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Altria Group, Inc. (NYSE:MO)

Q4 2012 Earnings Call

January 31, 2013 9:00 a.m. ET

Executives

Brendan McCormick - VP, IR

Marty Barrington - Chairman & CEO

Howard Willard - EVP & CFO

Analysts

David Adelman - Morgan Stanley

Michael Lavery – CLSA

Judy Hong - Goldman Sachs

Bonnie Herzog - Wells Fargo

Priya Ohri-Gupta Barclays Capital

Vivien Azer – Citigroup

Ann Gurkin – Davenport

Chris Ferrara - Bank of America

Chris Burritt - Bloomberg News

Operator

Good day and (inaudible) 2012 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. (Operator Instructions) 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 Mr. Brendan McCormick, Vice President, Investor Relations, for Altria Client Services. Please go ahead, sir.

Brendan McCormick

Good morning and thank you for joining our call. I am joined this morning by Marty Barrington, Altria’s Chairman and CEO and Howard Willard, Altria’s Chief Financial Officer. This morning we will only be discussing Altria’s 2012 business results for the fourth quarter and full year and will not be discussing the status of tobacco litigation.

Our remarks contain forward-looking and cautionary statements and projections of future results, and I direct your attention to the forward-looking and cautionary statement section at the end of our earnings release for the review of the various factors that could cause actual results to differ materially from projections. For a detailed review of Altria’s business results, please review the earnings release that is available on our website, altria.com.

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 on an adjusted basis, which excludes 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. In addition, comparisons discussed in this conference call are to the same prior-year period unless otherwise stated.

Before we begin I want to make you aware that high winds in the Richmond area have been causing interruptions to our phone service this morning. In the event we get disconnected, we have some backup plans in place and I ask for your patience. If you remain on the line, we will rejoin quickly.

Now it gives me great pleasure to introduce Marty Barrington.

Marty Barrington

Thanks Brendan. Good morning everyone. Altria delivered strong results and returns for its shareholders in 2012. Altria grew its full-year adjusted diluted earnings per share by 7.8% behind the business performance of our operating companies, complemented by higher earnings from our equity investment in SABMiller.

Our 2012 total shareholder return of 11.8% for the full year outperformed our U.S. tobacco peers and the S&P 500’s consumer staples sector, though not the S&P 500 index which delivered a total return of 16%. Altria’s results were driven by effectively executing on our core strategies. First, our consumer products companies invested in strong premium brands that provide the foundation for future income growth. Each of our tobacco operating companies seek to grow income while maintaining modest share momentum for its core premium brands.

Despite a continuing challenging external environment, our tobacco operating companies’ premium brands had an excellent year as our companies continued investing for their long-term success. These companies grew their adjusted operating companies’ income and gained retail share in cigarettes, cigars and smokeless tobacco for the full year of 2012.

Beginning with the smokeable product segment, PM USA introduced Marlboro’s new brand architecture in 2012 and supported Marlboro’s four product families, red, gold, green and black with brand building activities throughout the year. These activities included expanded distribution of products and equity enhancing promotions to engage millions of adult smokers.

PM USA also engaged adult competitive smokers with trial generating promotions as PM USA moderated as the year progressed. Behind these investments PM USA grew Marlboro retail share and strengthened the Marlboro brand. Middleton continued to enhance its product portfolio and new products contributed to its full year retail share gains.

In smokeless product segment, Copenhagen and Skoal delivered solid volume growth and retail share gains on a combined basis for the full year. These results were primarily due to the ongoing contributions of Copenhagen long-cut wintergreen and long cut straight and the expansion of Copenhagen southern blend. In wine, St. Michelle delivered solid volume growth through its continued emphasis on expanding distribution into off-premise channels.

Second, our companies continued to pursue product innovation. Products introduced in recent years by Marlboro, Black & Mild and Copenhagen and Skoal gained retail share and contributed to the company's full year share growth in 2012. During the year, PM USA repositioned Marlboro black, expanded Marlboro NXT, a part of the Marlboro black family into additional geographies and introduced Marlboro 83s, part of the Marlboro red family in updated packaging.

In 2012, Middleton continued to address adult cigar smokers interest in variety in seasonal cigar blends. Black & Mild dark blend and Black & Mild summer blend as well as with its 2012 third quarter introduction of Black & Mild Jazz untip cigars into select states. In December 2012, the brand announced the plans to launch Black & Mild Jazz, plastic tip and wood tip cigars nationally. In the smokeless products segment, U.S. STC expanded distribution of products, including Skoal, Ready Cut and Copenhagen Southern blend. Skoal Ready Cut offers adult long cut diverse great tastes in an innovative moist smokeless tobacco form. Copenhagen southern blend delivers a mellow taste in a manageable long cut form.

Our companies also continued to support the development of spit-free smokeless tobacco alternatives to cigarettes with the 2012 introduction of Verve discs into elite market and integrating it to develop innovative nicotine containing products with Okono AS.

Third, our tobacco operating companies effectively managed costs in 2012. For the full year, cost management and higher pricing supported expansion of adjusted operating companies’ income margins for the smokeable and smokeless products segments. Our companies made significant progress on our current cost reduction program by reducing head count, consolidating certain facilities, improving business processes and pursuing other savings. These actions with initiatives planned for 2013 as part of the program make us confident that we will achieve our goal of $400 million in annualized savings versus previously planned spending by the end of 2013.

Finally, Altria maintained a strong balance sheet which enabled it to continue to deliver strong cash returns to shareholders. In 2012, Altria enhanced its capital structure by purchasing high coupon debt and issuing new lower cost debt. These actions reduced our 2018 and 2019 maturity towers, lowered future interest expense and reduced our weighted average coupon rate.

Dividends contributed 5.8% to our 2012 total shareholder return of 11.8% as Altria maintained its target dividend payout ratio of approximately 80% of its adjusted diluted EPS and increased its dividend by 7.3% in August. As you know, Altria joined with the broad coalition of businesses, associations and shareholders to support making permanent the lower person tax rates on dividend income and maintaining parity between the tax treatment of dividends and capital gains. Congress and the President now have established dividend and capital gains tax rates for couples earning $450,000 or less between 0 and 15% and that 20% couple’s earnings more than $450,000.

We’re pleased that parity has been retained between the tax treatment of dividends and capital gains. In addition to returning cash to shareholders through dividends, Altria repurchased $1.1 billion of its shares in 2012. We have $57 million remaining under the current $1.5 billion program and expect to complete the program by the end of the second quarter of 2013.

In summary, in 2012 Altria continued its track record of delivering strong returns to shareholders. We achieved these results through disciplined execution of our core strategies and we believe that our 2012 performance including investments in our premium brands position us well for 2013 and beyond.

Turning to 2013, while there are signs of modest improvement in certain economic indicators, we remain cautious about the business environment. Adult consumers remain under economic pressure as they face the end of the payroll tax holiday, as well as continuing high unemployment. And with a number of states facing budget shortfalls, tobacco products will remain a target for excise tax increases.

Altria forecasts that its full year adjusted diluted EPS will increase by 6% to 9% to a range of $2.35 to $2.41 from a base of $2.21 in 2012. We also expect to achieve 2013 reported diluted EPS in the range of $2.34 to $2.40. Howard Willard, Altria’s chief financial officer will now discuss Altria’s business results in more detail.

Howard Willard

Thank you, Marty. Good morning everyone. The smokeable products segment’s reported operating companies income results for the fourth quarter increased 25.9% primarily due to higher list prices, lower restructuring charges and lower charges related to tobacco and health judgements partially offset by higher promotional investments by PM USA behind Marlboro’s new brand architecture and increased resolution expense.

For the full year of 2012 reported operating companies’ income for the segment increased 8.8% primarily due to higher list prices, lower restructuring charges, lower charges related to tobacco and health judgements and effective cost management, partially offset by higher promotional investments, increased resolution expense, unfavourable mix due to L&M’s volume growth and lower shipment volume.

Adjusted operating companies’ income, which is calculated excluding restructuring charges and tobacco and health judgments, increased 5.9% to $1.5 billion for the fourth quarter and 4.2% to $6.3 billion in the full year of 2012. For the fourth quarter and full year, adjusted operating companies’ income margins for the smokeable product segment increased nine-tenths of a percentage point to 39.9% to 41.2% respectively.

PM USA’s reported cigarette shipment volume increased 0.4% for the fourth quarter primarily due to retail share gains and one extra shipping day, partially offset by the industry’s rate of decline. After adjusting for the extra shipping day and changes in trade inventories, PM USA’s fourth quarter domestics cigarette volume was estimated to be down approximately 1%. For the full year PM USA’s reported shipment volume decreased 0.2% primarily due to the industry’s rate of decline, partially offset by volume growth as a result of retail share gains and one extra shipping day.

When adjusted for an extra shipping day and changes in trade inventories, PM USA estimates that its full-year domestic shipment volume was essentially unchanged, outperforming the estimated adjusted industry rate of decline of approximately 3%. Brand building initiatives to support Marlboro’s new architecture contributed to the brand’s retail share gains of one percentage point for the fourth quarter and six-tenths of a percentage point for the full year.

Marlboro’s retail share was 42.6% for both the fourth quarter and full year. These gains were complemented by L&M’s growth in discount. PM USA’s discount products gained three-tenths of a percentage point to deliver a 3.9% retail share for the fourth quarter and five-tenths of a percentage point for a 3.8% share for the full year. PM USA’s total retail share grew 1 percentage point to 49.8% for the fourth quarter and an eight-tenths of a percentage point to 49.8% for the full year.

Middleton’s fourth quarter reported cigar shipment volume declined 1%, primarily due to changes in trade inventories and retail share losses. For the full year of 2012, reported cigar shipment volume declined seven-tenths of a percent primarily due to changes in trade inventories partially offset by volume growth as a result of retail share gains.

Black & Mild’s retail share declined 1.4 percentage points to 29.3% for the fourth quarter and increased five-tenths of a percentage point to 30.0% for the full year.

Smokeless product segments fourth quarter reported operating companies income grew 27.1%, primarily due to lower restructuring charges related to our cost reduction program, higher volume and higher pricing, partially offset by unfavorable mix due to growth in products introduced in recent years at a low popular -- lower popular price.

For the full year, reported operated companies income increased 8.4%, primarily due to higher pricing, higher volume and effective cost management, partially offset by unfavorable mix.

Excluding the impact of restructuring costs and UST acquisition-related cost operating companies’ income grew 9.5% to $254 million for the fourth quarter and 7% to $959 million for the full year.

USSTC and PM USA smokeless product shipment volume increased 9.6% for the fourth quarter and 3.9% for the full year, primarily due to the combined volume growth of Copenhagen and Skoal.

Copenhagen shipment volume increased 12.4% for the fourth quarter and 10.8% for the full year, as the brand continued to benefit from products introduced in recent years, including the May 2012 expansion of Copenhagen Southern Blend into select geographies. Skoal grew its shipment volume by 9.0% for the fourth quarter and six-tenths of a percent for the full year.

Comparisons of Skoal’s full year shipment volume were negatively impacted by the de-listing of seven SKUs, partially offset by the growth of Skoal X-TRA. After adjusting for changes in trade inventories and other factors, USSTC and PM USA estimate that their combined 2012 fourth quarter and full year domestic smokeless product shipment volume grew approximately 5%. USSTC and PM USA believe that the smokeless category grew at an estimated rate of approximately 5% over the 12 months ended December 31, 2012.

Copenhagen and Skoal grew their combined retail share by 1 percentage point from the fourth quarter and 1.6 percentage points for the full year. Copenhagen's retail share increased 1.6 percentage points to 29.0% for the fourth quarter and 4.2 percentage points to 28.4% for the full year, as the brand continued to benefit from products introduced in recent years, including the 2012 expansion of Copenhagen Southern Blend.

For both the fourth quarter and the full year, Skoal’s retail share declined six-tenths of a percentage point to 21.9% and 22.2%, respectively. Skoal share for both periods was negatively impacted by competitive activity and Copenhagen strong performance, partially offset by share gains by Skoal X-TRA.

The 2011 de-listing of SKUs also negatively impacted Skoal’s retail share comparisons for the full year. USSTC and PM USA's total smokeless products retail share decreased one-tenth of a percentage point to 55.4% for the fourth quarter and increased three-tenths of a percentage point to 55.4% for the full year.

The wine segment delivered strong operating companies income and volume results in 2012. The wine segments 2012 fourth quarter and full year reported operating companies income increased 10.8% and 14.3%, respectively, primarily due to higher pricing, improved premium mix and higher shipment volume, partially offset by costs related to Ste. Michelle's sales force expansion.

Comparisons of full year reported operating companies income results were also impacted by higher costs for select vintages incurred in 2012, partially offset by UST acquisition-related costs incurred in 2011.

Adjusted operating companies income, which is calculated excluding UST acquisition-related costs, increased 10.8% for the fourth quarter of 2012 and 9.5% for the full year. Ste. Michelle's 2012 volume wine shipment grew by 2.9% for the fourth quarter and 3.7% for the full year.

The financial services segments reported and adjusted fourth quarter operating companies income was unchanged to $10 million, as comparisons were impacted by an increase in allowance for losses in 2011 related to the American Airlines bankruptcy and lower gains on asset sales in 2012.

Comparisons of the segments full year reported operating companies income were impacted by special items. For the full year of 2011, the financial services segment reported an operating companies' loss of $349 million, primarily due to the 2011 second quarter charge of $490 million related to the tax treatment of PMCC's LILO and SILO transactions.

Additionally, the financial services segment's reported operating companies’ income for the full year of 2012 was positively impacted by a decrease in the allowance for losses and recoveries related to transactions involving PMCC's leases to American Airlines. These factors were partially offset by lower lease revenues. For the full year PMCC's adjusted operating companies income increased 29.8% to $183 million.

Marty and I will now be happy to take your questions. While the calls are compile let me cover a few housekeeping items. Marlboro's price gap versus the lowest effective price cigarette was 36% in the fourth quarter and for the full year.

Marlboro's net pack price in the fourth quarter was $5.80 and $5.75 for the full year, while the lowest effective price cigarette was $4.26 in the fourth quarter and $4.23 for the full year. The cigarette discount categories retail share was 27.8% for the fourth quarter and 27.5% for the full year.

The estimated weighted average cigarette state excise tax at the end of the fourth quarter was $1.41 per pack, unchanged from the third quarter and up $0.04 from fourth quarter of last year.

Copenhagen's fourth quarter retail price was $4.11 and its price gap versus the leading discount brand was approximately 38% in the quarter. For the full year Copenhagen's retail price was $4.09 and its price gap versus the leading discount brand was 39%.

CapEx was $47 million in the fourth quarter and $124 million for the full year. Ongoing depreciation and amortization was $56 million for the fourth quarter and $225 million for the full year.

Operator, do we have any questions?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from line Nik Modi with UBS.

Nik Modi - UBS

Yeah. Good morning, everyone.

Marty Barrington

Good morning, Nik.

Nik Modi - UBS

So just a quick question on the Marlboro architecture, and I guess, now that’s been kind of in place for a year and you saw some pretty good retail share gains with pricing improvement. Just curious are there any diagnostics that you have, that you can share, kind of giving us some insight on how effective this has been and so we can think about next year and the years after in terms of some of the benefits you will get from this initiative.

Marty Barrington

Thanks for your question. Sure we have diagnostics, some of which are internal and some of which we talk about in settings like this, I think you’ve already alluded to one, which is we had nice share gain which is consistent with PM USA’s objective to maximize income but trying to keep Marlboro healthy. We have diagnostic, Nik, on resetting retail. One of our objectives during the year was to try to get a number of retail stores reset to better reflect the Marlboro architecture, and I think our sales and distribution group did an excellent job of doing that. If you have been in stores I think you have seen the improvements that have been made at the presentation of the Marlboro brand at retail. At the end of the day, it’s always about that balance about trying to maximize income while taking the steps that are appropriate to make sure that Marlboro is healthy over the long term, and we’re very pleased with how PM USA executed on that this year.

Nik Modi - UBS

And Marty, just a quick follow up to that. I don’t think I remember two quarters in a row where Marlboro has gained this much market share which is quite a feat given how big the brand is and it’s philosophical, I mean you say you want to maintain market share momentum and optimize income. It would be crazy for me to think that this is just too much share gains for a brand that size.

Marty Barrington

I think Nik, the difference simply is in what time period you are looking at. If you look at it, say for a quarter or even for two quarters you have to be sure that there were some share gains there, but that is not the strategy. I’d just give you a – for example, just one data point because we manage the brand over time, and when we say over time we’re talking about more than several quarters, in fact over years. And if one looks back, pick the data point, fourth quarter of 2009 and you measure share gains to the fourth quarter of 2012, it’s nine-tenths. So you have nine-tenths of share point over three years. We would characterized that as modest share momentum for Marlboro over time, and of course, we have other metrics to measure Marlboro’s health. We want to make sure that all of its brand equity numbers are strong and hopefully improving in the right direction. Nik, I think that’s how we think about it.

And we try to be sure -- share gains are not just a function of how much we invest into brand but other competitive dynamics. And so it’s awfully, awfully hard to read simply on a quarter or over two quarters. So I would return I think to understanding our strategy. Our strategy is to maximize income there.

Operator

Your next question comes from the line of David Adelman with Morgan Stanley.

David Adelman - Morgan Stanley

Just a follow up on pricing, Marty, if I could. So in 2012 relative to the last few years, there was clearly a greater emphasis on investing in Marlboro promotional spending, somewhat less than that pricing, and very good share growth. Can you give us a sense what’s in the plan for 2013 in terms of the relative emphasis of those variables?

Marty Barrington

Now I think we will continue with our strategy, David and obviously for competitive reasons we’re not going to lay out PM USA’s promotional plan for 2013. But I do think at a strategic level, it's important for investors to remember our strategy is to maximize income. You’ve seen the numbers in the release. In the smokeable segment we’ve got revenue net of excise up 3.6% for the fourth quarter, and overall the Marlboro brand is heading in the right direction. We have the Marlboro architecture started but remember big brands like Marlboro we don’t do everything in one-year. We've been clear I think about saying that we’re going to invest in Marlboro appropriately throughout 2012 and 2013. But I think that's just more of executing against that consistent strategy and some years as we say we invest a bit more, some years a bit less, some years the shares go up a bit more, it comes down a little bit. But it’s consistent with that long term strategy of trying to maximize income. I think that’s the way to understand it.

David Adelman - Morgan Stanley

Marty, with respect to the total U.S. cigarette category dynamic, you mentioned volumes for the full year or consumption got about 3% with almost no net price increase to consumer. Is that the kind of secular volume decline you would have expected and that you envision going forward?

Marty Barrington

Well, I don’t know about going forward, because it’s awfully hard to predict the future. But I think that we’ve seen the estimates of the secular decline rate being in the neighborhood of 2% to 3% for some period now, and that’s probably in the right neighborhood.

David Adelman - Morgan Stanley

And then lastly Marty, you would be surprised if the FDA doesn't release its report on menthol by when.

Marty Barrington

I’d try not to be surprised by regulatory action. I just don’t think we now – I mean they have had it for some time as you know and our understanding remains I think the last time we spoke about this which is they have sent it out for period review on the science. We led to understand that they probably have it back and are looking at it, and we would expect that would be the first action that they would take would be to publish their position on the science on menthol.

As you know they have had it for quite some time. So would you expect something in 2013? I suppose so, we just don't have a lot of line of sight into that.

Operator

Your next question comes from the line of Michael Lavery with CLSA.

Michael Lavery - CLSA

Just looking at the CapEx, your guidance is sort of roughly flat to up for ’13 and it looks like this ’12 was ahead of last year as well. What’s driving some of that increase?

Howard Willard

This is Howard. I don’t think there is any single big item. As you will note, our CapEx runs at a relatively low level for a company our size. I think that’s driven by the declining cigarette business. But our direction to our operating companies is they ought to spend the appropriate amount of money to keep the infrastructure appropriately ready to manufacture our products and execute our programs. So I think it really is more driven by the addition of a number of relatively modest sized projects across the business.

Michael Lavery - CLSA

And then just as you look at e-cigarette segment, it’s clearly got some strong growth at least in recent times especially, how do you view that, is it an opportunity to get involved in, a threat, something that you sort of dismiss, what’s your thinking? I mean obviously haven’t heard any announcement yet but do you have plans to participate in that somehow?

Marty Barrington

Well, what I would say about e-cigarettes, Michael, is that we’re monitoring it carefully. It’s obviously a development that has resulted in high awareness among adult smokers and everyone else the best I can tell. There is some trial but it’s still a relatively new phenomenon, and you are right to point out that it does grow off of a relatively low base. The FDA has said as you know that it intends to regulate e-cigarettes. So we’re monitoring all of that very carefully.

Michael Lavery - CLSA

And then lastly, just looking at share repurchases, you mentioned that you had $57 million remaining in this authorization. But you’ve said you would expect to complete that by the end of 2Q which would be a sharp slowdown, you did $360 million in 1H ’12. If you use that how quickly could you get a new authorization or do you think it will run its latest 2Q before you have another one?

Marty Barrington

Yeah. I think it’s hard to project exactly when we will finish that authorization but certainly we will have it complete by the end of the second quarter. I think you pointed out I think rightly so that we had fairly heavy purchases in the fourth quarter and we’re only $57 million left. There is not a lot of share repurchase needed to complete that. But at this point, the only authorization that we have out is that authorization is scheduled at the end of the second quarter.

Michael Lavery - CLSA

Okay. Thanks a lot.

Brendan McCormick

Thanks for coming on the call, Michael.

Operator

Your next question comes from the line of Judy Hong with Goldman Sachs.

Judy Hong - Goldman Sachs

Thanks. Good morning, everyone.

Marty Barrington

Good morning, Judy.

Judy Hong - Goldman Sachs

Marty, just a general kind of a macro comment, I know, in the press release you’ve talked about and then also in your prepared comment some of the cautions that you pointed to at the expiration of the tax holiday et cetera. I know you sort of start the year with the similar caution in the past but is there anything that you’re seeing in the market place that gives you a bit more caution at this point, particularly with the tax holiday being expired.

Marty Barrington

No. We haven’t seen any evidence of that but we’re just -- we're reminded almost everyday right about how complex the macro environment is. It looks like on some days the things are starting to turn in the right direction, say housing starts through the like, which is important. And then you get a big drop in consumer confidence or you see a kind of a tepid prediction on GDP.

I think that's part of it. I think the other part of it is excise taxes. We’re always careful at the beginning of the year with respect to state excise taxes, state budgets remain in difficult circumstances. Nothing’s happened yet but you’ve seen already a number of states proposing -- and proposing is one thing and getting them is another but they’re proposing fairly significant excise tax increases. And given that the FETs have been relatively restrained the last couple of years. We would expect that there would be an uptick in activity there.

So to answer your question directly is not that we see anything in the market that gives us that any cause for alarm. We’re just trying to be careful as we read the macro environment.

Judy Hong - Goldman Sachs

Okay. That’s fair. And then just going back to the Marlboro brand architecture, so heading into sort of the second year of that program. Can you elaborate on sort of your success with some of the line expansions, certainly the Black and then now with NXT. How are each of those brands kind of tracking versus your expectation. What is some of the other innovations of line expansion that we should look forward to in 2013 and then just in terms of the level of investment behind the brand equity program as well as some of the retail program. How do you sort of gauge whether the spending level is sort of at the right level if there is a need to continue to step up that spending?

Marty Barrington

Okay. There is a lot in your question there. Let me see if I could take sort of pieces of it at a time. If you look back at ‘12 at the accomplishments of the Marlboro architecture, I think they are actually quite significant and we pointed out that when we talk about building up the Marlboro architecture, it consists of multiple elements, right.

It's focusing on all of the elements of the value equation that we used to manage that terrific brand. So what have we done in packaging, you see what we’ve done with Marlboro 83s which is really a nice expansion into some more modern and classic packaging for that brand to bring news to Red.

So our product expansions in Marlboro-Black which has been a terrific contribution to the family while we don't report out at this sub-segment level on growth. As you know, I can tell you that we’re very pleased with how Marlboro-Black has done. And it certainly contributed, I think to the overall Marlboro equity.

But we saw Marlboro NXT, you see all this innovation in Marlboro space and that's good for the brand. And we think of building up the Marlboro architecture sort of less as a program, if you will then, what good stewards of tradition -- of wonderful brands like Marlboro are supposed to do that. They manage the brand over time. They keep it refresh, they keep it relevant to its target audience and that's how we've been working on it.

So you see, I’ve already mentioned retail, you see product introductions, you see packaging changes. I think that's the way to try to understand how we’re thinking about Marlboro. It's a big brand. It has a big franchise and our four product families, I think, are working hard to try to understand their consumer set carefully and bring to the market, what that consumer wants.

So we don’t announce in advance, when we’re ready to announce what we’re going to do in 2013. But you're probably aware of Southern Cut, which has been launched already in January. So there's a lot of innovation in Marlboro but we do this in a discipline way because all of that, that I have described sits under the strategy of trying to maximize income in that segment. We’ll make true that the brand does well.

So it’s a balance. That’s why we get paid to balance and that’s what we’re trying to do throughout 2013. But I think that PM USA did an excellent job of that in 2012 as you see in the results.

Judy Hong - Goldman Sachs

Okay. Thank you.

Marty Barrington

Thanks for the question.

Operator

Your next question comes from the line of Bonnie Herzog with Wells Fargo.

Bonnie Herzog - Wells Fargo

Good morning.

Marty Barrington

Hi Bonnie.

Bonnie Herzog - Wells Fargo

Hi. I guess, my first question is on retails and what are your thoughts on retailer cigarette margins being squeezed over the past year. How do you strike the right balance between growing your own profitability and then maintaining a mutually beneficial relationship with your retail partners? And also how do you ensure that retailers continue to emphasize important cigarette category and prevent them from shifting resources to other categories either within tobacco or other categories outside of tobacco maybe such as food service.

Marty Barrington

Okay. Well, thanks for that question. Our approach to retail has really been the same for some time which is we want to have a terrific relationship that’s mutually beneficial for both us and them. We work really hard at multiple levels to do that and we do that programmatically.

And so you see that we have programs like MLP in Marlboro [Flakes] and the like. And we try to have a range of options so retailers can decide which programs if any they want to participate in with us. We try to make it attractive for them to do so. Retailers for their part, of course, the cigarette and the tobacco categories a big part of their traffic, a big part of their revenue stream and we try to work with them very carefully.

We do that to our very talented salespeople who had very good market data to help them almost down to a store basis but our job isn’t to tell them what to do or to prevent them from doing something else, just to try to align their interests with ours. So that as we go to market that's a robust trade channel.

I think overall -- overall I think our retailers would tell you we do, I think, a pretty good job of that and we also meet with retailers regularly, Judy, both at the executive level and all the way down to the store level to get feedback from them about how we’re doing. Our hope is that we’re really the category leader for them in terms of solutions.

Bonnie Herzog - Wells Fargo

Okay. That makes sense. And then I had another question on kind of circling back on some of the earlier questions regarding promotions. And I guess, I’m aware that your promotions on certain line that Marlboro has decreased this month and then in February.

So I guess this leads me to believe that volume impact has been minimal on Marlboro. And I just want to make sure this is the right way to think about this and maybe you could touch on other levers you have to pull to improve your net price realization next year. And I definitely would like to clarify or verify that this is in fact a priority for you in 2013.

Marty Barrington

Well, I think I would say what I’ve said before on this topic, which is when you're trying to maximize income there are a number of ways one can do that. Certainly, pricing has been important in the category. It has been, it’s likely to be. It’s certainly something we look at very carefully. You saw PM USA took two price increases last year. You’ve already pointed out that you’ve seen some of the promotions moderate over time. So PM USA is very attentive to keeping an eye on the pricing element, but it's not the only one. You can expand your margins as you’ve seen them expand through effective cost management and Howard’s already described where we are in our current cost programs. We try to be efficient in going to the market. So we keep a good eye there, we have very good margins there. We’ve expanded them throughout 2012, and we’re mindful of that as we head into 2013.

Bonnie Herzog - Wells Fargo

And then just my final question is on innovation in your portfolio and understanding your strategy regarding innovation and in light of the lack of progress with substantially equivalent application approvals. So I guess I would like to know if your innovation will be as robust as last year, if approvals don’t happen for a while and maybe you could update us on the status of that please.

Marty Barrington

Sure. Well we continue to engage with the agency on our substantial equivalence application and I think we have good dialogue with them back and forth as they work through that. You probably know Bonnie, there is something in the order of 4000 applications that came in March two years ago but they are coming up on the two-year anniversary of that batch of filings. And so I think you expect for them to start working through those at some point in time.

With respect to our pipeline, we were pretty thoughtful I think about trying to get ready for the new regulatory environment, and you saw actually in 2012 that we've been able to keep a pretty robust pipeline of products and other offerings to our consumers. We do that in compliance with all the rules that are in place. We would expect to continue to do that. So it’s awfully hard to predict right because we don't see into the agency, I know you don't and I don't. But I would expect for them to start moving things along.

Operator

Your next question comes from the line of Priya Ohri-Gupta with Barclays.

Priya Ohri-Gupta Barclays Capital

Can you share your view around the potential for additional liability management, exercises, perhaps targeting your longer dated maturities that didn’t get tackled the last time? And then secondly, how do you think about the timing of prefinancing your upcoming maturities given the current market backdrop?

Howard Willard

Sure, this is Howard. I think as everybody is aware, we did do a tender for some debt last year and one of the drivers of that was we were mindful of the fact that we had some high maturity towers in 2018 and 2019. Additionally it provided us with some ongoing interest savings when we reissued debt at a lower interest rate. I think we’re pretty comfortable with our maturity towers right now. And I think as we look at both the debt issuance and any kind of tender or refinancing activity, I think we look at it in the context of a much broader analysis, how to effectively use our cash. And I think as you know 80% of our underlying EPS go out in the form of dividends, and then each year I think we make a decision as to what the most effective use of that remaining cash is, and I think we are going to remain flexible as to how we use that cash going forward.

Priya Ohri-Gupta Barclays Capital

And then any comments on how you think the runway ahead of the maturity if you are thinking about refinancings you like to have three to six months cushion, or sequentially even do something afterwards given the flexibility from commercial paper uses?

Howard Willard

Yeah obviously, when we are looking at issuing debt, we do quite a detailed analysis. I don’t know that we have kind of a hard and fast rule like you may be suggesting there, but it’s something we analyze quite carefully.

Operator

Your next question comes from the line of Vivien Azer with Citi.

Vivien Azer – Citigroup

I was hoping that we could talk a little bit more about Marlboro and specifically on the share gains that you posted, if you could give any color on the contribution from new product introductions to the share gains that you have seen in 2012 as well, if you could offer some color on some of the consumer demographics as you have done the work on that, are you gaining outside share with smokers of 18 to 30 or anything like that?

Marty Barrington

We do look at those, of course, but those are competitively sensitive details that we don’t discuss in these kinds of settings. But I can tell you Vivien, overall we’re really happy with those product introductions and what they brought to the brand. They brought innovation to the brand, they brought great packaging to the brand. We like the contribution that they're making to the overall equity of the brand. And as you might expect our brand teams monitor all of that activity carefully, and I think overall we’re very pleased with that. We just don’t break it out at this level for these purposes, I am sorry.

Vivien Azer – Citigroup

That’s fair. In terms of your guidance for 2013, you’re coming off of a big year in terms of the contribution that you got from SABMiller, certainly that’s really been a good contributor to your earnings growth. I was wondering if you could give us a sense of what your expectations are and how you are thinking about the balance between other non-operating items like that and then your reported operating income growth for your segment?

Marty Barrington

Well, I will start and Howard may want to say a word on this. We always start with the operating performance of our companies. This is as you heard in my remarks that, that's why we were able to grow the way we were in 2012 which was our operating companies had terrific business performance. And so we always start with that and they have robust plans for ’13. And now that said, we do have other levers that we can use to try to balance the overall equation but I think it’s important to understand that we always start with the operating performance of our tobacco companies and our wine companies because that’s the core of our business. Howard, do you want to say more on that?

Howard Willard

Sure, I would just add – the comment on SABMiller, I think you pointed out why we saw that SABMiller’s had a strong performance last year and has had quite a run of strong performances over the years. And so when we put together our guidance we certainly factored in an estimate for SABMiller and we have a fair amount of insight into that because of our broad participation. But certainly we have a much deeper assessment of the operating plans for the businesses that we operate. But we continue to expect SABMiller to be a nice contributor going forward.

Operator

Your next question comes from the line of Ann Gurkin with Davenport.

Ann Gurkin - Davenport

I don’t know if you’d comment on the elasticity model and how it has performed or how it compares to historical measures following the price increase taken in December. And I guess elasticity for the premium segments, the Marlboro brand architecture buildouts and the discount segments, can you comment at all on that?

Marty Barrington

Well, I can comment generally on elasticity and over time it hasn’t changed very much with respect to cigarettes, negative 0.3, we’ve seen that really for quite some time now and we don’t see any change in that. We haven’t seen any change actually in a while, we certainly don’t see any change in it now.

Ann Gurkin - Davenport

And then just want to be clear, as you think about the Marlboro franchise and your MST business, are there still white bakers (ph) opportunities whether it’s packaging or blends or mixes, to roll out new products, just in general, not specifics.

Marty Barrington

That’s what the brand teams are doing every day. They are trying to study their consumer set, trying to figure out where there is opportunity and try to develop products for adult customers that we could take to them, sure.

Ann Gurkin - Davenport

Okay. Thank you.

Marty Barrington

Thanks for calling.

Operator

Your next question comes from the line of Chris Ferrara with Bank of America.

Chris Ferrara - Bank of America

Hey, thanks. Guys, sorry for the basic question of advance. But I guess following up on the elasticity question, can you just talk about I guess, how you gagged the long-term capacity of U.S. consumer due to endure higher cigarette prices? I hear you that the point there hasn’t changed in a while, but I mean surely you guys must spent some time thinking about at what price levels that might change, right. So, I’m just curios how you sort of think about that framework?

Marty Barrington

I think it’s -- I don’t know how to predict that in the future other than to be informed by what we've seen in the past. There has been a lot of history with respect to, what the prices have been in the industry over time. And that elasticity has remained pretty durable.

I guess another way of looking at it, Chris, is that if you look at the pricing in the U.S. domestic markets, the other markets of course you would see that it probably has a pretty long runway in front of it. But nobody knows that I think until you get there and we are not there yet.

Chris Ferrara - Bank of America

And I guess just bringing it more to the short-term, I mean do you guys think that at current levels you could sort of maintain or drive modest share momentum without pricing below the industry average in the cigarette category?

Marty Barrington

Well, I’ll go back to the comments I made before, which is, it is always tempting I think to kind of break these things out into single constituent elements and it just doesn't work that way. There's always the dynamic between wanting to increase income, which is what our strategy is while trying to maintain share. And that's the balance that you have to assess based on a lot of factors at any one point in time. It depends on what the economy is doing. It depends on consumer confidence. It depends on other factors that we pointed out I think previously.

So the way we think about it is, we try to be thoughtful about that, as we run our business each year and we pay close attention to it, but to make a general statement about that is awfully hard to do.

Chris Ferrara - Bank of America

Thank you.

Marty Barrington

Thanks for calling.

Operator

Your final question comes from the line of Chris Burritt with Bloomberg News.

Chris Burritt - Bloomberg News

Hey, thank you for your time.

Marty Barrington

Good morning.

Chris Burritt - Bloomberg News

I was going to ask, the release mentions a headcount reduction and was wondering if you could discuss the number of jobs cut last year and whether there maybe further cuts this year?

Marty Barrington

Well, I can certainly talk about the program that we had in place which was, I think we all described it if I’m not mistaken. I think the results are in our public filings. We have to watch our headcount like every business does, but particularly in our category because cigarette volumes declined.

We prefer to manage that over time and we work really hard to do that over time by maintaining our headcount through attrition if at all possible. There have been programs in the past. No one can, never say that there won’t be one in the future. But that’s not our current intention. We are trying to manage our headcount over time, and we hope that we are going to be able to do that.

Operator

Thank you. At this time, I would like to turn the call back over to Mr. Brendan McCormick for closing comments.

Brendan McCormick

Thank you everyone for joining our call this morning. We appreciate your interest in Altria. If you have any follow-up questions, please contact us on Investor Relations.

Operator

Thank you. This does conclude today's conference call. You may now disconnect.

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