Good day, and welcome to the Altria Group 2013 fourth quarter earnings conference call. Today's call is scheduled to last about one hour, including remarks by Altria's management and a question and answer session. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question at this time, simply press star, then the number one on your telephone keypad. To withdraw your question, press the pound key. Representatives of the investment community and media on the call will be able to ask questions following the conclusion of prepared remarks. I would now like to turn the call over to Ms. Sarah Knakmuhs, Vice President, Investor Relations for Altria Client Services. Please go ahead, ma'am.
Thank you. Good morning, everyone, and thank you for joining us. We're here this morning with Martin Barrington, Altria's Chairman and CEO, and Howard Willard, Altria's CFO, to talk about Altria's results for the fourth quarter and full year of 2013. During our call today, unless otherwise stated, results are being compared to the same period in 2012. Earlier today, we issued a press release regarding our fourth quarter and full year 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 projection of future results. We direct your attention to the forward-looking and cautionary statement section at the end of today's earnings release for review of the various factors that could cause actual results to differ materially from projections. Altria reports its financial results in accordance with U.S. Generally Accepted Accounting Principles.
Today's call will contain various operating results on both a reported and adjusted basis, which exclude items that affect the comparability of reported results. Descriptions of these measures and reconciliations are included in today's earnings press release and are available on our website. Now I'll turn the call over to Marty.
Thank you, Sarah. Good morning, everyone, and thanks for joining our call. Altria successfully delivered against its financial goals in 2013 and continued its strong track record of delivering earnings and dividends growth for its shareholders. For the full year, Altria delivered adjusted diluted EPS growth of 7.7% on the strength of its diverse business model and solid performance by its core tobacco businesses. We also enhanced our capital structure in 2013 and provided significant cash returns to our shareholders. We increased our dividend by 9.1% in 2013, our 47th dividend increase in the last 44 years, and paid shareholders more than $3.6 billion in dividends. Altria further rewarded shareholders by repurchasing shares totaling $600 million in 2013. We have approximately $457 million remaining in the current $1 billion program, which we expect to complete by the end of the third quarter of 2014.
Of course, the timing of any purchases will depend on marketplace conditions and other factors. In the fourth quarter of 2013, Altria tendered for high coupon debt and replaced it with new, lower cost debt. These transactions, along with the retirement of debt at its scheduled maturity, improved our debt maturity profile and lowered future interest expense. As a result of our 2013 capital markets activities, Altria reduced its weighted average coupon rate to 5.9% at year-end 2013 from 7.2% at year-end 2012. We also delivered on our cost reduction commitments. Altria completed its cost reduction program in the fourth quarter of 2013 by achieving $400 million in annualized savings versus previously planned spending. Altria continued to deliver value to shareholders through its diverse income streams, including our equity investment in SABMiller, which generated pre-tax income of approximately $1 billion for Altria in 2013.
In summary, in 2013, Altria complemented its operating company's performance by effectively employing multiple tools, cost savings, share repurchases, debt management, and its SABMiller investment to enhance shareholder value. Let's turn to the performance of our core businesses. In the smokable product segment, PM USA delivered on its strategy to maximize income while maintaining modest share momentum on Marlboro over time. The segment grew adjusted operating companies income for the quarter and the full year, primarily through higher pricing. Investments in the Marlboro brand architecture and product expansions helped PM USA balance income growth and share gains to maintain its marketplace leadership. Marlboro grew one tenth of a retail share point for the year. In the smokeless product segment, our strategy is to maximize income by growing volume at or ahead of the smokeless category and to maintain modest share momentum on Copenhagen and Skoal combined.
In 2013, the smokeless product segment produced solid adjusted operating companies income growth, primarily through higher pricing and volume, and grew Copenhagen and Skoal's combined volume and retail share. Driven by its strong brand equity, Copenhagen performed well in both the quarter and the year, while Skoal continued to face strong competitive pressure. In the wine segment, Ste. Michelle delivered double-digit operating companies income growth for the full year through higher pricing and its focus on increasing distribution of premium wines. Altria also took important steps in 2013 to develop and commercialize innovative products for adult tobacco consumers. In the fourth quarter, Altria increased its investment in the e-vapor category. Nu Mark expanded the MarkTen e-cigarettes test market into Arizona with a new flavor system and packaging configuration. MarkTen is off to a very strong start in Arizona and has been effective at gaining trial.
It's now available in about 1,900 Arizona stores and about 5,000 stores across both the Arizona and Indiana test markets. Nu Mark is making good progress in understanding adult smokers' and vapers' preferences and the MarkTen value equation in a disciplined way. In December, Altria announced its agreements with Philip Morris International that create opportunities to commercialize our e-vapor products internationally and to expand our innovative products portfolio in the U.S. Through licensing, regulatory engagement, and contract manufacturing arrangements, Altria is providing PMI with an exclusive license to commercialize Altria's e-vapor products internationally. PMI is providing exclusive rights to two of its innovative next-generation products to Altria for commercialization in the U.S. We have also agreed to cooperate with PMI on scientific assessment, regulatory engagement, and sharing of improvements regarding these products.
We view these agreements as mutually beneficial to us and PMI and an important opportunity to advance Altria's development of innovative products for adult tobacco consumers. 2013 was a successful year for Altria. We delivered against our strategy to maximize the core tobacco business while innovating and investing to grow new revenue streams for the future. Altria delivered 2013 total shareholder return of 28.6%, which outpaced the S&P Food, Beverage & Tobacco Index's return to 23.9%. Looking ahead to 2014, our core tobacco businesses are well-positioned to deliver strong income growth through their leading premium brands. We also expect to benefit from lower interest expense, a lower effective tax rate, and a reduction in shares from our ongoing current share repurchase program.
However, we plan to make disciplined and incremental investments to build our e-vapor business, and we anticipate continued variability in gains from asset sales at Philip Morris Capital Corporation. Finally, although some economic indicators are improving, adult tobacco consumers continue to face challenges. Altria thus forecasts its 2014 adjusted diluted EPS will increase by 6%-9% to a range of $2.52-$2.59 from its 2013 base of $2.38. I'll now turn things over to Howard, who will discuss our business results in more detail.
Thank you, Marty. Good morning, everyone. As Marty mentioned, each of our reportable segments grew adjusted operating companies income in 2013. Notably, each of the segments also expanded adjusted operating companies' income margins through solid price realization and a continued focus on cost management. Although we have concluded the $400 million cost reduction program, we will continue to focus on carefully managing costs in 2014. In the fourth quarter of 2013, the smokable product segments reported operating companies' income increased 4.5% to $1.6 billion, primarily driven by higher pricing, lower selling general and administrative costs, and lower restructuring charges, partially offset by lower reported shipment volume. The segment's fourth quarter adjusted operating companies' income grew 3.6%, and its adjusted operating companies' income margins grew 2.2 percentage points to 42.1%.
For the full year, Altria's smokable product segment grew reported operating companies' income 13.2% to over $7 billion, primarily through higher pricing. PM USA's Non-Participating Manufacturer adjustment settlement and the NPM arbitration panel decision, as well as lower selling general and administrative expenses. These factors were partially offset by lower reported shipment volume and higher resolution expense. Excluding the impact of items detailed in today's press release, including the NPM adjustment items, adjusted operating companies' income increased 2.4% in 2013 to approximately $6.4 billion. For the full year, the smokable product segment's adjusted operating companies' income margins increased one percentage point to 42.2% in 2013. Over the past couple of years, PM USA estimates that cigarette category volumes have declined at a rate of 3%-4%, and we believe that trend continued in 2013.
After adjusting for trade inventory changes and other factors, PM USA estimates that its domestic cigarette shipment volumes decreased approximately 4% for both the fourth quarter and full year of 2013, and that the category also declined approximately 4%. Marlboro's fourth quarter retail share grew by two-tenths of a share point to 43.7%. PM USA's total share of the cigarette category was up three-tenths of a share point to 50.7% for the quarter. Marlboro's retail share was 43.7% for the full year as well. Share gains by Marlboro and L&M were partially offset by share losses on other portfolio brands. In 2013, L&M continued to gain retail share as the total discount segment was flat to declining. In total, PM USA achieved a 50.6% share of the cigarette category in 2013, up from 50.3% in 2012.
We're pleased with the performance of both PM USA and Marlboro, especially in light of competitive line extensions and price promotions in the second half of 2013. In the machine-made large cigar category, Middleton's volume decreased 3.2% for the full year. Black & Mild declined 1.3 retail share points, driven by heightened competitive activity from low-priced cigar brands. Middleton adjusted its plans during the year and moderated its decline rate. Although the competitive environment remains difficult. For the fourth quarter, Middleton's volume increased 8.5%. Black & Mild's retail share was down seven-tenths of a share point in the fourth quarter. Turning to smokeless products in the fourth quarter, reported operating companies income for the segment was essentially flat, while adjusted OCI increased by 1.2%, primarily driven by higher pricing and offset by higher promotional investments and lower volume.
For the full year, the smokeless product segment delivered reported operating companies income growth of 9.9% and adjusted OCI growth of 7% to over $1 billion, due primarily to higher pricing, increased volume, lower restructuring charges, and effective cost management. These factors were partially offset by higher promotional spending and mix. The smokeless product segment's adjusted operating companies income margins grew by 1.5 percentage points to 62.3% for 2013. Due to calendar differences, the smokeless product segment had one less shipping day in the fourth quarter and the full year of 2013, representing approximately one full week of volume, which affected reported shipments for both periods. In particular, Copenhagen and Skoal combined reported shipment volume was down 3.5% for the fourth quarter. For the full year, Copenhagen and Skoal combined reported shipment volume increased 4.3%.
After adjusting for calendar differences, trade inventory changes, and other factors, USSTC and PM USA estimate their smokeless shipment volume grew 5% and that the smokeless category volume for both periods grew at a rate of approximately 5.5%. For the full year, USSTC grew combined Copenhagen and Skoal retail share by three-tenths of a share point to 50.7%, supported by product expansions over the past several years, including Copenhagen Wintergreen and Southern Blend. Ste. Michelle delivered another year of strong income and volume growth. Wine segment operating companies income increased 9.8% in the fourth quarter and 13.5% to $118 million for the full year. Wine shipment volume grew 5.8% for the fourth quarter and 5% for the full year, primarily on the strong performance of 14 Hands. 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 housekeeping items. Marlboro's price gap versus the lowest effective price cigarette was 34% for the fourth quarter and the full year of 2013. In 2012, Marlboro's price gap was 34% for the fourth quarter and 35% for the full year. Marlboro's net pack price was $5.86 in the fourth quarter, up from $5.75 a year ago, and $5.83 for the full year, up from $5.74 in 2012. The lowest effective price cigarette was $4.38 in the fourth quarter and $4.34 for the full year, up $0.09 and $0.08 versus 2012, respectively. The cigarette discount category's retail share was 25.2% for the fourth quarter and 25.3% for the full year of 2013. For the fourth quarter of 2012, the discount category retail share was 25.6%, and for the full year of 2012, discount category share was 25.4%.
The estimated weighted average cigarette state excise tax at the end of the fourth quarter was $1.47 per pack, unchanged from the third quarter and up $0.06 per pack from the fourth quarter of 2012. Copenhagen's retail price was $4.07 for the fourth quarter and $4.06 for the full year, and its price gap versus the leading discount brand was 35% for the fourth quarter and 36% for the full year.
Copenhagen's fourth quarter 2012 retail price was $4.04, and its price gap versus the leading discount brand was 38%. For the full year of 2012, Copenhagen's retail price was $4.04, and its price gap versus the leading discount brand was 39%. CapEx was $41 million for the fourth quarter and $131 million for the full year. Ongoing depreciation and amortization was $54 million for the fourth quarter and $212 million for the full year. Operator, do we have any questions?
Thank you. Once again, as a reminder, if you would like to ask a question, please press the star key followed by the number one on your touchtone phone at this time. Investors, analysts, and media representatives are now invited to participate in the question and answer session. We will take questions from the investment community first. Our first question comes from the line of Vivien Azer with Citi. Please go ahead.
Hi. Good morning.
Hi, Vivien.
My first question has to do with your outlook for 2014 and specifically for the U.S. cigarette category combustibles. Can you offer a little color on how you're thinking about category volumes for the year?
Well, as you know, we don't forecast volume going forward, but I can tell you that what we see over the last several years is that the cigarette volume declines have been in the range of 3%-4%. We've gone through our model on that of both secular decline and some price elasticity. That's what we see basically in 2013, the continuation of that trend, and we don't see any particular drivers in 2013 that cause us to believe any differently about that.
That's fair. Given kind of the state of the consumer, do you think it's fair to say that volume declines will probably come in at the lower end of that range like they did in 2013?
Well, it's hard to say going forward. I do think that a word or two about the consumer is important. It's a good question. The macro trends are improving in some domains, but the way we look at our business is always, well, how do those macro trends impact our adult tobacco consumer? I can tell you how we're thinking about it, is that unemployment remains unfortunately high at about what? six, seven. Underemployment is higher than that. Labor participation rates are not robust. As you know, the adult tobacco consumer tends to over-index in those domains. It's hard to find a lot of encouragement there. Consumer confidence generally is up, but it's nowhere around where we'd like to see it, which is a typical score of, say, 100 before the recession hit. We watch housing starts pretty carefully.
We see some improvement in the housing figures. Again, they're far below where they should be. We are always hopeful that the economy is going to improve for everyone. It's just hard to find a lot of drivers to cause us to believe that for the adult tobacco consumer, 2014 is going to look very much different than 2013.
That makes a lot of sense to me. One last one, please. On the competitive landscape, you cited some stepped-up competitive activity in the back half. Would you categorize that as relatively rational? Are you seeing any shifts in competitive posturing?
Well, I say what I always say about this. This is a business that has always been competitive. It was competitive in 2013. Our plans assume that the businesses will continue to be competitive. I think what's important, though, is to look at how PM USA is able to navigate through that environment. We had a very good price realization, as you saw last year. We had a margin expansion, grew adjusted OCI to nearly $6.5 billion, modestly grew Marlboro share, modestly grew overall PM USA share. That was at a time when we continued to invest in our brands, like through the Marlboro architecture. What I would say to you, Vivien, is even though it's competitive, it's an environment in which PM USA has been able to really effectively operate on its strategy, have very good results in 2013.
Perfect. Thank you very much.
Thanks for your call, Vivien.
Our next question comes from the line of David Adelman with Morgan Stanley.
Good morning, everyone.
Morning, David.
I had two questions, Marty. The first, can you explain or speak to this gap in the fourth quarter between your cigarette shipments down 5.8% and your estimate that the underlying consumption was down 4%? I ask that in the context that the timing of your end-of-year price increases both years were fairly similar.
Yeah. This comes up from time to time. I think we talked about this actually in the first quarter, if memory serves. It really is the difference in trade inventory movements and other factors. The trade inventory movements, as you know, make a big difference. If you look at it throughout the quarter, though, on an adjusted basis or for the full year, David, on an adjusted basis, we're confident that it's about 4%. The pricing, as I remember it for the quarter was, I think PM USA announced its pricing, I think, the last week of November this quarter to have become effective around the first of the year. When we model it out, that's what it looks like to us.
Okay. Marty, with respect to MarkTen, could you speak to the market share you've been able to generate in the geographies in which you're competing, what the trajectory of your market share has been in those markets? Also because the spending you can see in the P&L wasn't insignificant this year, and you're calling out that as a potential headwind in 2014. What's the potential opportunity that you're calibrating your spending against?
Yeah, that's a great question about MarkTen. Thanks for asking it. Look, we have about a month's worth of data, I don't want to roll out numbers. We'll have more to say about this in CAGNY, which is coming up, I hope to have some numbers to show you there. What I can tell you is that we have a plan that we set out in Arizona, the same way we did in Indiana, really, about what we're trying to learn. That's how you do test markets in a disciplined kind of a way. I think we have a very good plan in place to learn. What we've learned is, so far, we wanted to get broad distribution of our MarkTen product at retail, and our sales force has done a great job of doing that.
As I mentioned in the remarks, we're in about 1,900 stores there. We wanted to find out trade acceptance, I can tell you the trade acceptance of the product is enthusiastic. We're learning a lot about working with the trade there. I can tell you we like the MarkTen product a lot. It is a terrific product. We think we have a good offering, we believe if we can get it in the hands of consumers, that they will think so, too. We have a revised promotion plan that is setting us out to do exactly that. I can assure you, when we enter these test markets, though, we have very specific goals that we're setting out to answer and to learn from. We have metrics that we put in place to know whether we're achieving them.
Of course, we're always looking to try to leverage those learnings, as we did, for example, from Indiana to Arizona, about learning our way forward. We believe that's the right way forward in emerging categories. We try to learn wisely, we try to learn it in a disciplined kind of a way. That's how we're thinking about Arizona. Again, I hope that we'll have more for you at CAGNY about that.
Okay. Thanks. See you then.
Thanks for calling in.
Our next question comes from Bonnie Herzog with Wells Fargo.
Morning.
Good morning, Bonnie.
My first question is on Marlboro. I guess I'm trying to get a sense of the overall health of your Marlboro franchise in light of the recent line extensions with Edge, then NXT earlier last year. How incremental were these lines, and how well did your core Marlboro perform? Then any learnings from these extensions and how full is your Marlboro innovation pipeline for this year?
Well, we think Marlboro performed terrifically. We've talked from time to time about its brand equity using a variety of measures. I won't repeat them all here. You know what they are in terms of its scale, in terms of being the largest brand everywhere, in terms of being able to have a really premium price gap that's been constant despite bad recessions and FETs and so forth and so on. When we roll out Marlboro extensions, we always check to make sure that they are incremental to the equity of Marlboro. So when we bring out products like NXT or we bring out products like Edge, we're confident that they're adding to the Marlboro equity, and we measure that, as you know, Bonnie, over time. This has been the most successful brand in the category for decades.
Our approach continues to be that, to do that over time. We've spoken before about the number of SKUs in Marlboro. We don't bring them out willy-nilly. We try to make sure that there is a consumer demand for them there. Of course, we're always trying to attract adult competitive smokers, and I think that PM USA has done a very good job with that, both over time and in 2013.
Okay. Thanks for that. Then I wanted to ask you a little bit more about the agreement you reached with Philip Morris International. To me, it seems like a very big opportunity. Could you talk a little bit more about this opportunity as well as timing and next steps? Also, how should we think about the potential upside to your earnings from the royalty payments you'll receive as PMI rolls out your e-cig technology internationally? Then finally, as you look into the future, could you talk about how you envision your reduced-risk portfolio evolving?
Okay, there's a lot there. Let me see if I can unpack that a little bit for us. It is an important step forward. I appreciate your asking about it. From the Altria perspective, as I was just discussing with David, we really like our technology in e-vapor. We think we've done a very good job with that. It's great that we have an opportunity to partner with PMI so that it can be sold in international markets. As you know, PMI is a terrific company. We have a high regard for it. It has global scale. It has global infrastructure. I think putting our technology in PMI's hands to try to sell that to adult vapers elsewhere in the world is a good thing for Altria. It's a good thing for PMI.
I think in addition, as we've spoken about previously, our innovation strategy for adult tobacco consumers is to offer them a variety of products that are innovative from conventional products and may hold out the promise, if FDA were ever to approve them, of reduced harm. That's exactly what PMI has been working on with its NGP platforms 1 and 2. We now have those in our portfolio through this agreement. As PMI and with our support work on FDA, it's an extremely important strategic step forward for harm reduction, I think, for consumers, and we're hopeful about that. In terms of contribution to earnings, I think it's early there.
There are royalty agreements in place. Really, I think this is more about getting the products in each other's hands and seeing if we can bring them to adult tobacco consumers, and see if they'll take them. From our perspective, that's the way we're thinking about innovation. We follow the consumer. The consumer will decide about innovative products. Our job is to invent them, to commercialize them, and to work with the FDA where appropriate, to make sure that they make it to market. That's kind of our strategy in a nutshell.
All right. Thanks for that.
Thanks, Bonnie.
Our next question comes from Thilo Reddy with Jefferies.
Morning, everybody.
Thilo.
Just to follow up on the MarkTen question. In your base business case for MarkTen, what level of indoor usage restrictions is built into that base business model?
You broke up just a little bit, Thilo. Say it again.
Oh, sorry. For the base business case for MarkTen, what level of usage restrictions, similar to smoking bans, do you have included in that base business case for MarkTen?
Yeah. We've modeled out basically three scenarios. We don't know. There are some unknowns, obviously, in e-vapor and innovation, generally. They regard excise taxes, technology improvements, the regulatory situation. Rather than we have built three cases where we assume there's varying degrees of flexibility or regulation there. We've actually done three cases.
What's the assumption for the base case?
I'm not going to get into the proprietary nature of how we've modeled it out. I think it's fair to say, though, that if there is a general belief by the regulators and others that movement to e-vapor is a good thing for adult tobacco consumers, you can assume that there will be greater migration than less.
Fair enough. In your outlook for fiscal 2014 or calendar 2014, what impact will the end of the tobacco quota buyout have on the competitive landscape? What's your expectation there?
Howard?
I think with regard to the end of the quota, it happens really to impact the fourth quarter of 2014, that really occurs across the industry. I think it's a cost reduction opportunity really across the sector in the U.S. With regard to how the various players react to that cost reduction, I think we'll have to wait and see how that plays out. Of course, we continue to be focused on our strategy in the smokable segment of maximizing profitability while maintaining modest share momentum on Marlboro, clearly, that cost reduction is an opportunity.
There's no assumption yet that you would be willing to share whether you can be able to keep the cost reduction, or whether you have to pass it on to smokers, given the competitive environment?
Yeah, I think we're not going to share our plan at that level of detail. Certainly, that is one of the items that's baked into our overall guidance for the year.
Okay. Then last question I have for you, can you give us an update on your strategy and plans for L&M? I think so far you've always commented that it was supposed to offset the share losses for basic. Is that still the case, or is there maybe something more ambitious in place for L&M these days?
No, I think it's pretty much as we've described it before, Thilo. There are some people who participate in the discount segment. That's not our focus, of course, but we want to have an offering there. L&M is the offering that we give them. Our retailer trade partners in particular would like for us to have a good discount brand there. We're not trying to grow the discount category. That's not our focus.
Okay, perfect. Thank you.
Yep.
Our next question comes from Greg Kessler with Bank of America.
Hi, you got Alex Averan for Greg.
Morning.
Good morning. A quick question for you about your debt plans and capital structure plans going forward. I know you guys did the tender at the end of last year, as well as paying down that maturity. What are your plans for the upcoming maturity? As a follow-up to that, do you have any more liability management plans going on in the future?
Sure. I think we're pretty pleased with the progress we've made on our balance sheet. We've got our weighted average interest cost down to 5.9%, and we feel pretty comfortable with our current credit ratings as well as our current debt to EBITDA ratio. I don't know that I would communicate anything beyond the fact that we've been following a pretty consistent strategy over time to bring our interest rate down. We think we've been successful, we'll continue to look for opportunities in the future to improve that. We're certainly not going to share anything at the detail level about changes in the short term.
Thank you.
Thank you for calling in.
Our next question comes from Michael Lavery with CLSA.
Good morning.
Michael.
Your price mix in smokable in the quarter was good. It was roughly about the pace it's been all year, or even a slight uptick from 3Q, even despite the competitive launch of Newport Gold. What are you seeing in the marketplace there, and can you compare or contrast that to when Newport Red would've launched?
Well, I guess maybe I'll take it up a level. We did have good price realization, as you could see, both throughout all the quarters and then above 4% for the year. I think this is consistent with what Howard just said about trying to maximize income in the smokable segment. It's always a balance between growing income and watching the share, and I think PM USA did a good job of that, and I expect them to do a good job of that in 2014. Manufacturers do launch products into the market from time to time. You do see promotional pricing as they try to gain adult tobacco consumer awareness. That's just part of the usual backdrop of how the business gets done, Michael.
All right. No, that's helpful. Thanks. Somewhat related, on margins, you had a strong lift in that segment as well against a decent comparison and an even stronger one the year before. Is there anything specifically driving that? Or part of what I'd love to get a little color on too is the fourth quarter's gone from one of the lowest margin quarters in the year to one of the higher ones. Is there any shifts you've made in the operations or is it just getting some better pricing there? What's been driving that?
Yeah. I wouldn't put too much into quarter-to-quarter variations in the cost trend. I would probably tend to look at this full year of 2013 compared to the prior year to get a better estimate. You're pointing out the fact that we had an above-trend for the quarter's cost reduction in the fourth quarter, but I think that has more to do with just the way the spending unfolded on a quarter-by-quarter basis. Of course, we're always managing to a full year, I don't think there's anything significant that I would call out that was a change in trend.
Okay, that's helpful. Just on the review process for the deeming regulations with the FDA. It's been at the OMB now for close to two months. Is there any involvement you have with them or any visibility you have on that process, or is it a little bit of a black box?
Yeah. We said before, we have lots of ongoing relationships at the agency and also with OMB and others, but I just don't have anything to offer you on that. You're exactly right. It's been at OMB, and there have been periodic announcements that it's coming, but we haven't seen it, and we haven't really heard much about when it might be coming other than what they've said.
No. Okay, that's helpful. Just one last one on e-cigarettes. In terms of how you think about a broader launch nationally, is it just a question of getting the learning and the product sort of honed, or is there any capacity issues, or what are the sort of things that would trigger that into a national launch?
Well, we haven't said anything about that, and I won't this morning, but we have a disciplined way of learning our way in. All of the factors that you mentioned, of course, are important to make sure that we would know if and when we decide to do that. We'd want to make sure the product offering would be right, and the branding is right, and the promotion is right. We just think about this through our value equation that you've heard us talk about before. Certainly, you want to make sure the capacity is in line.
All right, great. Thank you.
Michael, thanks for calling in.
Our next question comes from Judy Hong with Goldman Sachs.
Morning.
Morning, Judy.
Marty, just wanted to go back to the 2014 outlook. Between the interest expenses coming down, the lower taxes, and the share buyback benefit, it seems like the operating income growth in 2014 is expected to be pretty modest. I understand you called out some of the headwinds, was just hoping to get some more perspective on, is this really the stepped-up spending that's causing a bit of a slowdown in terms of the operating profit growth? How should we think about that in the context of your guidance?
Thanks for asking. Listen, we have a good plan for 2014. I like the plans of our operating companies. I think they've done a good job of that. It's the factors that we identified for you really that we're trying to explain, which is we do have some headwinds in terms of making investments in the innovative space. We do have variability. I may ask Howard to comment on this. We have variability in the capital core contributions from time to time. You want to talk about that, Howard?
Sure. I think we've communicated this before, that as we unwind PMCC, not only does the lease income come down over time, there are asset sales that are quite variable on a year-to-year basis. Certainly in 2013, we had quite strong asset sales. After settling some of the tax issues with the IRS on the LILO/SILO leases, we found the opportunity to sell several of those assets in 2013. I think that certainly one of the drivers of the comparison from 2014 to 2013 is some of the lumpiness in PMCC's income. I think the second thing is that while certainly we made investments in 2013 towards competing effectively in the e-cigarette category, we are certainly planning in 2014 to make further investments as we focus on being successful in that emerging new category.
Okay. Just maybe a bit of a follow-up on MarkTen and just the e-vapor category generally, Marty. As you obviously participate in the broader tobacco category, how do you sort of think about how you build brand equity in e-vapor category versus cigarettes or smokeless? Are there some differences, similarities that you can call out and your thought process and thinking about how to invest in that particular product or category?
That's a terrific question. The brands, obviously, that have been in the take-the-cigarette category have obviously been out there for some time, and brand equity, as you know, is built over time. Marlboro's equity has been built over decades. Because everyone is now launching products and trying to gain brand equity, it will take some time. I think one of the advantages that some players will have is those that know how to build brands will have an advantage here. I would argue that Altria and its operating companies have a long and a rich heritage of being able to build brands. That's one. Two, I think, is making sure that you're being consumer-centric. You always have to start with the consumer. You have to give them the offering that they want, and then you build equity off of that platform.
That's how we think about it, at least. It's early days in e-vapor. It's going to take some time for a lot of things to sort itself out, and it will take time for equity to be built in this category, just like most others.
The two test markets that you've entered, Marty, have you noticed the pickup in the category growth in those markets as you've entered in those markets?
Obviously, Arizona is very early. We'll have some data to share about this, I expect, at CAGNY. I don't want to get ahead of looking at those numbers at this time, but we'll try to get that information for you.
Got it. Okay. Thank you.
Judy, thanks for calling.
We will now take questions from the media. If you would like to ask a question, please press the star key followed by the number 1 on your touchtone phone. Our next question comes from Nik Modi with RBC Capital.
Good morning, guys.
Hi, Nik.
Just two quick questions, Marty. A lot of talk, obviously, about e-cigarettes and shift from regular cigarettes. If you really look at the underlying trend, and you go back rolling over the last three years, looks like for this particular year, in 2013, the category decline rate's actually moderated as the year progressed, despite e-cigarettes growing as fast as they've been growing. I wonder if you could just provide some big picture thoughts on that. The second question, which is more specific to Arizona, can you talk about some of the product changes that you've made to MarkTen relative to Indiana? Just talk about some of the modifications that you made to the product. Thanks.
Sure. Thanks for your question. We continue to look carefully at the growth of e-cigarettes and its potential effect on cigarette volumes, and we continue to believe that it's modest. It obviously is a category that has grown very fast, and you're right, it gets a lot of attention. We believe it's probably still in the secular decline rate, which we've estimated to be 2%-3%, which makes up a variety of things, which is lower incidents, fewer cigarettes per day, people dabbling in pipe tobacco. We believe that the e-cigarette number is probably in that number. With respect to Arizona, we made a couple of changes that are probably worth mentioning. One of them is we put a new flavor system in. We think it significantly enhanced the sensorial experience.
We changed the bundle that we were offering, including a charger and a kit, and I think those things have been extremely well received by the consumer to date.
Okay, our next question comes from Chris Growe with Stifel.
Hi, good morning.
Hi, Chris.
Hi, just two questions for you. I wanted to ask first, maybe a bit of a follow-up to a question earlier. Howard had a good response on the variability in PMCC. If you were to look at the fourth quarter where that division actually turned to a loss, I just wanted to be clear on, or maybe you can characterize, was it heavy investments in e-cigarettes? Was that something that's a dramatic mover in the quarter, or was it more about the volatility in PMCC that caused that to turn to a loss in the quarter?
Yeah, certainly, I would say that the year-over-year variance there was driven by both PMCC and e-cigarettes. I would tell you that the Arizona test market, given that a lot of that investment occurred in the fourth quarter, was certainly a driver.
Okay. Would you then expect that division in 2014, just from your commentary, to be down in profitability, noting the investments that are making plus the volatility at PMCC?
Yeah, I think as we indicated in the guidance paragraph, we do expect to make incremental investments in the e-vapor business in 2014 compared to 2013.
Okay. Just a follow-up question on new products. We've had a pretty slow process around the substantial equivalence approval, if you will, from the FDA. I just was curious for Philip Morris USA, you've had a good bit of activity, new product activity in that division. The longer this takes for SE applications, is it putting the division at more of a disadvantage going forward? Do you have less in the hopper, if you will? Do you need more activity from the FDA on the SE applications?
We're actually in pretty good shape, I would tell you. We continue to interact with FDA regularly about our SE application. I think while everyone would like to see more outcomes from the agency, I think we're actually in pretty good shape, Chris.
Okay. If I could ask one final follow-up, which is just you characterized the inventory change in the fourth quarter. If you said I didn't hear, but could you characterize the inventory levels then? Are you at the right level, if you will, or where you were maybe a year ago with the fourth quarter, given that change that occurred in the quarter?
Well, the inventory levels of cigarettes ended the quarter lower in 2013 than they did a year ago, is what we were trying to communicate.
Okay. Thank you.
Thanks for talking.
Our final question comes from the line. Bonnie Herzog with Wells Fargo.
Yes, good morning.
Good morning.
Wanted to see if you could talk a little bit about the smokeless category. It looks like your reported volume was down for the quarter and for the year, but in here you talk about with some adjustments, shipment volume, you estimate actually grew about 5%.
Right.
Can you help us reconcile the difference there?
Sure. The principal difference was that in both the fourth quarter and in 2013, there was one fewer shipping day, and in the smokeless business, it happened to be a Monday when a lot of the volume goes out, so it's roughly equivalent to a shipping week. That basically explains it. Few other factors, but it's basically that movement.
Okay, that's helpful. Thank you.
Thanks for calling.
Thank you. At this time, I would like to turn the call back over to Ms. Sarah Knakmuhs for closing comments.
Okay, thank you everyone for joining our call this morning. If you have any follow-up questions, please contact us at Investor Relations. Just a reminder, Altria will present at CAGNY, and the presentation will be webcast. Thank you again. Have a great day.
Thank you. This does conclude today's conference call.