Welcome to the Altria Group 2014 Second Quarter Earnings Conference Call. Today's call is scheduled to last about 1 hour, including remarks by Altria's management and a question and answer session. Representatives of the investment community and media on the call will be able to ask questions following the conclusion of the prepared remarks. I would now like to turn the call over to Ms. Sarah Nokness, Vice President of Investor Relations for Altria Client Services.
Please go ahead, ma'am. Good morning and thank you
for joining us. We're here this morning with Marty Barrington, Altria's Chairman and CEO and Howard Willard, Altria's CFO to talk about Altria's 2014 business results for the Q2 and the first half. During our call today, unless otherwise stated, we're 2013. Earlier today, we issued a press release regarding our Q2 and first half results. For a detailed review of Altria's business results, please review the earnings release on our website at altria.com.
Our remarks contain forward looking and cautionary statements and projections actual results to differ materially from projections. Actual results to differ materially from projections. Ultra reports its financial results in accordance with U. S. Generally Accepted Accounting Principles.
Today's call will contain various operating results on both a reported and adjusted basis, which excludes items that affect the comparability of reported results. Descriptions of these measures and reconciliations are included in today's earnings release and are available on our website. Now I'll turn the call over to Marty.
Thanks, Sarah. Good morning, everyone, and thanks for joining our call. In the first half of 2014 Altria delivered adjusted diluted EPS growth of 5.2% and we made good progress against our full year plans. Our company's leading premium brands and the strength of our diverse business model continued to deliver value for shareholders. Here are the highlights for the Q2 and first half of twenty fourteen.
The Smokeable Products segment delivered adjusted operating companies income growth of 3.6 percent in the 2nd quarter and 4.9% in the first half, while maintaining modest retail share growth on Marlboro. In the 2nd quarter, Marlboro achieved excellent retail share of 44 points, up 3 tenths from last year. For the first half, Marlboro share grew 1 tenth to 43.8 share points. Adjusted operating income margins also increased both in the quarter and the first half with pricing as a key driver. So year to date, the Smokeable Products segment's performance has been strong.
In Smokeless, in the first half of twenty fourteen, USSTC focused on strengthening the Skol value equation in part by better managing price gaps on Skol Classic. On a sequential basis, Skol's retail share was unchanged versus the Q1. Copenhagen and Skol delivered 2nd quarter retail share of 51.1 share points, up 0.4 from last year and the highest combined share since we acquired UST. For the first half, Copenhagen and Skol delivered combined retail share of 51 points, an increase of 0.3. Operating companies income grew 5.6% in the 2nd quarter and 6.5% in the first half, while operating companies' income margins expanded to 66.6% and 64.5% respectively.
Our smokeless business continues to perform well in a competitive environment in line with its strategies. Turning to innovative products. Newmark began the national expansion of Mark 10 e vapor products in June in the western half of the U. S. Mark 10 achieved strong distribution in over 60,000 stores.
These stores account for more than 70% of cigarette industry volume in the Western U. S. Where MarkTen is distributed. Newmark is also making good progress integrating Green Smoke into its business starting with a well established supply chain that Green Smoke adds to Newmark. Altria continued to reward shareholders through dividends and share repurchases.
Altria paid shareholders almost $1,000,000,000 in dividends in the quarter and nearly $2,000,000,000 in the first half. As of July 18, our annualized dividend yield of 4.6% surpassed the S and P 500 yield of 2% and the 10 year treasury yield of 2.5%. We expect to return a target payoff of adjusted diluted EPS in the form of dividends. In the 2nd quarter Altria repurchased $132,000,000 of its common stock at an average price of $40.72 We expect to complete our current $1,000,000,000 share repurchase program by the end of Q3 of 2014. Further, Altria's Board recently authorized a new $1,000,000,000 share repurchase program to enhance shareholder value.
We expect to complete this new program by the end of 2015. Timing of share repurchases depends on marketplace conditions and other factors. And of course dividends and share repurchases remain subject to the discretion of our Board. Based on our results so far and expectations the diluted EPS growth of 7% to 9% in a range of $2.54 to $2.59 off an adjusted base of $2.38 per share in 20.13. We also expect to achieve full year reported diluted EPS in the range of $2.54 to $2.59 We expect stronger adjusted diluted EPS growth in the second half of the year, particularly in the Q4 driven by various factors including lower 4th quarter costs in the smokeable products segment due to the end of the quota buyout payments and a significantly lower 4th quarter effective tax rate compared to the year ago period resulting from our 2013 debt tender offer.
So in all, we're pleased with the progress we're making against our strategies and financial goals and the momentum we are carrying into the second half of the year. Will now provide additional details on the quarter and the 1st 6 months.
Thank you, Marty. Good morning, everyone. Altria grew 2nd quarter adjusted diluted EPS by 4.8%, primarily driven by higher adjusted operating company's income in the smokeable and smokeless product segments, lower interest and other debt expense and fewer shares outstanding. These factors were partially offset by the investments we're making in innovative products and comparatively lower operating companies' income in the Financial Services business. As Marty mentioned, the Smokeable Products segment's adjusted operating company's income grew 3.6% to $1,800,000,000 in the 2nd quarter and 4.9 percent to $3,300,000,000 in the first half.
In both periods, higher pricing was the driver, partially offset by lower cigarettes shipment volume. As we anticipated the Q2, the trade reduced inventory levels they built during the Q1. After adjusting for trade inventory fluctuation and other factors, PM USA estimates that its 2nd quarter and first half cigarette shipment volume declined approximately 4% and that industry volume declined approximately 4.5% for both periods. PM USA grew total retail share by 0.3 to 51 share points in the 2nd quarter and 0.2 to 50.8 share points in the first half of twenty fourteen. In addition to Marlboro's strong retail share, L and M continued to grow retail discount share.
John Middleton also contributed to our solid first half smokeable segment results. Middleton Cigars shipment volume increased 11.1% in the 2nd quarter and 6% for the 1st 6 months, supported by Black and Mild in the Tipped segment and the expansion of Royal Comfort in the Untipped segment. While the competitive environment remains challenging, Black and Mild's retail share was essentially flat for the first half of the year. In Smokeless, operating company's income increased 5.6 percent to $285,000,000 in the 2nd quarter and 6.5 percent to $524,000,000 for the first half of twenty fourteen. Through the second quarter, USSTC and PM USA achieved a 55.1 share of the category, benefiting in part by continued momentum Copenhagen Long Cut Wintergreen.
Changes to Skol's promotional strategy resulted in trade inventory shifts that negatively affected smokeless shipment volume in the first half of the year. After grew 3.5% in both the second quarter and the grew 3.5% in both the second quarter and the first half. And the smokeless category volume grew approximately 4.5% over the past 12 months. In the Wine segment, operating companies income was up 12% in the second quarter and 11.1 percent for the first half of twenty fourteen. Shipments increased 1.9% in the quarter 1.5% in the first half.
In both the quarter and the half, strong volume performance by Chateau Ste. Michelle and 14 Hands was mostly offset by lower shipments of Columbia Crest and other brands. That wraps up our operating results. Marty and I will now take your questions. While the calls are being compiled, let me cover a few second quarter housekeeping items.
Marlboro's price gap versus the lowest effective price cigarette was 33%. Marlboro's net pack price was $5.93 up $0.15 from the Q2 of 2013. The lowest effective priced cigarette was $4.47 up $0.17 from the Q2 of 2013. The cigarette discount segment's retail share was 24.8%, down from 25.2% in the Q2 of 2013. The estimated weighted average cigarette state excise tax at the end of the second quarter was $1.48 per pack, up $0.06 from the end of the Q2 of 2013.
Wholesale inventory changes are one factor PM USA uses to estimate adjusted PM USA and industry volumes. PM USA estimates that for 2014 wholesale inventories were approximately 2,100,000,000 units at the end of the 2nd quarter and 2,500,000,000 units at the end of the 1st quarter. Last year PM USA's wholesale inventories were estimated to be approximately 2,200,000,000 units at the end of the second quarter and 2,300,000,000 units at the end of the first quarter. PM USA estimates that for 2014, cigarette industry wholesale inventory levels were 4,800,000,000 units at the end of the second quarter and 5,500,000,000 units at the end of the Q1. Last year, we estimate that wholesale inventory levels were 5,600,000,000 units at the end of both and first quarter.
Copenhagen's price gap versus the leading discount brand was 31%. Copenhagen's retail price was $4.10 up 0 point 0 $6 from the Q2 of 2013. The price of the leading discount brand was $3.12 up $0.14 from the Q2 of 2013. CapEx was $33,000,000 and ongoing depreciation and amortization was $50,000,000 For the first half, CapEx was $60,000,000 and ongoing depreciation and amortization was $100,000,000 Operator, do we have any questions?
Thank you. Your first question comes from the line of Michael Lavery of CLSA.
Good morning. Good morning, Michael.
I wanted to just actually talk about a hypothetical a little bit and just in terms of looking at SAP and if somebody were interested in trying to find that asset, can you just help us understand a couple of things? 1, first in the mechanics, is it right to assume that every shareholder yourself included would be treated the same so that for instance you couldn't get shares and somebody else's cash? And then especially if a cash deal is sort of the proposal, how do you think about what would make it interesting for you in terms of do you just look at accretion? Is it do you measure economic profit differences? Or how do you think about the valuation creation or potentially dilution that comes with that?
Sure. This is Howard. I think any acquisition is going to be governed by U. K. Takeover law, which has a number of protections in place to try and ensure that shareholders are treated fairly.
And so I think at the highest level that would certainly govern the transaction. I think with regard to a cash deal, I think we would evaluate that the way we would any potential transaction for SAB and we would evaluate it through the eyes of the Altria shareholder and determine whether or not we thought that provided significant enough incremental value to warrant giving up the strong performance that we've gotten on an ongoing basis from S. A. D. Miller.
And I think that we would vote our shares based on that view.
Okay. That's helpful. Thanks. And then just one last question. Smokeless, at least I think I do it on kind of a servings equivalent if it just loose, but it's around 7% of your volumes and 14% of EBIT.
Certainly those margins are fantastic. E cigarettes are sort of getting all the attention on the margin these days, but with 2 very different margin profiles in those businesses and of course different potential long term opportunities. How do you think about allocating resources or making those investments in terms of if those compete for resources with each other at all?
Yes, that's a good question. I mean, we allocate resources obviously based on the core businesses that we have today. You've mentioned 1 which is smokeless. Of course, we have smokeable and wine. And we obviously have strength in our core businesses.
They're terrific businesses with leading positions, great shares, great margins and so forth and so on. With respect to innovative products, the way that we're going about that Michael is to have a disciplined approach to innovating our way forward. You saw that for example about the way we handle test markets in Indiana and Arizona before we determined to do a national launch. So it's a little early as everyone keeps saying to know about margins in the e vapor But we're focused on the adult tobacco consumer. And if they're interested in these kind of innovative products, we want to make sure that we're developing positions there.
And in any category which emerges we intend to be the market leader. That's great. Thanks very much. Thank you for calling.
Your next question comes from the line of Judy Hong of Goldman Sachs.
Thank you. Good morning, everyone.
Good morning, Judy.
Marty, obviously, we had the major announcement last week, which if the deal does go through potentially changes the competitive landscape with 2 of your competitors getting bigger and then obviously Imperial getting bigger in the U. S. Market as well. So just wanted to get your thoughts on what you think the competitive implications might be and how you're thinking about your strategy going forward in maybe a different competitive environment?
Well, thank you for your question. As I'm sure you can understand, I'm not going to comment on a transaction that's been proposed by others. I think the questions there are best directed to them. But I can tell you that at Altria we're the market leader today. We would be the market leader after any transaction has been proposed.
We are really focused on maintaining our market leadership. That's what we've told our organization and that's how we're thinking about it.
Okay. That's fair. And then maybe just in terms of the cigarette industry trends, Marty. I guess this year the industry decline declining of sort of 4.5% is probably a little bit worse than what we've seen. And then maybe the pricing at the same time though is getting better.
So is that how you kind of characterize the environment maybe the overall volume is a little bit softer, but the industry is getting actually pretty healthy pricing and the competitive dynamics are a little bit more rational and that's kind of the balance that we're seeing at this point?
Yes. So let's talk about those at turn. Good questions both. The volume our estimate of course is 4.5%. I would counsel folks not to over read one estimate in 1 quarter.
If you go back and you look at the historical line rates say for the last 3 years actually you see an average rate over that period of about 3.5% and it's been as high as 4%, it's been as low as 3%. So they bounce around a little bit, which is why we always say and believe that we should read them over time. It is higher at 4%, 5%, but I wouldn't over read again one estimate. Certainly, PM USA had very nice pricing realization. In fact, it's having quite a strong first half.
Its income is up nearly 5%. Its margin is growing. Price realization is strong. So I would tell you that at least from our perspective, I think what PM USA is doing is spot on strategy. We're trying to maximize the income.
We're trying to keep modest share momentum on Marlboro. And I think that the dials that they've been moving at PM USA in the first half have really worked very, very well.
Okay. And then lastly, Howard, just in terms of your guidance change, so the low end is coming up by $0.02 what's driving that change?
I think probably the biggest driver of that is the performance we've had in the first half. We feel like we've had a good performance in the first half. Our strategies have been progressing quite nicely. And frankly, the risk of anything upsetting those strategies in the first half has kind of passed now. And so we feel like we're in a position to kind of narrow the range that we think we can hit for the year.
Got it. Okay. Thank you.
Goody, thanks for calling.
Your next question comes from the line of Owen Bennett of Nomura.
Hello, Owen. Are you there?
It seems that line has disconnected. Your next line question comes from the line of David Adelman of Morgan Stanley.
Hello, David, are you there? Operator, can we check our connections please to make sure people are in the queue?
Your next question comes from the line of Vivien Azer of Cowen and Company.
Hi, good morning.
Hi, Vivien.
So my first question has to do with Marlboro. Clearly, the share momentum is good with share gains accelerating sequentially into the Q2. I know you guys don't comment on kind of specific lines of the Marlboro brand family that drive outsized performance. But if you could offer any color at all in terms of the share gains that would be helpful.
You're right, Vivien. We don't offer specific insights in the lines of the Marlboro business. But sure, I think that what you see is that the Marlboro franchise overall is performing very well. Since we've put in the Marlboro architecture and in particular with the new platform of Marlboro Black, which has been quite successful, what you see is that Marlboro really has continued to perform very well. I think that speaks to the strength of the architecture.
It's a big brand and we have now opened it up I think to the possibilities that it has in terms of marketing slightly differently to different segments within the franchise, attracting competitive smokers while all the time being faithful to Marlboro's positioning. And I think that's what we're seeing play out in the marketplace.
Fair enough. Very early days on Mark 10 to be sure, but any kind of initial color that you'd like to offer in the first month of the national expansion?
Well, we're pretty encouraged. It is early, but we have achieved strong distribution. It's now in 60,000 stores, which is quite a lot in a short period of time. It's been enthusiastically received by the trade, Vivian. And as you know, we have a lot of confidence in that product.
So we're very, very pleased to be able to roll this out nationally and we'll be moving eastward as the year goes on. But we're off to a good start is what I would say.
Okay. Fair enough. And last thing, I know you guys weren't a party to the lawsuit against TypTap the resolution that was announced yesterday. But do you have any comment on how you think that might impact the FDA's view of menthol in the sciences they published their report?
I haven't read it yet. I just saw the press reports. But I would say that the press reports are consistent with the position that our regulated companies took with the FDA really for the last 4 years. Our position was the composition of the TypSAC was flawed by appointment of people that had conflicts of interest. We thought it was inconsistent with the statute.
And we have been calling on FDA as you know if you look at the filings that are available on our website consistently to try to correct that. So I'm sure that we're trying to be a constructive partner at FDA, but it's important for the integrity of the system that everybody play by the rules. So I'm sure FDA is assessing what it will do. And I haven't seen anything from them yet this morning.
Fair enough. Thank you very much.
Thanks for calling.
Your next question comes from the line of Bonnie Herzog of Wells Fargo. Good morning.
Good morning, Bonnie.
I have a follow on question on March 10. So you mentioned you have distribution over 60,000 retail points since you began the national rollout. So how quickly do you anticipate getting to full distribution? And then it seems like the focus right now is expanding the distribution. So I'd like to hear how big of a priority technology and innovation are for you?
Yes. Good question. So our plan as we've described previously is to have a rolling launch. We started that in June in the 25 states in the western part of the country. Obviously, as you're building a new brand and you're building capacity, you want to roll this out.
Over time, you want to be cognizant of having product in the stores so that people can get it, no out of stocks and the like. So we'll be rolling eastward as we go through the summer and into the fall. And that's how we're thinking about the distribution. Distribution is important, but it's not the only thing and you've touched on a couple of others obviously. I continue to be very encouraged by the product development pipeline I see out of Newmark in e vapor space.
And so as everyone knows I know and many have written, the consumer continues to move around unsurprisingly in a new category about what they want out of these products. And so we are hard at divining those consumer insights and having products that are available for them. So while we're excited about Mark 10, I don't think it's the last thing that anyone should expect either from us or others.
Okay. That's helpful. And then I had a quick question on your SG and A expense in the quarter. It was up 21% year over year and was almost 14% of sales. So I guess I'm assuming this is primarily due to the rollout of Mark 10, but could you talk about any other potential factors for this being high?
And then really how we should think about your SG and A going forward?
Yes. Hi, Bonnie. This is Howard. Hi. I think certainly one of the drivers in the quarter was as you pointed out the rollout of Mark 10.
Given that this was the quarter that we did the Western launch that was an impact. But I would also say too that historically you've seen some movement quarter to quarter in the amount of SG and A expense and we tend to budget that on a full year basis. So I think that you'll get a better idea of the trend by looking at that on the full year basis. And I think while certainly the innovative product space is going to have an impact, we continue to have quite a focus on reducing costs in the core and you should continue to see us focus quite sharply on that. But that's going to probably reveal itself on a longer term basis looking at annual trends.
Okay. And then if I may, I just had one final question a little bit of a follow-up. Given the expected changing industry dynamics, maybe you could remind us of your priority in terms of how you're going to continue to strike the optimal balance between growing market share and defending your turf while trying to maximize profitability?
Well, again, I'm not going to comment with regard to any proposed transactions, but I will tell you I guess 2 things. Smokeable segment remains the same. We're trying to maximize income while making sure that we have modest momentum on Marlboro. That's been the winning strategy for decades and that is not going to change. The other thing I just would observe is that change constant in business and we at Altria prepare for all scenarios.
And I think that's the way to think about it, which is we're prepared to compete today and we're prepared to compete tomorrow.
All right. Thank you for that.
Thanks for calling.
Your next question comes from the line of Chris Growe of Stifel.
Hi, good morning. Hi, Chris. Good morning.
Hi. I just had two questions for you if I could. I just wanted to get a little better sense around the Q4 expectations. We I think we've known all along it's going to be a pretty strong quarter for you with the MSA cost reductions and
as well as
the tax rate decline year over year. I don't know if maybe Howard can give a little more color on the tax rate decline.
Is that still expected to be down? I think
there was I think you used the word significant in the press release. I just want to get maybe a little more flavor for how much it could be. But then just to understand your thoughts around the MSA cost savings and any change in your view given the competitive conditions in the category? I think a lot of that could come to the bottom line.
Sure. I'll ask Howard to comment on that for you Chris.
Sure. I think we've communicated that our full year tax rate is expected to be about 35%. And if you compare that to the back half of last year, you see that that's significantly lower. And in the Q4, I think last year's tax rate was a little in excess of 37%. So that gives you an idea going from 37% to 35 that's a pretty significant impact.
And then with regard to the FETRA payments, quarter's impact that would be estimated to be about 100 a quarter's impact that would be estimated to be about $100,000,000
Okay. If I
could ask a question and thanks in advance for the inventory information you gave today.
It was very good.
I just want to get a sense of where you think the your inventory levels are impressive for the category are currently just to get kind of a base case based on numbers you've given. So I think they're down a lot year over year in the Q2 for the industry. Is that considered a low level? Or is that a level you think that's pretty normalized going forward?
I would say at the end of the second quarter, I mean the one thing to remember always is that they tend to wash themselves out over the year Chris. So they do go in and out a little bit for the quarter. But at least for PM USA the inventory levels tend to wash themselves out over the year. And the other thing to understand is as industry cigarette volume does come down over time you would expect for wholesale
inventories to come down with them.
But I don't think there's any 2nd quarter.
Okay. Thank you for the time.
Thanks for calling.
Your next question comes from the line of David Adelman of Morgan Stanley.
Good morning. Can you hear me?
Hi, David. We lost you there. I'm glad you called back.
Okay. Great. Thanks, Marty. A couple of quick things from me. First out of curiosity, given the prospect of real competitive change amongst your competitors in the U.
S. Cigarette market, going into the prospect of that transaction closing or those transactions closing and then the subsequent aftermath, are there particular strategies to try to be opportunistic, because there could be some disruption that you've already planned for or even starting to implement?
I guess what I would say David is what I said once or twice already this morning is that I'm not going to comment on the transaction that's been proposed by others. What we do at Altria is we focus on our business. We're the market leader today. We have the leading positions, the leading brands, I think superior infrastructure. I would expect for all of that to obtain.
It is true that the competitive environment changes and you take that into account when you set strategy. And it will be unsurprising to you to know that Altria has examined lots of scenarios over time to examine how best we might compete. So all that work has been done, but I think it's both premature and inappropriate for me to say what those might be.
Okay. Second question. If Laurelard and Reynolds do combine as planned and are successful in achieving the cost synergies that they envision that combined company would have per pack controllable costs that are considerably lower than where PM USA's per pack costs are today, that company would be smaller than you are and it would have a more diverse brand portfolio than you currently have. And I'm curious if they are successful in achieving that would that cause you to sort of take a fresh look at your overall cost structure? Do you think that that would indicate that there are further opportunities to make sizable cost reductions at PM USA?
David, I admire your persistence and I'm sure you will appreciate my answer, which is I'm not going to comment on a transaction by others. But I would say this, we look at our costs all the time. And you've seen where PM USA is in terms of its controllable cost. And I don't think anybody should have reason to think that we won't continue to have that focus on controlling our cost. It's part of the algorithm for growth.
Okay. And then lastly a question about the with during this quarter, the price verdict was reinstated. And I'm curious as a result of that was there any change in the policy or the timing and the magnitude of intercompany cash, cash flows from PM USA to Altria?
Hey, David. I really don't think it had any impact. I mean, we continue to have a strategy to address the reinstatement of that verdict and we've been managing our businesses much the way we have over the last several quarters.
Okay. Thank you.
David, thanks for calling back in.
We now invite the media to ask questions. Your next question comes from the line of Michael Silverbaum of the Associated Press.
Good morning. I'm curious as far as the your Mark 10 evapour products go, how do you see Altria's ability to become a market leader in that category when the company is kind of the last of the majors to enter the category on a national level? And what differentiates your product that will help that growth? Sure. Thank you for your question.
I would say the following. One is, it's very important to remember that the e vapor category is just really beginning. It's emerging. It's very early days. There's very little brand equity that has been built by anyone.
The products continue to change over time. So I think the idea that the category is somehow fully developed and we're late to the game is not the right way to look at it in our view. I would say the second thing that gives us confidence in our ability to move to market leadership in the e vapor category is the fact that we are the market leader in every category in which we compete virtually. So whether it's cigarettes or smokeless or our wonderful wine company, what we've done is we've built terrific brands with superior products satisfied adults in a way that allow us to build our businesses. So that's how we're thinking about it.
This is the business we were in. These are the consumers that we set out to satisfy. And if consumers are interested in e vapor products, we want to be the best at it. Thank you. Thank you for your question.
Thank you. At this time, I would now like to turn the call over to Ms. Sarah Nokomis for closing remarks.
Thank you, everyone, for joining our call this morning. If you have any follow-up questions, please contact us at Investor Relations.
Thank you. This does conclude today's conference. You may now disconnect.