to have a good working regulatory framework.
I know the company is committed to it because if we can reduce harm, it really makes a difference for society.
Just the mere fact that harm reduction now is recognized, is just an incredible opportunity for us. And that future we think ought to belong to us.
For those of you I haven't yet met, I'm Brian Quigley. And for the past 5 years, I've had the privilege of leading U. S. Smokeless Tobacco Company. I've been with Altria since 2003 and have held various leadership roles at USSTC and PM USA, including brand management and business development and planning.
I'm happy to be with you today to discuss our smokeless tobacco products business. USSTC is the world's largest and most profitable non combustible tobacco business. It's a great example of how we've translated our deep knowledge of adult tobacco consumers and our brand building expertise into market success in a category outside of cigarettes. Altria acquired the smokeless business in 2,009 for several reasons. First, it was and continues to be a growing and highly profitable business, helping Altria meet its earnings growth goals and diversifies business.
2nd, we observed some adult smokers migrating to the category seeking alternatives to cigarettes. And third, we believe smokeless tobacco products would play an important role in harm reduction, so we wanted to lead the category. At the time of the acquisition, USSTC had the leading smokeless tobacco brands in the U. S, but was losing an average of 2 share points per year. Copenhagen's retail share was about 22% and declining.
However, its equity was strong and we saw revitalize the brand. Over the past 8 years, we have strengthened Copenhagen, expanded its product portfolio to include wintergreen and mint, enhanced its appeal among competitive adult dippers, improved its demographic profile and fine tuned its pricing strategy. It's now the largest smokeless brand with the highest brand equity in the category and nearly 34% retail share in the Q3 of 2017. Today, one of every 2 smokeless tobacco consumers chooses a USSTC brand. We continue to make focused investments to strategically grow our brands and maximize our income growth.
From 2009 through 2016, we about doubled adjusted operating company's income to $1,200,000,000 And through the Q3 of this year, we achieved year to date adjusted OCI margins of nearly 68%. We achieved this income growth through an efficient use of our promotional resources as we adapted and deployed revenue growth management or RGM. This approach allows us to tap our deep understanding of adult tobacco consumer purchase behavior and use advanced analytics to help us compete more effectively. Through USSTC, Altria has demonstrated the ability to successfully enter a new category and evolve our business to meet changing adult tobacco consumer expectations. USSTC is a strong core operating business and a platform to lead in harm reduction.
To that end, our goal is to be the leading oral tobacco and oral nicotine products company with products that appeal to a diverse set of adult tobacco consumers and have the potential to reduce harm. As Marty previously announced, USSTC will take an important step towards our harm reduction aspiration with our plans to file with the FDA an MRTP application for Copenhagen snuff in the Q1 of 2018. We believe USSTC is uniquely positioned to achieve this claim because we have been conducting the most comprehensive assessment of the health effects of smokeless tobacco in almost 30 years. This assessment using decades of epidemiology clearly shows that smokeless tobacco products are less risky than combustible cigarettes. Let's walk through a few highlights from the substantial scientific evidence that will support our MRTP application.
The data we're going to share are based on our analysis of 2 large independent nationally representative datasets from the federal government. These datasets are widely used by health researchers including the FDA. Copenhagen snuff is well represented in these studies providing a solid scientific foundation for MRTP application. This chart illustrates our combined analysis of those 2 government datasets. It overwhelmingly demonstrates based on decades of U.
S. Epidemiology that smokeless tobacco use is less risky than smoking conventional cigarettes. Let me quickly orient you to the slide before I walk through the findings. The gray bar represents the mortality risk associated with cigarette smoking indexed to 100%, while 0% represents the mortality risk of a non tobacco consumer. The small yellow bar represents the relative mortality risk associated with smokeload tobacco use.
You can see that when looking at all causes of mortality, smokeless tobacco use is at least 96% less risky than cigarette smoking. Drilling down to specific groups of diseases, these data show that smokeless tobacco consumers have significantly lower mortality risks for chronic lower respiratory disease, heart disease, lung cancer and digestive cancers. And contrary to popular belief, even oral cancer risk is substantially lower for smokeless tobacco consumers than for cigarette smokers. This robust scientific evidence is just one aspect of our MRTP application. While millions of adult smokers also use MST, many misunderstand the risks associated with smokeless tobacco use versus cigarettes.
We've conducted substantial research to demonstrate the modified risk claim we're seeking is supported by science and understood by adult tobacco consumers. We believe that providing this accurate information to adult smokers would encourage many of them to fully replace cigarette smoking with Copenhagen snuff with minimal unintended consequences among non users. In our MRTP application, we are prepared to demonstrate a net population benefit in terms of additional lives saved and years of life added for adult smokers who switch to smokeless tobacco products. Our view is that the substantial science behind this first MRTP application will serve as a stepping stone for future ones on other USSTC products. Skol also plays a targeted role in our harm reduction strategy.
While growing profitability on Skol overall, we are investing to grow Skol Flavor Blends and snus. These products appeal to adult smokers who are interested in smokeless alternatives, but are looking for familiar flavors and manageable forms to help them transition. Let's talk about snus for a moment. While the bulk of USSTC's business is moist smokeless tobacco, MST only appeals to a subset of adult smokers. And for some, there is social friction.
While the snus segment is currently small, representing about 4% of the smokeless category, it has been growing faster than the category. Skold Snus is specifically positioned for adult smokers who are interested in oral alternatives to cigarettes, but who want a spit free option. It currently comes in 2 flavors and offers a more discreet smokeless tobacco product with enjoyable flavor. We will continue to invest in snus as we believe it will play a role in helping us achieve our goals. Beyond snus, we see an opportunity to expand our product portfolio to appeal to a more diverse set of adult smokers, including women, many of whom reject MST and snus.
Given the number of adult tobacco consumers who are still searching for a satisfying alternative to cigarettes, we believe oral nicotine products represent another opportunity for USSTC to build on its already strong leadership position in the smokeless tobacco category. We've been conducting extensive research to understand adult smoker interest in other novel forms of oral nicotine containing products. And one promising product we're testing and enhancing is VRV. VERV is designed to provide adult smokers discrete tobacco enjoyment with reduced social friction. We've developed 4 forms of VERV, discs, chews, chewable dissolvables and melts, all in 4 different flavors.
Verve Discs and Chews in blue and green mint flavors are currently in a lead market in Virginia, where results are encouraging. In 2018, we plan to expand the sale of Verve discs at retail, in other geographies and through e commerce. We also plan to file our first VERVE PMTA application in 2018. And we continue to focus on product development and FDA filings to build out a robust portfolio of oral tobacco and oral nicotine products over time. Wrapping up, we believe our strong platform of products, leading brands and regulatory science positions USSTC to continue to drive profit growth for Altria, while also significantly advancing harm reduction in the U.
S. Now, I'll turn it over to Jody to discuss the e vapor category.
Thanks, Brian, and good morning, everyone. I'm Jody Begley, President and General Manager of Newmark. I joined PM USA in 1995 and have held various leadership positions in PM USA, U. S. Smokeless Tobacco and AGDC.
For the past 2 years, I've been leading the team that's building our e vapor business. And I'm happy to share with you the progress we've made and importantly some of our future plans. By way of background, the category saw rapid early growth from $1,300,000,000 in consumer spend in 2013 to approximately $2,500,000,000 in 2016. During that time, there was an influx of new competitors, new products and new e vapor retail stores. However, many of the early stage e vapor products failed to satisfy adult smokers' expectations.
And adult smokers increasingly became confused about the health risks associated with e vapor products. Over the past 5 years, we saw the rise and fall of multiple leading brands and a flattening of the category growth rate in 2016. But we continue to believe e vapor holds great long term promise. Today, the U. S.
Represents the largest e vapor market in the world. There are nearly 10,000,000 adults who are current e vapor users, roughly equal to the number of current adult dippers and large mass cigar smokers combined. And there are another 20,000,000 U. S. Adult smokers who tried e vapor products, but went back to smoking cigarettes.
With improved products and accurate relative risk information, we believe we can accelerate adult smoker conversion to e vapor. Newmark entered the category in 2013 with the 1st generation Mark 10 e vapor product. We've been thoughtful and disciplined in building this business and have learned a lot over the past 5 years. I fully expect Newmark to achieve our long term goal, which is to lead the U. S.
E vapor category through a portfolio of superior reduced risk products that adult smokers and vapers choose over cigarettes and that generates cigarette like margins at scale. So let's talk about where we are today and importantly, our plans for the future. Our product development is informed by a deep understanding of adult smokers and vapers. We know that different segments of adult smokers and vapers are looking for a range of different product formats, flavors, nicotine levels and vapor volumes. And as a result, Newmark believes that a portfolio of products address a broad spectrum of adult consumer preferences will be required to leave the U.
S. E vapor market. The e vapor category today consists of 3 primary product formats: Cigalytes, closed tank products and open tanks. I'll start with Cigalyte products, which have been Newmark's emphasis to date with Mark 10. Cigalike e vapor products generally appeal to adult smokers looking for an experience that closely resembles cigarette smoking.
They want a product that delivers flavor and nicotine satisfaction without the social frictions associated with secondhand smoke, smoke odor and ash. And while they tend to initially prefer traditional tobacco forward flavors, we've seen a growing preference for additional flavor varieties. We've designed our current Mark 10 products to meet these expectations. MarkTen's patented 4 Draw technology delivers a fullness of vapor in the mouth that simulates the draw of a cigarette. There is no smoke odor or ash.
And Mark 10 offers a range of 14 flavors, 5 available nationally and the rest in lead markets. Mark10 also offers a range of nicotine levels to satisfy different adult consumer preferences. The Mark10 Bold formulation currently in a lead market offers a differentiated experience with greater nicotine satisfaction for current smokers. It includes 4% nicotine by weight and uses a proprietary recipe for nicotine salts commonly found in the tobacco leaf. This slide shows the results of our pharmacokinetic or PK studies, which we use to measure nicotine delivery.
As you can see, Mark-ten Bold Classic offers nicotine delivery at levels approaching that of cigarettes. We've seen promising early results for Mark-ten Bold and are planning to expand it to about 15,000 additional stores in the Q4 of 2017. We've grown Mark 10 by focusing on stores with the highest e vapor volume. Mark 10 is currently available at about 65,000 stores and has nearly tripled its market share since 2014. It is now one of the leading e vapor brands with a 13.5% retail share in mainstream channels and 27% retail share in major chain accounts selling Mark 10 for the full Q3 of 2017.
Mark 10 also has promising repurchase rates, with cartridges comprising nearly 90% of Mark 10 sales. E Commerce also represents a significant opportunity for e vapor. When Newmark acquired Green Smoke in 2014, we also acquired its large and established e commerce business, which we then used as a foundation for MarkTen's e commerce platform. Together, these two sites generate higher e vapor volume sales for Newmark than any single retail chain in the U. S.
We're also building equity in the Mark 10 brand. With a campaign designed to appeal to a diverse adult tobacco consumer audience. We're using print, digital advertising, mark10.com and direct mail to showcase MarkTen's brand imagery and connect with adult smokers and vapers. From a regulatory standpoint, we plan to file PNTAs for our Mark-ten products in 2018 with MRTP applications to follow. To support these applications, we've been compiling a robust package of scientific research to demonstrate Mark 10's harm reduction potential compared to smoking cigarettes.
Our research includes chemical and physical characterization of the product, a toxicological assessment, clinical studies and consumer perception research. As you can see from this chart, we expect to show that when compared to a reference cigarette, Mark-ten Classic reduces And we intend to prove that Mark 10 e vapor products can facilitate switching from conventional cigarettes without materially impacting cessation efforts or tobacco initiation among non users. So as you can see, Newmark has made substantial progress in the Sigalike segment. And we believe it has a solid runway for the and have positive gross margin. And have positive gross margins.
Now let's talk about the closed tank segment. These products consist of prefilled cartridges of e liquid that are used in different format devices. These devices span a range of sizes and shapes, but bear less physical resemblance to traditional cigarettes. Adult tobacco consumers interested in these products tend to seek a slightly different product experience. They want flavor and nicotine satisfaction, but without the visual cues and social frictions associated with cigarettes and without the complexity of open system products.
Through our joint development agreement with PMI, Newmark has exclusive rights to commercialize the mesh technology, which we put in the U. S. Market before the FDA's August 8, 2016 deeming deadline. The product consists of a closed tank of e liquid that is heated through a mesh like metal plate rather than the traditional wick and coil method. We received positive results from our initial consumer research.
And as a result, we plan to further test this product called Apex in the U. S. As a line extension under the Mark 10 brand. Newmark has also been working to build strategic partnerships to expand our access to additional products and supply chain capabilities. 2 examples of these efforts include a closed tank product designed specifically for current open system adult vapers called VIM by Mark 10 and a small pod based product that offers a variety of flavorful liquids in a modern discrete format called Mark 10 Elite.
These products were in market by August 8, 2016, and we plan to further test both of these propositions in 2018. Newmark has also been evaluating various acquisition opportunities. One example is our recent acquisition of an additional pod based product called SYNC. The SYNC device comes in several forms with a variety of flavorful liquids. This product was also in market by August 8, 2016, and we plan to further test this proposition in 2018 as well.
Now let's move on to the open system segment. Open Systems consist of refillable e liquid tanks that connect to larger, more powerful devices and batteries. These products are primarily sold in specialty vape shops that offer a range of e liquids and devices. Adult open system consumers are seeking flavor variety and vapor fullness. And while they are also seeking stylish and customizable products, some dislike their complexity.
So first, let's acknowledge that the open systems segment is likely to face some regulatory hurdles. Some open systems have the potential to be tampered with or misused and the use of interchangeable elements can vary device performance and vapor chemistry in unknown ways. Further, from a user experience perspective, we believe emerging closed tank products can meet some of the desires of open system vapers with less complexity. That said, open systems represent a large e vapor segment and an excellent learning opportunity. Recently, we made a minority investment in Avail Vapor, one of the largest vape store chains in the nation with over 100 company owned stores.
Within those stores, AVAIL sells over 100 premium Aveil branded liquids and a wide range of predominantly open system devices. The company manufactures its own liquids in a state of the art ISO certified clean room. It also has a full service analytical science laboratory to support regulatory compliance. We have already benefited in various ways from this investment in AVEVA. We've gained a better understanding of the vape store channel and adults open system vapers and have access to extensive data around adult vapor purchasing patterns.
Through their retail stores, we've also learned a great deal about educating adult tobacco consumers about new products. Insights Altria's companies can apply to other areas of their reduced risk portfolios going forward. So to wrap up, we recognize that innovation can be achieved in multiple ways through organic product development, through strategic partnerships and acquisitions like the ones I've discussed, And we have an exciting portfolio of products in multiple formats to meet the expectations
of
a range of adult smokers and vapers. And we have a promising pipeline of future e vapor products in development. Now I'll turn it over to Sarah to discuss heated tobacco products.
Thank you, Jody. Good morning, everyone. I'm Sarah Nachmus, Vice President of PM USA's Heated Tobacco Products Group. It's great to see so many familiar faces from my prior role in Investor Relations. Today, I'm here to share an update on our exciting plans in the heated tobacco product space.
Clearly, the IQOS tobacco heating system is an important step forward in providing tobacco enjoyment to adult tobacco consumers with the potential for less risk. For those U. S. Adult smokers seeking alternative to conventional cigarettes, IQOS will offer a great sensory experience with a similar nicotine satisfaction in a familiar format using real tobacco, but with no ash and less lingering odor. At the same time, PMI's extensive regulatory filings for IQOS present a compelling case for the product's harm reduction potential.
For example, the research demonstrates that IQOS reduces levels of 18 harmful and potentially harmful constituents identified by the FDA by over 90% and reduces levels of 15 known carcinogens by more than 95% versus conventional cigarettes. Internationally, 3,700,000 adult smokers have switched to IQOS, and we're excited to offer this choice in the future to U. S. Combustible cigarette smokers. Given its harm reduction potential, our goal is to maximize the number of U.
S. Adult smokers who would otherwise continue to smoke, who convert to IQOS. So let's talk about our planned approach to this. Because we'll be building a new tobacco category in the U. S.
From the ground up, we're designing innovative new tools to raise adult smoker awareness of the product, provide education and product trial and support their conversion to IQOS over time. We'll discuss each of these areas in a moment, but first, a quick reminder on the regulatory process and timelines. As you know, we've been working closely with PMI throughout this process. The FDA is currently reviewing both a PMTA and an MRTP application for the IQOS app device and a 3 variants of Marlboro Heat6, 1 non menthol and 2 menthol. Let's take the PMTA first.
If authorized, PM USA will be able to sell IQOS in the U. S. Without a modified risk claim. PMI submitted the PMTA in March 2017, and the FDA accepted it for scientific review this August. The Tobacco Control Act guides the FDA to act on PMTA applications within 180 days of receipt.
So a marketing order could be granted as early as February 2018, though the FDA controls that timing. The MRTP application was submitted in December 2016, and the FDA accepted it for scientific review this May. If authorized, we'd be allowed to explain to consumers that IQOS use presents less health risk than combustible cigarette smoking. Based on this timing, we are hopeful that the FDA will host a Tobacco Products Scientific Advisory Committee or Kitsap Meeting about the MRTP application in 2018. We are working closely with PMI to prepare for this opportunity.
Of course, ongoing product innovation will be important for category leadership and to maximize adult smoker conversion. Because IQOS is already in 30 markets around the world, we and PMI are learning quickly from a broad base of adult tobacco consumers and identifying potential product that may appeal to U. S. Consumers. For example, we anticipate future device technology upgrades and additional heat stick varieties and brands.
We therefore plan to engage with the FDA to advocate for a streamlined regulatory process that will enable the ICOS system to evolve at a faster pace. Upon FDA authorization, we'll begin executing the lead market plans we're preparing. The lead market and subsequent expansion markets will be focused in major metropolitan areas, where we can engage with a large number of adult smokers efficiently and effectively. While we aren't announcing the location of our lead market today, I can share with you some of our selection criteria, which includes the size and composition of adult smoker population, the presence of e vapor rejecters in competitive adult smokers, a constructive legislative and regulatory environment and the presence of strong retail partnership. Because this will be a new product experience, we'll first need to raise adult smokers' awareness.
We plan to leverage the global This Changes Everything campaign, while building on Marbo's brand recognition and equity. The campaign will communicate that IQOS represents real tobacco pleasure and liberation from some of the conveniences associated with smoking, like ash and odor. Our consumer research shows this campaign resonates with adult smokers, reinforces Marlboro's leadership position and aligns seamlessly with Marlboro's core value of freedom. We plan to run digital banner ads and print ads for IQOS in our lead market. Once adult smokers are aware of IQOS, we'll introduce them to the product, educate them about it, guide trial and provide post purchase support.
This morning, you visited a prototype IQOS store, which just one of several retail executions we're considering. Within the lead market, we plan to IQOS focused stores and mobile units at select retail partner stores and events. Here, adult smokers will be able to try the IQOS device and all heat stick varieties with personal assistance from trained salespeople. They will then have the option of either purchasing the IQOS device or initiating a trial period. We will learn from and revise these retail models and sales approaches as we move forward.
We also plan to distribute the product through AGDC's existing retail partners, many of whom have expressed interest in IQOS. Again, we're looking to do things differently to maximize this opportunity. In some markets, select sales force members will be organized into dedicated IQOS teams. These will be IQOS experts with deep product knowledge and can educate our trade partners, provide rapid inventory replenishment and help us collect market information and consumer insights. We're also building a consumer engagement and customer care program to support adult smokers as they convert to IQOS.
This is a behavior change that can take several weeks and support during conversion help. Our trained consumer engagement and customer care professionals will provide 1 on 1 personalized guidance, including tips on device usage and maintenance, information about where to buy heat sticks and encouragement to convert them from conventional cigarettes. We're building a comprehensive digital strategy across online, mobile and e mail. We plan to leverage PM USA's extensive age verified adult smoker database, Marlboro digital tools and web analytics to identify potential IQOS consumers and communicate with them about IQOS. And a separate IQOS website will provide adult smoker information about the product, tips on device maintenance and the ability to purchase IQOS devices and accessories.
Once an adult smoker purchases an IQOS device, he or she becomes a registered IQOS consumer and receives ongoing digital outreach and customer care. So we have extensive plans and we'll test a range of innovative approaches with our lead market. We expect to learn a lot to inform our future expansion plans. For example, we'll better understand how U. S.
Adult smokers consider IQOS and to switch to it, how IQOS interacts with the overall tobacco category and how the Marlboro brand name influences perception of IQOS and the brand itself. Of course, financial performance will also be important. We expect to learn about this from our initial markets, including IQOS pricing dynamics, volume and competitive sourcing. As you can imagine, we've done extensive scenario planning to assess potential financial performance across several variables and assumptions. Let's use PMI's experience in Italy as an example for competitive sourcing variable.
PMI share of the cigarette market in Italy is roughly 50%. And in late 2015, nearly three quarters of in switching to Heatfix sourced from PMI brands. 1 year later, that declined to 67%. Assuming our experience was similar, we would be generating incremental gross profit on IQOS and after an investment period, we'd be generating total profitability. In summary, we're excited about the opportunity to launch a new heated tobacco category in the U.
S. We remain optimistic about FDA authorization of the PMTA and the MRTP application, and we're looking forward to hearing from the FDA about them in 2018. In short, we're dedicated to making IQOS a big success in the U. S. Now I'll invite Marty and the other presenters on stage for Q and A session.
Okay. So I'm sure there are no questions after all of that. I want to first
of all thank all of
our presenters. I have to say that Jody wins the heroic award. As you can tell, he's coming off the throat grip or something early in the week. I don't know why he has his chair next to me at the podium. But in any event, Jody, job well done under tough circumstance.
You all did great. So the way this will work folks, for people on the webcast especially, please direct your question to me. That way I can direct the question and the people on the webcast can follow along. So who would like to ask a question? Chris Growe has a question in the front and I'll work my way back here.
It's right here, Max.
Thank you. So a question for you, Marty, pertains to everyone, but just there was a whole host of new reduced risk products there, far more than we were aware of. And that pipeline was impressive over the next several years. So I'm just I think about the we don't know where the consumer is going to go, and therefore, we've got a wide array of products. It would seem like between the PMTAs and MRTPs and all the expense related to that, not to mention putting it out into the market, there's considerable expense behind that.
So I'm just trying to understand how you're balancing that. And then as you move ahead, like how you're going to isolate the products that are working, you move out of the portfolio, but just understand where the profit implications of that big expense of moving those products out in
the market? Yes, sure. So Billy is going to talk at the end, after we get back from the factory tour about how we're going to do that in some more so I won't steal his thunder. But the idea is basically that it's the consumer, right, who will decide. We firmly believe that they're going to segment as they move into the innovative space.
And so rather than to be empty or foreclosed, we believe that we should bring these products to the marketplace and we believe that we should tell them what the facts are. It will take some investment to be sure. But as I tried to demonstrate in my initial setup, we have the financial engine to be able to do that. We believe we can continue to grow at the rate that we've been growing. But obviously, from time to time, you're going to make investments.
Everybody in the room knows what I'm about to say. We have run our company for the last 8 decades for the long term. This is the long term and if it takes investment to do that, Chris, we're prepared to do that. In terms of sort of sorting it out, I think Sarah did quite a good job of identifying in IQOS how we think about making sure that when we go to lead market and test market that we are very disciplined about the questions that we are answering. And I think that's represented frankly an evolution in our ability to learn.
It's not just let's put it out in the test market and see what the share is. No, no, no. We have very specific questions we're going to answer. Once you answer them, then you can put resources on it and scale. So that's the concept behind it.
And as you know, we'll guide the Street every year about our investments. I hope that's helpful. Okay. I saw a question up here.
Hi, thanks. Owen, Jefferies. Hey. I'm just curious in terms of how you see distribution evolving going forward. You spoke about a lot of sales done online right now.
And the bears on the space will argue that if it is done online, then it's easier for new entrants to come in. I just wanted to get some views on will the traditional channels become more dominant as the category grows?
Howard, do you want to talk about distribution a little bit?
Yes. Certainly, we're making investments e commerce, but I think we really believe that the initial engagement with adult tobacco consumers is going to be at traditional retail outlets and potentially with IQOS through IQOS stores, because really that is where the adult tobacco consumers are. We have highly developed alternatives to cigarettes in the U. S. Today and for vapor and for smokeless tobacco, the predominant channel where adult tobacco consumers purchase those products is at traditional retail and frankly mainly convenience stores.
Next question. Wow! Okay. Judy, we'll go here and then I'll just try to work my way across. Thank you.
Thank you. So I guess a question about the FDA and kind of the new plan. So clearly embracing the risk continuum of risk strategy is beneficial to the industry and the innovation. Can you hear me?
Maybe we can hand Judy a different microphone. This one seems to be maybe not so good.
Hang on everybody, we're solving for technology here. She's about to ask a technology question, I think.
Can you hear me now?
Yes, ma'am.
Thank you. So just from an FDA plan perspective, so clearly, it's positive in a sense that they're embracing the continuum of risk strategy. But they've clearly also said it's a dual pronged strategy, right, making the combustible less appealing and less addictive. And we've also heard there's some promising research in the whole nicotine reduction side. So can the industry actually get the benefit of the continuum of risk and the harm reduction strategy without sort of being impacted by some of the regulatory proposals that the FDA ultimately could make on the nicotine reduction side.
And then some of the PMTA submissions or the MRTP submissions on the e vapor and the smokeless, I guess my understanding is there's sort of a total population impact that you have to really showcase. So it's clear that the individual risk based on the science is there. But can you talk a little bit more about sort of the data that you've seen from a total population impact perspective?
Yes. So there's a lot there. I also don't so in just a few minutes, Murray Garnock is going to come up and he's going to take us through how the nicotine product standard might work, which I think is half of the question. The short answer to that I think is the commissioner has made clear that it is a package deal. There has to be created a market of these innovative reduced risk products in order for smokers to have somewhere to go if they want to try them.
And so he has repeatedly and so has Director Zeller repeatedly said that it is a 2 pronged strategy that if a nicotine product standard can be implemented and smokers migrate out, you can't have that unless you have products for them to go to. So I think the answer to your question is, what is our job as a leading manufacturer? Our job is to engage in that process, make sure that sensible policy, which I tried to articulate in my opening remarks, obtains to invent or acquire the products that hold out less risk, to engage with the regulator to get them approved and then to put them in the market. One would like to think that if the products are compelling and indeed have less risk that smokers will migrate to them with or without a regulatory policy on nicotine. So again, I don't want to foreclose further comments, but that's a start.
Listen, on population effects, again, we have Jim and Murray. Jim, do you want to talk about population effects a little bit?
Sure. I'll just mention briefly. We didn't put up some of the data on the population effects because obviously that's some of the longer term information that we're developing. So we've done a lot of the population based surveys to try to understand with again smaller subgroups what is likely to happen. And then really the only way without epidemiology to be able to do some of the prediction is to take it through a population based model.
And so that's a lot of what we're doing and other manufacturers are doing. If you don't have the epidemiology, it is a bit of looking at the data you have, model it and then provide that data to the agency. So we're in the process of doing that for all of the SKUs except for smokeless where we have epidemiology. So we
didn't have time to show you all of the CRT, but we have a very, very strong modeling group, which is working on this right So I'll have Michael here, then I'll try to work my way down. Thanks.
Thank you. You mentioned in Mark 10 Bold some nicotine salt technology. Can you give a little sense of how that may compare to any competitive products that have nectine salts? And then just related to that second one, when you talk about the PMTA applications for MARC 10 specifically, those deadlines obviously have been extended. Can you just give a sense of why you might do it sooner than necessary when for a product you already have on the market?
Sure. So, Gary, do you want to say a word?
Yes. As it relates to nicotine salts, Jim and his guys have been working on products for a while and includes nicotine salts. We've been working to optimize that with lots of consumer feedback. I won't necessarily speak to how it compares to other products, but I'll tell you from a consumer standpoint, we've gotten very positive results. Been in lead market, we've got very positive results in lead market, so good that to my point earlier, we intend to take the brand to 15,000 more stores in the Q4 this year.
So I'd say we feel really good about Martijn Bold and Nixteen's, excuse me, in a total formulation from a martin bold standpoint.
You want me to take the PMTA? You take PMTA. You got through one question. That's good. So Michael, in order to get an MRTP claim, you have to have an approved product through FDA.
So they won't take MRTP application without a PMTA application in this area where we don't have substantial equivalents available to us. And so we are going down a pathway at a reasonable pace to try to ultimately get to the MRTP, but we have to go through the MRTP land first.
I think the other thing to take from the slide that Howard put up was, as you can tell, we've tried to pace these out over 5 years. And so they will I'm sure they'll vary over time. But because of the degree of work that's required, if you don't get them in the slot, Michael, and get them started, you've got to do it because we only we have 400 or so down there, but we don't have 4,000. So it's quite a lot of work. Vivien, I think you're next and I'll come here.
Thank you. I had a question on IQOS and the MRTP application, a 3 part question if you don't mind, please.
A 3 part question. Okay. That's
4 questions, but go ahead.
So number 1, since the scientific review began, has the clock been running continuously? Number 2, do you have a sense of when in 2018 you might expect a tip sack? And then number 3, what are your expectations for how long that tip sack review process would take? Because I believe for Swedish Match, it was 18 months.
Okay. Thank you.
Sarah? So the first one was about MRTP as I think I'm running continuously.
Our understanding is the clock starts once they've considered that started their review period on that. So the answer to that piece is yes. I think your next two questions are related more specifically to around timing and how long that review process and specific dates. We don't have any definite on that.
I would supplement just to say, I think Michael asked me this question on the earnings call, we chatted about it a little bit. There's been a high degree of interchange between the applicant and we who are supporting the applicant that leads us to believe, Vivien, that they are hard at it. In other words, we haven't heard it hasn't been radio silence. In other words, there's interchange between the regulator and the applicant.
And just to clarify that, that interchange is not disruptive to the clock?
No. As a matter of fact, it's essential for the process. If you talk to people who, for example, are regularly in there with pharma, it's exactly the process you would anticipate. Hey, I'm looking at your application. I have a question.
Can you answer this question and so forth? It's exactly what's anticipated. I wish I
could tell you about 'eighteen, we just don't know.
And as you can imagine, the teams are working really hard. So whenever that date is that they're ready to go for the hearing.
Matt, you had a question.
And I'll go to Bonnie.
Thanks. If I could ask 2. First, Jody or Marty, you talked about optimism that you could achieve cigarette like margins in vapor over time. And the major hurdle there obviously isn't on the gross margin side, it's just getting the scale and the leverage and the frequency of use that you need to get the economics there. But is there any guidance you can give us on what level of frequency or what level of conversion to sort of more sort of dedicated use you need to get to reach to begin to approach those cigarette like margins?
So I'm going to give Jody's voice break here for a second. I'll ask Kyle maybe to start and then Jody will come to you. Sure.
We have experienced on Mark 10 where we have been making progress, but I think you hit it exactly, which is essentially what you need is you need higher volumes and ultimately some consistency in what product they're demanding, so you can move towards automation. We've made significant progress on Mark 10, but I would say we're a ways away from having the kind of 10. And I think we think over the passage of time, there is certainly the opportunity to achieve automation and start to move towards more favorable margins. Jotin, maybe I could ask
you to talk about the supply chain. Yes. I mean,
from a supply chain standpoint, we've taken significant costs out of our product over the past couple of years. We feel really good about where we are financially. I am encouraged given the FDA's recent announcement, because I think when you can start to tell consumers the accurate relative risk information about this product category generally will be an accelerant that will take off because really what we're missing is volume. So how long will that take? It's hard to say, but I think we are pressured nicely
to be able to capitalize on that when it happens. My final punctuation point would be excise taxes matter. And as you know, there's significant difference right now in the excise taxes and we aim to keep it that way if we can. You had a second question, Matt?
For Sarah, so the experience in Asia on IQOS, obviously different consumer, different market dynamics, seems to be the appeal skews a bit more toward adult tobacco users who prefer menthol. Generally, you have 2 menthol styles, 1 non menthol style that you're considering commercializing in the U. S. I guess, I know this is what the lead markets are for to better understand these things. But is your kind of expectation going into the lead markets that, that preference towards menthol on the heated tobacco platforms might hold true in the U.
S. As well? And is that going to play into your choice of lead market?
So I think I'll take your topic sentences. That's part of what lead markets are for, right? What we have seen in some of the markets overseas is both menthol and non menthol cigarette smokers have preferred the menthol heat stick variant. I think some of that comes to us, the tobacco consumer is looking for alternative products. Flavors play a role in that, right?
It's not going to taste exactly the same as their cigarettes. So this helps provide them a product that they're willing to take the changes for and have the trade off for it. So we'll see, right? But by design, we've got the 2 menthol variant. We have the traditional variant and we'll see how they do in the U.
S.
The only thing I'd say further into that, I guess, is to the extent that we under index in menthol and cigarettes and we can pick up some competitive, it would help the cannibalization rate. Bonnie? You may have the privilege of the last question for this session, but there will be more, I promise.
No pressure. So part of my question is similar to what's already been asked. Just I really want to understand the portfolio approach that you guys are taking with the wide variety of offerings and trying to balance the execution risk of that, while again trying to achieve scale and driving profitability? And within the context of that, are you comfortable today to give us a sense of your thoughts on being able to maintain your long term growth algorithm, maintaining your 7% to 9% EPS growth while continuing to invest in the future?
Yes. So let's begin by distinguishing between long term aspiration and year of the guidance, right? So our long term aspiration is to continue to grow 7% to 9%. And to be sure, we'll have investment years somewhere in those years. And some years, the income is up at the higher end of the range and sometimes at the lower.
But don't misinterpret that for guidance. We'll guide in January when we come out. Listen, on our 3 platforms, I think you're getting to the heart of it. It's one of the reasons we haven't chosen 7 platforms. I think we can execute 3 and one of them is already built and that's Brian's business.
So you see he's got the highest operating margins in the family of companies. He has the sales distribution he needs. He has the brand plans. There's nothing to build there. Jody's business, we've been building for the last 3 or 4 years.
And you can tell from his presentation today, he's made a lot of progress on that. And then finally, in Sarah's neck of the woods, IQOS is to be built. And so sure, there's stuff to be done there. And also, it's the most different. That consumer experience is going to be different.
So they may be in different levels of maturation. But this is what we do. We manufacture products. We know what the consumers want. We put brands on them and we build equity in them.
So I'm confident that we're going to have to invest for our future. That's what we've done all along. Done it with Marlboro and we've done it with our other brands.
And one final quick question, if I may. Given everything that you've discussed this morning and again the reduced risk portfolio, what are the potential opportunities in the future to take some of these offerings internationally, distributing them international, again partnering with PM and any interest there, anything you can talk about today?
So naturally, we've thought about whether we can take these things internationally. The fact of the matter is today, we're in the largest profit pool in the world. And we have the leadership positions and the infrastructure in place to exploit that first. So we're not ruling that out, but we'd like to continue our success here before we talk about that. Thanks.
So with that, I appreciate that. I promise there's going to be another at least 1 bill or 2 Q and A sessions. So we'll have plenty of time. Thank you all very much. And I think with that, I'll excuse our panel and I'm about to go to the next section.
So as you know, Altria maintains a dual focus on maximizing our core businesses while innovating for the future. In fact, it's our core tobacco businesses that have allowed Altria to deliver substantial shareholder value over time, while providing the funds to invest in the innovative products and supporting regulatory infrastructure that you've just heard so much about. So I'm going to turn the floor over to Casey Crosswayte, who's going to discuss the largest component of our core, which is the smokeable product segment. Casey? Thanks, Marty.
I'm KC Crossway, President and CEO of Philip Morris USA, where I oversee PM USA and John Middleton. I joined PM USA in 1997 and have held various leadership roles, including VP of Strategy and Business Development and VP and General Manager of Marlboro. As you heard today, we're excited about the evolution of the tobacco industry and the role Altria's businesses will play in transitioning adult smokers to lower risk non combustible products. My role at PM USA is to execute the smokeable segment strategy, generating substantial profits that enable Altria to invest in innovation, new capabilities and harm reduction, while continuing to reward shareholders. Altria's smokeable product segment consists of 3 operating companies, PM USA and Nat Sherman in cigarettes and John Middleton in machine made large cigars.
The smokeable segment remains large and highly profitable and despite the long term secular decline in cigarette volume has continued to grow income year over year. Over the past 3 years, the Smokeable Products segment grew adjusted operating company's income by 7.6% on a compounded annual basis to $8,000,000,000 of adjusted OCI in 2016. We achieved these results by carefully executing our strategy to maximize income while maintaining momentum on Marlboro and Black and Mild over time. We view momentum as continued strength across several brand metrics, including brand equity, demographics, retail share and profitability. Our strategy requires a thoughtful balance of pricing, cost management, retail share performance, equity building and product innovation to grow segment profits over the long term.
Before we dive into the brand portfolio, let's talk briefly about a couple of consumer trends we're observing. 1st, consumer taste preferences continue to evolve as they look for superior experiences and search for increased flavor, which continues to drive menthol growth in cigarettes. On the other end of the spectrum, there's a small, but fast growing sub segment of adult smokers adopting a less is more view and seeking cigarettes manufactured with just tobacco and water. This sub segment is likely to continue to grow, and Nat Sherman is well positioned to address this opportunity, which we will discuss shortly. With this backdrop, our companies have a portfolio of leading brands to address these evolving adult smoker trends.
The portfolio is led by Marlboro, which remains the top choice for adult smokers, and also includes Parliament, Virginia Slims, Benson and Hedges, L and M in the discount segment, and Nat Sherman. Together, these brands represent more than half of the U. S. Cigarette industry. Let's start with Marlboro, one of the world's most iconic and valuable brands.
PM USA's introduction of the Marlboro architecture in 2012 provided a broad platform to communicate with adult smokers, while staying true to the brand's essence. The 4 distinct flavor families opened new ways for Marlboro to express its values and connect with a diverse base of adult smokers, helping to further strengthen Marlboro's brand equity, which continues to significantly exceed any other competitive brand. The architecture's broad reach also strengthens Marlboro's demographics. Marlboro share among smokers 21% to 29%, which was in decline prior to 2012, has stabilized. And today, Marlboro share among smokers 21 to 29 remains at or slightly above its overall share.
As we discussed last week on our Q3 earnings call, we're very pleased with the financial performance in the Smokewore product segment year to date, with adjusted OCI growth of 7.4% through the 1st 9 months. Across our brand metrics, Marlboro continues to have category leading equity, strong demographics, and remains highly profitable. As for retail share, Marvel declined by 0.3th of a share point for the 1st 9 months to 43.4%. This is explained by dynamics related to California's state excise tax increase and elevated competitive activity, including high levels of promotional spending and competitive product launches this year. Share performance is best measured over years, not quarters.
As you can see from 2011 through 2016, PM USA grew Marlboro share 1.7 share points.
And in
the 1st 9 months of this year, we've given back about 0.3 share declines by reallocating certain marketing resources, including in California. For example, PM USA has enhanced its retail trade programs to focus retailers on the profitability Marlboro brings to their stores. In this process, PM USA has moved resources from underperforming retail program options and reallocated them behind promotions that support maintaining Marlboro's leadership position. We believe these actions combined with our long term investment in product and packaging innovations will help stabilize Marlboro share and enhance Marlboro's momentum over the long term. PM USA continues to invest in Marlboro to maintain the brand's vibrant franchise from finding new ways to engage with adult smokers, particularly through digital marketing to product and packaging innovation.
In digital marketing, Marlboro.com is among the leading consumer packaged goods websites in the U. S. According to Comscore. Through the 1st 9 months of 2017, Marlboro has responsibly generated close to 100,000,000 adult tobacco consumer connections. Mobile connections continue to represent more than half of our digital connections, And mobile coupon redemptions are up over 40% versus the same period in 2016.
PM USA continues to invest behind its digital platform and plans to introduce marbo.com 4.0 by the end of this year. This enhanced platform will allow greater flexibility to quickly change and personalize content and automate brand communications based on adult smokers' engagement. We are rapidly developing the capabilities to deliver personalized value to each adult tobacco consumer. We believe these digital enhancements and initiatives will improve Marlboro's engagement with adult smokers and build on the brand's competitive advantage in digital marketing. On the product side, Marlboro Black Label and Marlboro ICE are the latest innovations for Marlboro.
In October, PM USA announced lead markets for Marlboro Black Label in California and Washington State. Marlboro Black Label is a bold and robust non menthol cigarette in a premium, contemporary and stylish pack that PM USA expects to enhance Marlboro's premium non menthol position. In menthol, Marlboro remains the nation's 2nd largest brand. In the Q1 of 2018, PIM USA plans to accelerate its efforts in menthol with the national expansion of Marlboro ICE. Marlboro ICE is a unique, crisp and cool to the finish menthol cigarette in an innovative reseal pack.
Its resealable pack technology will be the first of its kind in the U. S. Cigarette market. The distinctive new pack and differentiated packaging innovation has patents pending in the U. S.
PM USA is now complementing Marlboro's menthol portfolio with Benson and Hedges. In October, PM USA announced the expansion of Benson and Hedges menthol into select stores in 3 lead markets, Maryland, Washington, D. C. And Virginia. This is a premium brand that provides a fresh, cool menthol taste and a distinguished package design.
Our research on beds and hedges demonstrated strong purchase interest among competitive menthol smokers. Coupled with Marlboro's menthol offerings, we believe Benson and Hedges menthol will help PM USA continue to grow its share of the menthol segment. And in discount, L&M continues to resonate with value conscious adult smokers. Over the past 3 years, L and M grew retail share more than any other discount brand without growing the discount segment. And L and M's brand equity is the highest in the discount category.
Despite a challenging competitive environment among discount brands and deep discount brands, L and M has maintained its retail market share throughout 2017. Beyond TMUSA's legacy brands, Altra is always looking for white space opportunities to gain incremental share and profitability. Earlier this year, Altria acquired Nat Sherman, a super premium brand synonymous with classic American luxury. Shannon Leestra, who you met this morning in the brand display runs the business and will join us shortly for Q and A.
But in the interest of simplicity of presentation,
I will cover the topic. Since the acquisition in January, Altria successfully integrated Nat Sherman as a standalone operating company, improved its regulatory and compliance procedures, expanded its cigarette production capabilities and integrated with Altria's distribution system. Additionally, Nat Sherman conducted extensive adult tobacco consumer research on the brand. Acting upon those insights, the team redesigned the product packaging and marketing materials to more clearly communicate a tobacco and water value proposition, which you saw in the brand display this morning. In August, Nat Sherman announced Colorado as its lead market for the repositioned brand, Nat's, which will be priced at a super premium price point.
The Nats Sherman team believes this new pack will resonate with competitive adult smokers. The team is looking forward to taking its lead market learnings, quickly fine tuning its marketing strategies and rapidly expanding nationally. With Nat Sherman, Altria now has a presence in the fast growing and highly profitable super premium cigarette segment. Combining this terrific brand with our company's distribution, brand management and consumer engagement capabilities, we have a tremendous opportunity to take incremental market share and income in the super premium cigarette segment. Let's touch briefly on cigars.
As you know, from our Q3 discussions, Middleton continues to perform well. Middleton's focus on growing Black and Mild's leading share in the highly profitable tip segment continues to produce strong results. Over the last 3 years, Middleton grew volume by 5 point 4% per year, increasing its share of category profits and strengthened its already sizable share of the tip segment. We're extremely pleased with Black and Mild's performance and the cigar business' contribution to the smokeable segment's profit growth. In fact, since our acquisition of Middleton in 2007, our return on invested capital has significantly exceeded our cost of capital, again demonstrating our ability to profitably build a brand and business over the long term.
Before leaving the Smokewhip Products segment, we want to acknowledge and address the recent FDA announcement, including a potential nicotine standard for combustible cigarettes.
Let me turn the floor over
to Mary Garnick, Altria's Executive Vice President and General Counsel to share our thoughts on the announcement.
Thanks, KC. As we have discussed in late July, Commissioner Gottlieb outlined the FDA's new multi year approach to regulating tobacco products and took a meaningful step forward in developing a comprehensive regulatory policy based on the continuum of risk. We are encouraged by the agency's new approach in this regard, which acknowledges that nicotine is not the problem, rather the problem is the combustion delivery mechanism. You've just heard from my colleagues how Altria has been building a compelling portfolio of non combustible nicotine products to succeed in the future. Now, let me spend a few minutes discussing certain other aspects of the FDA's new approach.
1st, as part of this new approach, Commissioner Gottlieb has directed the FDA to issue regulations outlining what information the FDA expects to be included in substantial equivalence reports and to reconsider its process for determining substantial equivalents for provisional products. As we described at CAGNY, this process continues to be onerous and expensive. Given that the FDA will be issuing clarifying regulations, we believe that as a matter of simple fairness, the agency should hold off on making any substantial equivalence decisions until it issues those regulations. We continue to engage with the FDA on our submissions for both new and provisional products. 2nd, the FDA is planning to consider product standards governing nicotine in combustible cigarettes.
This is not new. Since the act became law in 2,009, this has been a possibility and Altria has already been preparing for any reasonable product standard. Let me briefly address what a potential nicotine standard rulemaking process would look like and the requirements that FDA must satisfy to implement such a standard. FDA's rulemaking process, Mr. Zeller described it as a multiyear roadmap, will be a long term process with multiple opportunities for stakeholders to provide perspective.
On July 28, the FDA indicated it intends to issue an advanced notice of proposed rulemaking, which asks for information and comments on the concept of a potential nicotine standard. We believe this advance notice is likely to come this year. Once the advance notice is issued, the FDA begins to collect information and scientific studies to help determine if a rule is needed. If the FDA determines, VA determines based on the science and evidence that a rule is needed, it will prepare and publish a specific proposed rule. In so doing, the FDA will have to consider a range of issues from technical achievability to unintended consequences.
While there's no definitive timeframe for a proposed rule, this initial process could easily take years. It's also important to understand that the issuance of an advanced notice does not necessarily mean that the FDA will ultimately issue a proposed or final rule. Indeed, the FDA has issued several tobacco related advance notices and years later, still has not issued a proposed or final rule. Next, the Office of Management and Budget will assess the economic consequences of any proposed rule. Also, once the FDA issues a proposed rule, the process of notice and comment begins again.
The FDA may receive 100 of thousands of comments. And in issuing a final rule, the FDA must address every comment received. Furthermore, any final rule will again go through the OMB before it's issued. If a final rule is issued, there's a statutory mandated delay of 1 to 2 years before the implementation period. Finally, any final rule would be subject to legal challenges if it is not grounded in science and evidence or is otherwise contrary to law.
As you can see, this is hardly an easy or straightforward process. Now, let's talk briefly about the statutory requirements governing a potential nicotine standard. The FDA will need to examine and resolve various complex issues based on science and evidence. They have to consider, for example, if a potential nicotine product standard will perform as intended. That is the FDA will have to show that a product standard will migrate smokers from combustibles to non combustibles and not result in widespread withdrawal or compensation, meaning that smokers will not smoke more or take deeper draws to get the same level of nicotine.
The FDA must also consider if a potential product standard is technically achievable. We believe that to be technically achievable, any product standard must allow manufacturers to make cigarettes that are sincerely acceptable to adult smokers. Additionally, the statute bars the reduction of nicotine in cigarettes to 0. It stands to reason that this limitation also prevents the reduction of nicotine in cigarettes to an amount that is functionally no different from 0, such as when the nicotine is in such small amounts that it has no physiological impact. Finally, the FDA needs to show that its product standard would not result in widespread unintended consequences, such as the creation of a black market.
There are also practical questions as to how the standard will be measured and implemented. Will FDA measure nicotine levels in the tobacco or in the smoke? Will FDA provide a phase in period? And if so, for how long? Additionally, the implementation of any nicotine product standard cannot occur in a vacuum.
To accomplish its intended purpose, the FDA would have had to already create the conditions for a marketplace where consumers have access to and information about FDA authorized reduced risk products. Commissioner Gottlieb has acknowledged that any proposed nicotine standard would need to be part of a comprehensive package, which also includes steps to foster potentially reduce risk products. We've already been working for years on key technologies to allow us to meet any reasonable potential standard. We've done extensive work on nicotine reduction through cigarette product design, tobacco leaf treatment and tobacco seed technologies. Our biotechnology capabilities have led to several significant discoveries, which we've shared at scientific meetings and in multiple patent applications.
For example, we've developed seed varieties with substantially reduced nicotine levels from which we are producing small quantities of tobacco for further product development. While these technologies hold promise, it's premature to comment on their applicability to any specific future FDA standard. So to sum up, any potential nicotine standard will go through a rigorous science and evidence based process before it becomes a final regulation. In the interim, we are advancing the development of our non combustible products portfolio and doing work to prepare for reasonable potential standards. No doubt this will be a multiyear process and we look forward to participating every step of the way.
Before we break for lunch, we'll have another brief Q and A session. I'd like to invite Shannon, KC, Jim and Marty to join me back on stage to take your questions. Okay. So the clock says
that we have about 10 minutes of Q and A and I want to open up the floor again. I'm going to try to reach people perhaps who we didn't reach in the first. Yes, they're right here. Thank you.
Mr. Garnett, what is the status on the FDA regulating menthol? And do you think it would take the same timeline as reducing nicotine?
The FDA issued an advanced notice of potential rulemaking in 2013 for regulating menthol. We've submitted extensive comments. Our position is that the science does not justify ban on menthol. Since then, the next we've heard from the FDA on that issue, which has now been pending for 4 years, is on July 28, they said that they would issue an advanced notice of proposed rulemaking on flavors. And they said this would include menthol.
So we are waiting for that. It could well happen by the end of the year. But with respect to menthol specifically, there has been no action since its advanced notice that they issued some 4 years ago.
Need the microphone, sir, sorry. Just for the I don't
see the timing similar as on reduction of nicotine that it's not up, it's so complicated, take time?
I would think so. I think the best predictor of future behavior is past behavior. And given that the advance notice has been pending on menthol for 4 years, it's difficult to really ascertain how long it might take, but it will take some time.
And in fact, menthol, you may remember was in the statute when it passed in 2009, the study. So we're now 8 years out on menthol. I see a question here. Adam?
Hi. It's Adam Spielman from Citi. Two questions, please. First of all, in one of the earlier slides on your new you said you were planning up to, I think, 2022 something like 6 or 7 new applications to the FDA, sort of labeled 8 gs, if I remember rightly. Can you just confirm, are we talking are these predominantly products which are already in the market for which you need to apply under the deeming regs?
Or should we think of these as new to world products that haven't that you're not disclosing yet, but you will be
want to look at the slide to remember exactly which ones we're making reference to. But at a strategic level, they're both, aren't they? You heard Jody make reference to some products, for example, that we got in the market before the magic date of deeming. There's some of those. We also have some products in the pipeline that will require PMTAs, meaning that they were not in the marketplace at that time.
So it's a combination of both, I think is the answer.
And the second question, if you had to take a guess, let's say, in 10 years' time, do you think in the U. S, e vapor products will be significantly larger, the same size or significantly smaller than tobacco using products.
Yes. So one of the things they taught me when I got this job was not to guess over an open wire. So I don't think I'll guess over an open wire. Here's what we do believe though. We believe that consumers, their natural tendency is to segment.
And it's true in most CPG categories. I know the categories that you follow, you see them segment, which is why we believe in the portfolio approach. And then what we can do is, as we get in market and we see where the consumers are segmenting, then we can allocate our resources on the ones that are growing faster as opposed to the ones that are not. So as we step our way into this, we'll be able to allocate resources. We have just chosen simply not to bet on one product or another as attractive as they may be until we know more from the consumer.
So I wish I could give you an answer 10 years out, but I just don't know. Thank you very much. Sure. Thanks for the question. Let me
just see, Judy, if
there's another question before I come back down here.
One up, Tom.
There's one in the back. If you can indulge me, please. I can't see that far with these lights, so thank you.
Greg, can you hear
me from Janice. Murray, just the comments you made about the stance reason that you can't take the functional impact of nicotine to 0 either. I'm curious sort of how controversial that is? Is there any sort of precedent around that sort
of principle legally speaking that would give us some guidance on how the FDA might behave?
I don't think the FDA has come out and stated a position on that yet. And look, and we'll have to see what kind of product standard they come out. If they do come out with a product standard, the whole issue might well be moved. I mean, so I don't expect them to stay at a position on that until and unless they have to. I think such an argument would be well grounded in the law, we would not have stated it.
I think that it's a very natural and appropriate reading of the statute. Judy, maybe we'll come down here
and then I'll start picking other people up.
Question for Casey. So the Marlboro situation the share situation, so you talked about some of the underperforming trade programs. So can you talk about exactly what happened? And then as you're reallocating resources, is this just in California? And ultimately, is the idea that consumers would see a lower price on Marlboro as you're implementing and shifting some of those resources?
Go ahead, Katy. Sure. On our trade programs, I'll get to a couple of details for you. We have a variety of called business enhancement funds in our previous program where retailers can elect options to support Marlboro. So for example, a fund on 72s or a fund on Marlboro Black.
And we decided that reallocating those resources towards our mainline business, so think red, gold, green, would be a far better return on our investment. So we've made those changes. They're implemented nationally and actually took effect yesterday. On a state level, you mentioned California. So let's talk about California for a moment as a good example of making state level adjustments, because although it's a national huge brand, we do examine state by state and determine do we have the right value equation in place.
So in California, we made adjustments to our special blend franchise sort of after the SET settled to get a better sense of the state. We're bringing terrific brand news with Marlboro Black into the marketplace as well, which we think just elevates the brand's equity in that state and believe that those efforts among others will stabilize our performance in California. So you'll see states that will take time to time, we'll make those types of adjustments.
I don't think we've heard about Benson and Hedges for some time, and so that was a little bit unexpected. Could you just talk about maybe what how that's positioned price point wise? And what your objective in terms of how you see that competitively? Yes, exciting news about B and H.
KC, you want to take that? Happy to. On Benson and Hedges, we just see a premium menthol opportunity. Marlboro menthol has done terrific for us, as I mentioned in my remarks, and we expect it to continue to do so. So it's really not an or, it's an and here.
And with Benson and Hedges, we know we've got lots of incremental white space opportunity to source competitive business. We're excited about B and H with a redesigned pack. And you're right, you probably haven't heard about it in a while. We think it's going to be exciting news in
the market. It's a good example.
We have these other premium brands that actually enjoy very, very nice margins. But we think that we can put them to better use in the portfolio because the consumer is evolving. They're choosing different things at different times and we've got a great portfolio, a great lineup to attract them through that.
Just a quick follow-up, it's premium price, but how would that compare relative to say Marlboro Red? Is it more expensive or in line or? In line. Yes.
Okay. Thanks. I'll go down the aisle here, Matt, and then I'll come to
Chris. Just
Marlboro, a follow-up for Casey. The change in the trade program that you just elaborated on a bit, trying to emphasize some of the core styles a bit further. Is there are you expecting there to be a trade off between perhaps sort of the ASU-thirty demographics and the profitability of the broader franchise when you make that change? Or are there other ways to mitigate any impact
you might see? Absolutely not. I mean, we look at a suite of offerings across our go to market strategy and our architecture and we have lots of exciting news across, take Marlboro Black, for example. So although one part of the trade program, we're focusing on mainline and here we are focusing on Marlboro Black product news in certain states. So I wouldn't draw that conclusion.
We'll be focused on all areas of Marlboro. Chris, indulge me one second because I do have a question here. I want to go out and take it.
Tim Gamache from JPMorgan Asset Management. I have question geared
towards Murray. Thank you for the walk through of the rule making process and the analogs, I
guess, for past examples. So appreciating
that the whole process could be open ended on the long end, if in a hypothetical world, all the research was signed, sealed and sound, Is there a
minimum amount of time that it would take to go through this, the process on the nicotine reduction standard?
I don't have there's no timeframe involved that would be the minimum amount of time. And I've not seen FDA do anything in the minimum amount of time.
Said with all respect.
Hypothetically, there could be, but it's difficult to answer that question. I think that the FDA could move with relative speed and shave a couple of years off of that. But I think we're still talking about a number of years just because of the complexity and all the steps they have to go through, all the stakeholders and the inevitable thousands of comments that they're going to receive with respect to any kind of proposed rule. So, we can talk about, is it going to be 7 years, 10 years, 15 years, I tend to think it's going to be in the longer end, if anything ends up happening, but you could shave a couple of years off of that. But if you're asking, is this something that they could do the next few months, The answer is no.
And they've acknowledged that themselves. That's just not practical. The system is not set up for that. Jim, do you want to say
a word about FDA's deliberative stuff?
Yes, sure. And I'll mention a little bit about the science too. FDA is very deliberate in these areas. I use just by way of example, in the Center For Devices and Radiological Health, they've only approved and put forward one product standard. And it took well over a decade to get passed.
And then you look at even GMPs, good manufacturing practices on the device side that took between 10 15 years to actually get through. So being very deliberative when you're going to influence the entire industry, they tend to do that with a lot of deliberation. I'll just mention the science because it really is going to pivot on the science. And I think what we're seeing is the early science. We're not seeing the pivotal trials yet.
And so much of the work that's being discussed today is very early. It's one product. It's one researcher. Policy generally doesn't get made until you have studies on top of studies with multiple researchers to be able to really tell what the science tells us. So I think we're early on the science as well.
Okay. And then Chris,
I think I'll have to give
you the privilege of the last question before we break for lunch and I'll come back, I promise.
Thank you. I had intended one question, but I have a quick follow-up to that, Jim, which is, we're seeing early signs say does Altria or Philip Morris, she would say, have science that on nicotine as well that will contribute to the discussion? Maybe I'll ask that first and then the second one for Casey.
Yes. So I think as Murray sort of mentioned, we've been at this for well over a decade. So we know a lot about nicotine. We've done a lot of work. We've prepared for the standard, knowing that it was in the statute.
And so what I would tell you is that we are working towards being the authoritative industry body on this particular topic.
Thank you. And a quick question for Casey on Marlboro. Just the degree to which as you're bringing value to a Marlboro consumer, there's a lot of ways you can do that coupons and obviously new products and that kind of thing. I'm interested though in, has there been any expansion or maybe increased depth in the use of special blends, for example, perhaps even in a market like California, where you've had a little bit more of a challenge with the big price increase there?
Yes. No, I mean, special blend is one of the many tools you mentioned, mobile coupons or others where we can provide value to the Marlboro consumer that we believe needs it. And I would say our plans are pretty stable. Okay. So with that, I'll ask a panel to stay put for a second.
We're now going to take a break for lunch and then a tour of the manufacturing center. So for those of you on the webcast, thank you for joining us. We will be back at 2:30 sharp for the final session.
Welcome back. We hope you found the manufacturing center tour insightful and came away with 2 key takeaways. First, our meticulous approach to the quality and efficiency of our production process. 2nd, the quality of our dedicated and passionate people. We'd like to spend our remaining time discussing why we believe we'll continue to create enormous value for our shareholders into the future.
Then we will again open the floor to questions. Let's start by reminding you of our long term financial goals, which are unchanged. To grow adjusted diluted EPS at an average annual rate of 7% to 9% and to maintain a dividend payout ratio target of approximately 80% of adjusted diluted EPS. We pursue these goals by focusing on 3 strategies: 1st, maximize income from the core tobacco businesses over the long term 2nd, to grow new income streams with innovative tobacco products and third, to manage our diverse income streams and strong balance sheet to deliver consistent financial performance. This morning, we described the dynamic and exciting environment for the U.
S. Tobacco industry. Also, we described our strong track record of successfully managing through changes in our industry. We were successful because we had the tools, talent and experience to win through these changes. We believe we will continue to win because of our terrific talent, the strength of our brand portfolio, our approach to cost control and productivity and the strength of our balance sheet.
Let's take each one separately, starting with our talent. Marty addressed earlier how we have been preparing our people for success in the dynamic tobacco landscape. The Unleash Our Potential program is as straightforward as it sounds. It encourages each individual in our organization to unleash his or her full potential and strengthen our talent advantage. For example, our recent productivity initiative was designed to reduce reporting layers and increase spans of control.
This design allowed for clear decision rights and increased responsibility across the enterprise. When we unleash our people's potential, they bring the same dedication and passion that you've seen today. Next is our brand portfolio. The strength of our brands provides robust pricing power in our core businesses. From 2013 through 2016, Smokeable Products segment net revenue per 1,000 units, our measure of net price realization, grew at an compounded annual rate of 4.6% and adjusted OCI margins expanded by 6 percentage points to 48.2%.
Totalsmokable adjusted OCI grew $1,600,000,000 over this same period. Even while the smokeable operating companies expanded their product portfolios, invested in industry leading digital capabilities, introduced new packaging technologies, battled excise tax increase proposals and met new regulatory requirements. Similarly, as you heard from Brian, USFTC's revenue growth management uses data and analytical capabilities with greater precision to compete more effectively. We are now applying RGM across our entire business portfolio. From 2013 through 2016, the Smokeless Products segment expanded its already high adjusted OCI margins by more than 2 percentage points to 64.4 percent and increased total segment adjusted OCI by over $200,000,000 Our approach to cost control and productivity also contributes to the increased adjusted OCI margins.
Our consistent performance and long track record of cost discipline have enabled us to efficiently reallocate resources and invest for the long term. Since 2007 through the Q3 of 2017, our company's cost and productivity initiatives have generated approximately $2,300,000,000 in cost savings. Some of these savings have fallen to
the bottom
line, while some have been reinvested for the future we have been describing. For example, in 2012, we made investments in Marlboro's equity with the Marlboro architecture. More recently, as part of our 2016 productivity initiative, we invested in strengthening our company's digital marketing platform, harm reduction efforts and regulatory capabilities. Now that the FDA has outlined a clear path forward for harm reduction, we're prepared to make the appropriate additional investments in product development, regulatory science, distribution and brand building to expand our leadership there. We will make these investments from a position of strength to deliver leading products and brands as you have seen today.
The final item is the strength of our balance sheet. We have worked to position our balance sheet to provide the financial firepower and flexibility to be successful in this dynamic environment. A debt to EBITDA ratio of 1.3:one as of September 30, 2017 is further enhanced by approximately $1,000,000,000 of excess cash from operations after dividends on an annual basis. Put simply, we have the flexibility and we'll continue to make the investments we need to win. To sum up, we believe Altria is well positioned for continued success in this dynamic and exciting environment.
We have a strong track record of winning through a changing tobacco industry, and we have the tools, talent and experience to win through changes in the future. I will wrap up with our guidance. We are reaffirming our 2017 guidance to deliver adjusted diluted EPS in a range of $3.26 to $3.32 representing a growth rate of 7.5% to 9.5% from our adjusted diluted EPS base of $3.03 in 20 16. Now Marty, Howard and I are happy to take any remaining questions.
Okay. Thanks, Billy. All right. So we have just a couple of minutes. We want to keep on track here.
I see one in the back already.
Adam? Hi, it's Adam here. Just I want to make this absolutely crystal clear, some answers to questions you gave earlier. You remain committed to the 7% to 9% long term EPS algorithm, I think you said at one point. But you also said there might be investment years.
And I just want to given all the new products that you've outlined today, I just wanted to make sure that I understand how to match those 2 different statements.
Sure. What I tried to point out earlier and Billy just made reference to it in his remarks again, I think is that our long term aspiration is to grow our EPS 7% to 9%. That's a long term aspiration. And of course, we guide on an annual basis depending on the circumstances for the year. So I was trying to point out the distinction between that long term aspiration in any annual guidance, which as you know, Adam, we give that in January.
Anne?
Thank you. And then just referencing some of Billy's comments about robust pricing and balancing that pricing and the nice margins we're seeing and particularly the MST segment, how do we think about that balance versus future investments? And I guess I would argue in the latest price increase you kind of pushed towards the upper end of historic ranges. And is that how we should think about it in order to have enough to fund these investments you've laid out today, these future products, innovation, etcetera, if you could comment on that?
Let's start and
then you
can maybe go to Howard.
Yes. I wouldn't read anything into any individual price increase. I think there are a lot of factors that go into it. It's the economic conditions facing the consumer and how we feel about that. It's the competitive pressures in any given market and it's what's going on in the macroeconomic environment.
Gas prices is a factor. So we look at a multitude of things to decide what pricing is. You're right, if you take let's just take smokeable. It's been running in that range about 4% to 5% if you look over a more recent period. But there are a number of factors.
So I wouldn't read anything into a specific price increase.
And I would just add also, when you look at the cigarette environment, you've actually got an adult tobacco consumer where the economy is actually quite positive at this point. And if you look at price gaps, which we've always looked at, they're relatively narrow. So I think that that gives us confidence that we have a long runway. And then with regard to the large number of products, I think of the products that you saw are options for us to test with consumers to take through a series of steps to ultimately verify that they should be ramped up and get increased investment. And I think that, that discipline in doing that really is going to allow us to have a number of options to try with the adult tobacco consumer, but also to do it very cost effectively.
Okay. Vivien?
Thank you. I wanted to also focus on vapor margins and I recognize given all of the new products that you just showed us, this might be a little bit more of a difficult question to answer. But if I could I just take a step back and I look at a category that admittedly didn't grow last year, but it's 2 $500,000,000 you have a 13 share. At what point like what kind of scale do you need for profitability? Because that's already a pretty sizable position in an established category.
So just how do we think about Sure.
I think you are right that volume is a contributor to getting to attractive margins. I would also say that predictability of future demand is the other key variable, because a lot of times the way you get higher margins in the product is you automate. And frankly, I think what you've seen in the e vapor space is that there is some consistency of the products they're demanding, but particularly in this closed system space, there's still a fair amount of moving around of consumers. And so I think that you have to get some predictability there in order to really make progress on margins through automation.
Michael? Thank you. Just given that PMI has had some capacity issues with IQOS, how for your near term planning have you tried to factor that in? And then a little bit longer term, how do you think about what production dedicated in or for the United States might look like? And with their business in Latin America or Canada, is it something you might consider doing jointly or that you would likely pursue on your own?
Or I know it's a little early, but have you given some thoughts of that?
Sure. Our agreements contemplate that they'll provide us with capacity we need for our launch and for our lead markets. And obviously, we've been having discussions about depending on how the performance is about the capacity here in North America, it would make sense to have capacity in North America at the right volumes. And you're right to think about it as more of a North American strategy, I think, than an American strategy alone. But we'll have to see what the volumes look like.
But we are contemplating that in our long term plan. Okay. We have a question up here. Yes, ma'am.
Priya Ury Gupta from Barclays.
Billy, you talked about the financial flexibility that you have to make the investments that you need and specifically highlighted how low your leverage is right now along with the cash flow that you have available. How should we think about where that leverage can be flexed in determining sort of the total capacity that you have for some of these investments?
Yes, it's a great question. I will say we don't have any specific metric in mind as far as a specific number. What we do appreciate is that flexibility to your point. And so it allows us the flexibility if we see something to flex up, but it really is dependent. We want to make sure we're investment grade because we do access the commercial paper market.
But that would be the only factor that would factor in there. It wouldn't be a specific number in mind.
Questions? I just want to make sure I get around here to Jane. I'll come back, I promise.
Thank you. So there's a lot of debate outside
of the U. S. Around what markets appear more or less amenable to IQOS taking off the way it has in Japan. And I'm sure you've looked at the experiences of IQOS ex U. S.
Sarah mentioned Italy as one example.
What markets, if any, do you think
are the closest corollary to what you might expect the U. S. To look like or why would the U. S. Be different?
Yes. We get this question a lot and we give the same answer all the time. Our focus has been less on trying to extrapolate from this market to the U. S. And trying to understand what are the dynamics in that market relative to the dynamics in the U.
S, if that makes sense. And so for example, several of us spent time in Italy during the early launches, as you know, it's a very, very dark market, indeed darker than the United States. And so it was difficult for the consumer to get the information she needed to know what to do about that. So that's one experience. In Japan, on the other hand, as you know, it's quite open in terms of the communications and indeed and there's no vapor market there.
So what we have done with the IQOS team is try to pull out those dynamics to figure out for the United States where do they plot relative to what our dynamics are likely to be and then to build a plan based off of that as opposed to will be more like Japan than we will like Korea, like Italy because I think it's a bit of a false comparison. Now that said, I have to say PMI has been a tremendous partner for us. We have had total access to all of the market learnings. We've been in the markets with PMI. Sarah and her team spend regular time with the PMI team and they're with us.
So I think we have a pretty good read on what those dynamics are. Judy?
So I just wanted to go back to the long term growth algorithm question and recognizing that obviously it's an aspiration of the 7% to 9% and there could be an investment here. So first, does just transitioning to your aspiration to be the leader in non combustible products, does it inherently just introduce more volatility in terms of business planning and thinking about kind of the earnings growth year to year? And then secondly, I guess one could argue that you could have a once in a lifetime of an opportunity where you have a 2 or 3 year lead versus your competition on really accelerating that shift into this non combustible. So just trying to understand the level of investment that you're willing to make to really take advantage of that opportunity.
Yes, I think it's a good strategic question for us. Maybe we can begin by going back to what the past has been. So we've had this long term growth aspiration for the last several years. And I think on average, we've grown adjusted diluted EPS about 8%, almost spot on 8%. If you look at what happened during the period of time that we've been able to do that, we had the greatest recession since the Great Depression.
We took a federal excise tax increase of 150% on cigarettes. We had the installation of FDA and all of the costs that came with installing regulatory capability to deal with it. And then as you can tell, I hope from this morning's presentation, we've been making investments kind of underneath all that in order to be ready for this. So that's the place to start, I think, which is it isn't like we haven't had periods where we have higher costs in our business and thus there's a big change in the 7% to 9% aspiration and begin there. It is always a question I think about where the market is about when is the right time to invest.
We are prepared for example and I think you help but take that from Howard's comments and from Sarah's comments that we want IQOS to be a big success in the United States and we are prepared to invest behind that. But when we run our models and when we look at what we've been doing, we believe that we can continue to do that. I just don't want people to mix up a yearly guidance with a long term aspiration. But the businesses, when you look at the I don't mean for this to sound both flurr arrogant for a second, I really don't. But we are the market leader.
I believe we have the best installed manufacturing capacity. You just saw it out there and how we're using it. We have the best brands. We have leadership advantages that we should be able to turn. This is not like we used to be like this and now it's going to be like that.
The way we think about it is, it's like this today and now we have a growth opportunity that's been added to that platform. So if you think about it like that, it's less of a binary. You used to do it this way and now you have to do it some other way. So we don't think about it that way. We think about this as a growth opportunity and we place resources where we think growth will pay off for the long term for the investor.
And we'll take a long term view.
Thanks. I guess I have
a question on Marlboro. There have been questions, concerns from investors about the softness that we've seen from Marlboro. You guys have certainly talked about that and things that you're doing to improve that and turn things around. So let's pretend we're all here a year from now. You're going to fight us back.
What would you consider success would look like for Marlboro at that time? Would it be stabilized share increase? Just want to get a sense from you what your targets or goals are for maybe Marlboro?
Yes, I don't want to be too precise about that because all you do is signal to the competition about what you're going to do with your lead brands. So I want to be careful about that. But I think I heard Casey say, which I think we would endorse is, he's taken actions to stabilize the Marlboro share. We have some unique events and we also have some structural dynamics in the marketplace. So the unique event obviously is California had not taken an increase in a very long time.
It takes $2 It's a big shock to the system and we over index out there. So that's just a unique event that we have to manage our way through and we've been trying to do that. I mentioned a couple of times, I think on some earnings call, however, there is a different market dynamic also, which is you have far fewer unprotected brands in the marketplace because of industry consolidation. Our estimate is prior to the latest consolidation there were probably 12 or 13 share points that were relatively unprotected in terms of marketing support. And so Marlboro used to regularly pick up its share that is with some of our competitors.
Well, we're probably down to about 2 share points. So there's less to pick up from that. The key thing for us is to remember what the strategy is in the smokeable segment, which is to maximize its income while maintaining momentum. And it's also why we measure momentum by more than share. Okay.
It's easy I think to fall into the share trap. But when we look at its equity and when we look at its pricing power and we look at its demographics and we look at its share, we'd look at that altogether. But the key thing in the smokeable segment because of the volume dynamic is you want to maximize income when you can. I don't know, Howard,
I think you answered the Marlboro question very well. I think that given the size of Marlboro and the attention it gets and the health of that brand, we tend to focus on that quite a bit. But if you look over the last 3 or 4 years, we also had our L and M discount brand that performed quite nicely at the same time that Marlboro was growing share. And I would expect if you look at the end of next year that we'll have a contribution NAPS and we'll have a contribution from the B and H menthol packing. So I really agree with what KC said, which is, I expect that we're going to maintain the momentum on Marlboro and we're going to have these more surgical brand tools that will also contribute to the portfolio.
Question, I'd say that there's one up in the back, maybe we'll try to get to the back of the room.
Thank you. Brian Cowen from Bank of America Merrill Lynch. In light of the potential for tax changes and the loss of interest deductibility, I guess, does it incentivize you? Or how would you think about making any changes with regard to the balance sheet? And then are you considering additional liability management exercises around any of your high coupon or higher coupon debt?
Yes. It's a great question. I think we'll have to wait and see what the tax proposal is before we can really decide what to do. There's been many proposals around exactly what they're going to do with the interest deductibility. No overall, if you step back from that, any rate reduction not offset by something huge that would impact us is a huge benefit to us.
So that's a great positive. As far as future liability management, it's all dependent on what the market conditions are. We've done a really good job of managing our towers and getting that coupon rate down to just under 5% now. So we feel really good about where we are, but we'll monitor the marketplace to see if there's anything to take advantage of.
I mean just to dimensionalize what Billy is saying about the rate, I mean our effective tax rate is about 35%. I guess the proposal that came out today was 20%. So obviously on our base, it would be a huge advantage for us which would allow us more firepower to invest in the things that we've been talking about today.
Matt? Thanks, Marty. Just I'm curious how you think about the relative pricing looking forward of reduced risk products versus cigarettes in the U. S. And I know it's ultimately going to be dependent on regulatory treatment and taxation and there's a lot of unknowns there.
But any market these products are launching in, there's that tension between ensuring affordability for all tobacco users and communicating and extracting sufficient value for the investments you've made and the premiumness of it. So I know there's not one answer, but any directional thoughts you can
Well, I can give you a strategic concept is I think that the price that one can charge for products in the marketplace go to their inherent value. And to the extent that there is marketplace that have sensory attributes that people like, but they don't have the harm associated with them, you would think that it would command premium pricing. The tax does matter. And obviously, I think you also have to plot it over time. At the beginning, you have to price so as to incent trial from adult smokers.
But over time, you would like to have obviously premium or better pricing on those products. Other questions? The lights are hard for me in the back.
Okay, we're back to you Michael.
I don't want to beat to death, but I just want to
visit some
of your thinking one more time quickly. And check me if I'm
wrong, maybe. You've
had years in this stretch of the 8% that you've started with 6% to 9% guidance. And so that shouldn't spook anyone, I think. Is that correct? And as you think about it, part of that, of course, is just some of the uncertainty of any given year. But as you think about the longer term, you also have investments you've been making and some ability to shift those.
And so is there anything particularly unusual that you would flag? Or I think this feels like investments is part of what you do and that it's something you can weather pretty well.
It is. That's exactly the way to think about it. Billy has described this before. The way that we build our budget every year I think is well known to people. We have these operating companies that are able to generate operating company income.
We put that into our model. We get income either equity or otherwise from our alcohol assets. We have a pricing plan. We look at our investment strategy. Others have written about how if it's particularly strong, for example, in the beer contribution that we can make other adjustments elsewhere.
We have many levers, including all those and the balance sheet. That's how we build the budget every year and that's what we tell you guys about when we set our guidance in January. It's the same process. Thank you. Looks to me like we have time for one more question or there's going to be a run for the bus.
I can't tell. Okay. It looks like it's a run for the bus. So that concludes our day. For those of you who are on the webcast, I want to thank you for joining us very much.