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Altria Group Inc. (NYSE:MO)

CAGNY 2014 Conference Call

February 19, 2014 9:15 am ET

Executives

Martin J. Barrington - Chairman and Chief Executive Officer, Altria Group, Inc.

Howard A. Willard III - Executive Vice President and Chief Financial Officer, Altria Group, Inc.

James E. Dillard - Senior Vice President, Regulatory Affairs, Altria Client Services Inc.

Analysts

Christopher Growe - Stifel Nicolaus

Judy Hong - Goldman Sachs

Nik Modi - RBC Capital Markets

David Adelman - Morgan Stanley

Constance Maneaty - BMO Capital

Christopher Growe - Stifel Nicolaus

We move on to the next presentation. Thank you. I'd like to warmly welcome Altria to the CAGNY Conference. So Altria has been a long-time supporter of the conference and once again would delight us tonight with what should be a great dinner. We're glad they still own that Ste. Michelle Wine business too. We'll also like to thank SABMiller for providing its products tonight, and again, should have a great event.

Here to present for the Company is Chairman and CEO, Marty Barrington. Altria has featured consistent growth with its leading position across the tobacco industry. The Company generates very strong cash flow which it uses to reward its shareholders. The Company is also entering into e-cigarette category with its MarkTen product. So here to discuss those opportunities and more is Marty. I'll turn it over to you, Marty. Thank you.

Martin J. Barrington

Thanks Chris. Good morning, everyone. Thanks for joining us for our presentation. We're really glad to be back at CAGNY and to discuss with you why we believe Altria continues to be a compelling investment. Howard Willard, Altria's CFO, and Jim Dillard, Senior Vice President of Regulatory Affairs will present with me this morning. Dave Beran, Altria's President and Chief Operating Officer, and Murray Garnick, who is responsible for litigation, will join us for questions in the break-out room.

Before we begin, please review the Safe Harbor Statement in today's presentation and the Forward-Looking and Cautionary Statements section in today's press release for a description of the various factors that could cause our actual results to differ materially from projections included in today's remarks. Reconciliations and further explanations of the non-GAAP financial measures we discuss today are available on altria.com.

Altria has an outstanding long-term track record of creating value for shareholders. Over the past six years, we've grown our adjusted diluted EPS at a compounded annual rate of 7.9% and we've consistently grown our dividend. Over this period, we've produced total shareholder returns of approximately 137%, more than three times the return of the S&P 500. We expect Altria to produce consistent, attractive financial results in the future and this morning, we'll share the reasons for our confidence.

Our long-term financial goals remain unchanged, to grow adjusted diluted EPS at an average annual rate of 7% to 9% and to maintain a dividend payout ratio of approximately 80% of adjusted diluted EPS. Our strategies are to maximize income from our core premium tobacco businesses over the long-term, grow new income streams with innovative products, and manage our diverse income streams and strong balance sheet to deliver consistent financial performance.

Our capabilities and expertise drive execution. They include deeply understanding adult tobacco consumers, building and sustaining premium brands, creating strong sales and distribution relationships, developing innovative products, and managing external challenges facing our businesses including litigation, regulation and taxation. We believe that these strategies and capabilities position us to consistently achieve our long-term financial goals.

Let's begin by explaining how Altria maximizes income from its core tobacco businesses and then review our approach to innovation. Howard then will describe how Altria's business model and strong balance sheet help us deliver consistent financial performance, and Jim will share how we're interacting with FDA and using our regulatory capabilities to support Altria's operating companies, I'll then wrap up with Altria's track record for delivering shareholder returns, and then we'll take your questions.

The U.S. tobacco industry is an attractive investment opportunity and Altria remains the leader. The U.S. tobacco manufacturers' profit pool is large and growing. Over the last five years, the profit pool grew at a compounded annual rate of 5% to $14.5 billion. In 2013, cigarettes generated most of the industry's profits, followed by smokeless tobacco and machine-made large cigars.

Although cigarette volumes continue to decline, the rate of decline has held steady at 3% to 4% since 2007, with the exception of years impacted by the federal excise tax increase in 2009. Over the last several years, increases in smokeless tobacco and machine-made large cigar volume have partially offset cigarette volume declines. We estimate that total tobacco volume, based on pounds, declined at a compounded annual rate of about 1% per year from 2010 through 2013.

For context, cigarettes are by far the largest consumer product category by dollar sales in major U.S. retail channels, twice the size of beer, the next biggest category. Cigarette dollar sales are also greater than sales of carbonated beverages and salty snacks combined. The smokeless category is smaller, but has grown dollar sales faster than many of the largest non-tobacco consumer products categories over the past four years.

Altria earns the largest share of the U.S. tobacco manufacturers' profit pool. Our tobacco operating companies hold leading positions in the most profitable segments, cigarettes, smokeless tobacco and machine-made large cigars, and together, Altria's tobacco businesses earned approximately 51% of the total U.S. tobacco profit pool in 2013, more than twice that of its largest competitor.

Our tobacco businesses are fueled by large premium brands with strong brand equity, including Marlboro, Copenhagen, Skoal, and Black & Mild. Marlboro, at nearly 44 share points, is larger than the next 10 cigarette brands combined. Copenhagen and Skoal together capture more than half of the retail share in the smokeless category. Black & Mild is the leading premium brand in the machine-made large cigar category. These premium brands produce attractive margins, consistent income growth and strong cash flow. Our strategy is to maximize income from these businesses, focusing on long-term results. We believe that our long-term focus leads to better results for shareholders over time.

Because different dynamics exist in the tobacco categories in which we compete, we pursue different ways to maximize income in them. In the smokeable products segment, Philip Morris USA and John Middleton strategy is to maximize income while maintaining modest share momentum on Marlboro and Black & Mild over time.

In the cigarette category, PM USA grows income by thoughtfully balancing different income drivers, including pricing, cost management, retail share performance, equity-building activities and product innovation. PM USA successfully uses these tools to deliver consistent income growth despite declining cigarette volumes. The contribution each of these tools makes varies over time as PM USA pursues its long-term objectives.

Marlboro is the flagship brand in the smokeable products segment. It's the iconic cigarette brand, positioned as the cigarette men smoke for flavor. Marlboro has grown its share of the U.S. cigarette category consistently since 1954 and is by far the most profitable U.S. cigarette brand. PM USA has grown the brand by building superior brand equity and loyalty.

In 2012, PM USA began investing in a new brand architecture for Marlboro to continue its momentum. The architecture allows the brand to more effectively engage both loyal and competitive adult smokers. Each of Marlboro's four flavor families, Red, Gold, Green and Black, expresses the brand's positioning and values in a unique way, allowing the brand to broaden its offerings. The architecture is driving innovation in products, packaging, equity campaigns and promotions. For example, PM USA has grown its product portfolio by expanding distribution of Marlboro Southern Cut in the Gold family and Marlboro NXT and Marlboro Edge in the Marlboro Black family.

PM USA communicates Marlboro's flavor families in equity campaigns and promotions. At retail, PM USA communicates the flavor families on the fixture, in point of sale signage and on packs. PM USA uses its large adult smoker database to communicate with smokers 21 or older through direct mail and email. The brand also connects with smokers 21 or older on Marlboro.com, where they can access articles, interviews, photographs and videos on their PCs and mobile devices.

PM USA's investments in the Marlboro architecture are long-term, but we're very pleased with results so far. For example, Marlboro Black is growing share and building a strong position, including with 21 to 29 year old smokers. Marlboro.com is effectively and creatively engaging adult smokers with Marlboro's flavor families. Since PM USA relaunched the site, it's experienced more visitors who stay longer. According to comScore, Marlboro.com is among the leading CPG websites in the U.S. based on the average number of unique visitors. From 2011 to 2013, PM USA used tools like pack inserts, direct mail, e-mail and Marlboro.com to increase the number of Marlboro connections with adult smokers by almost 50%.

PM USA's investments support modest Marlboro share momentum over the long-term. Since 2008, Marlboro has grown its retail market share by an annual average of about 0.2 share points. A strong Marlboro franchise provides the foundation for attractive margins and consistent income growth over time.

Pricing is an important driver of income growth in our smokeable products segment. Marlboro's brand equity supports a premium price at retail. PM USA carefully manages its pricing to deliver long-term income growth. The Company considers several factors when making pricing decisions, including the impact of economic conditions on adult tobacco consumers, price gaps and competitive dynamics.

With regard to the economy, PM USA continuously monitors key indicators to understand the conditions of adult smokers. These include employment rates, housing starts and consumer confidence. While some economic metrics are improving modestly, the recovery has been uneven and most measures remain well below pre-recession levels. Our 2014 plan assumes that the economic situation for adult tobacco consumers will be similar to 2013.

PM USA also carefully monitors price gaps in the cigarette category. Since 2009, Marlboro's price gap versus the lowest effective priced cigarette has consistently been about 35%, and during this period, the smokeable products segment continued to grow adjusted operating companies income margins.

Although the cigarette category remains competitive, overall premium category trends remain positive and PM USA has a strong track record of growing its premium Marlboro franchise while delivering income growth. Premium brands continue to capture about 75% of retail share in the U.S. cigarette category and this share has held steady for many years. The long-term trend of the premium category consolidating into the three leading premium brands has also continued. From 2009 through 2013, the combined share of Marlboro and the other leading premium brands increased by 2.6 percentage points, with each brand growing its share.

Turning to our machine-made large cigar business, Black & Mild is positioned as the best any-day cigar adults enjoy for its smooth taste and pleasant aroma. Since the federal excise tax increase in 2009, the competitive environment in the machine-made, large cigar category has been negatively impacted by increased imports of low-priced cigars. In this environment, Middleton has focused on income growth while managing share performance, resulting in an average annual share loss of 0.6 percentage points.

Our strategy in the smokeable products segment has produced strong, long-term results. PM USA's investments in Marlboro has strengthened the brand and supported modest share momentum. And from 2008 through 2013, the smokeable products segment grew adjusted operating companies income at a compounded annual growth rate of 4.2% to $6.4 billion.

In our smokeless products segment, USSTC's strategy is to increase income by growing its volume at or ahead of the category growth rate while maintaining modest share momentum on Copenhagen and Skoal combined. Since 2009, USSTC increased its volume at a compounded annual rate of 5.1% and the company grew Copenhagen and Skoal's combined retail share at an average of 0.9 share points per year. This strong share growth was driven by Copenhagen, which grew by almost 7 percentage points, partially offset by Skoal's share loss of 3.4 percentage points.

Copenhagen has provided adult dippers moist smokeless tobacco satisfaction since 1822. The brand's strong equity is grounded in craftsmanship. Copenhagen has a long history of leading the natural segment with Fine Cut Copenhagen Snuff and Copenhagen Long Cut Natural. And recently, the brand expanded distribution of Copenhagen Southern Blend in select markets.

The brand also has broadened its product offerings to reach adult dippers with different taste preferences. In 2009, Copenhagen entered the largest and fastest growing segment of the category with Long Cut Wintergreen and later added Pouch Wintergreen. Since 2009, these products have delivered strong retail share growth. USSTC also invests in equity-building programs like the 'Men of Copenhagen' promotion, in which Copenhagen partners with local non-profit organizations to bring its dippers together to make a difference in their communities.

Since 1934, Skoal has provided products that offer a smooth, balanced smokeless tobacco experience. Skoal has expanded its traditional product portfolio as adult dippers taste preferences have evolved. Adult dippers can choose between the balanced smooth taste of Skoal Classic and the bold smooth taste of Skoal X-TRA.

Skoal X-TRA has performed well since its launch in 2011. However, Skoal Classic has lost market share, driven in part by its large price gap versus the leading discount brand. To address this issue, USSTC recently began offering Skoal Classic at more competitive price points in select geographies. USSTC also is investing to strengthen Skoal's equity by reintroducing the 'Skoal. A Pinch Better.' campaign, which highlights the way Skoal enhances everyday experiences.

And finally, the brand is investing in exciting new promotions like '80 Days of Saturdays' to enhance Skoal's relevance with adult dippers. This promotion offers adult dippers daily chances to win great prizes. Overall, USSTC's strategy continues to produce strong financial results. Since 2009, the smokeless products segment has grown adjusted operating companies income at a compounded annual rate of 12.9% to just over $1 billion. So, Altria's premium tobacco businesses are the core of our business model and these businesses continue to deliver on their strategies.

Altria's second strategy is to grow new income streams with innovative products that meet adult tobacco consumer preferences. Nu Mark, which leads our efforts, is taking a three-pronged approach to creating a portfolio of innovative products. First, Nu Mark has deep expertise in premium brand building and supply chain management and will use the scale of Altria's service companies to accelerate its progress. Our service companies have industry-leading capabilities in areas like consumer research, product development and sales and distribution. Second, Nu Mark supplements these resources by acquiring products, technologies and capabilities that accelerate its progress. And finally, Nu Mark will create strategic agreements with third parties when they create value.

Nu Mark is applying these strategies in the rapidly growing e-vapor category. In 2013, consumer spending on e-vapor products reached approximately $1 billion in the U.S. Increased awareness and trial of e-cigarettes have driven category growth and we estimate that 90% of adult smokers are aware of e-vapor products and about two thirds have tried them. The category's long-term growth rate is likely to be shaped by several variables, including product innovation. While awareness and trial are high, only a small number of adult smokers use these products daily. Many adult smokers and vapers are still looking for a product that meets their requirements and desires. Regulation and taxation also will impact the category's trajectory.

Nu Mark's goal is to achieve leadership in the U.S. e-vapor category. Since it entered the category in August 2013, Nu Mark has taken several important steps toward its goal. Nu Mark launched MarkTen e-cigarettes in Indiana and Arizona, announced an agreement to acquire Green Smoke and its affiliates to supplement its organic strengths, and signed agreements with Philip Morris International to sell its products outside the U.S., and this morning we're pleased to announce another significant step forward, Nu Mark plans to expand MarkTen nationally beginning in the second quarter of 2014. So let me share some context for this announcement.

The work done in our test markets has helped shape our way forward. Nu Mark is focused on the following areas to create a path to leadership; product superiority and innovation; premium brand building; distribution and customer partnerships; a reliable, high-quality, low-cost supply chain; and regulatory and government affairs capability. Nu Mark has made progress in several of these areas in Arizona.

In the product area, Nu Mark improved MarkTen's flavor systems and added a USB charger to the single unit package so adult vapers don't need to purchase the charger separately. Nu Mark also quickly gained distribution in over 1,900 stores and is driving awareness and trial with direct mail, magazine ads and promotions in adult only facilities. Although it's still early, Nu Mark's results in Arizona have exceeded our expectations. In just seven weeks, MarkTen has achieved brand leadership there, with a current market share of 48%. Nu Mark will apply all that it's learned to MarkTen's national launch.

Earlier this month, we announced that Nu Mark signed an agreement to acquire the e-vapor business of Green Smoke for approximately $110 million, subject to closing adjustments and additional incentive payments. Nu Mark's acquisition of Green Smoke should accelerate its progress toward leadership. Green Smoke has been manufacturing and marketing high-quality, premium products since 2009 and will add additional depth to Nu Mark's already strong team. The acquisition also expands Nu Mark's product portfolio to address adult smokers' and vapers' different product preferences. Green Smoke markets products in different styles and formats, sold under the Green Smoke brand, including products that are larger than MarkTen. We expect the deal to be closed by the second quarter of 2014.

Altria's strategic agreements with PMI further strengthen Nu Mark's e-vapor strategy. Through licensing, regulatory engagement and contract manufacturing arrangements, Altria is providing PMI with an exclusive license to commercialize Nu Mark's e-vapor products internationally. The agreements give Nu Mark the opportunity to generate royalties and contract manufacturing fees on the products provided to PMI. Overall, we're very pleased with Nu Mark's progress in e-vapor. As categories go, the e-vapor category is, of course, just leaving the starting gates, but Nu Mark has made meaningful progress towards leadership in a short time.

Before concluding on innovation, it's important to remember that our agreements with PMI cover more than e-vapor. Importantly, they also support Altria's broader strategy to create a robust portfolio of innovative products for adult tobacco consumers, including those that have the potential to be authorized by FDA as modified risk tobacco products. PMI granted Altria an exclusive U.S. license to sell two of the heated tobacco products that PMI is developing. Further, Altria and PMI have agreed to cooperate on regulatory engagement related to heated tobacco and e-vapor products.

Howard will now highlight how our business model delivers strong, long-term results.

Howard A. Willard III

Thanks Marty. Altria's third strategy is to manage our diverse income streams and strong balance sheet to deliver consistent financial performance. Our diverse business model sets us apart from other U.S. tobacco companies. We generate cash flow and income from the three most profitable U.S. tobacco categories, the global beer industry and the domestic wine category. Since 2002, we've also made significant progress unwinding our financial services business. Although the business dynamics in these categories and industries differ, our positions in them have helped us consistently achieve our long-term financial objectives.

As Marty mentioned, our tobacco operating companies and their strong premium brands are at the heart of our business model. They have a strong track record of producing consistent, attractive results. From 2008 through 2013, the smokeable products segment grew revenues net of excise taxes per 1,000 units at a compounded annual rate of 5.2%, grew adjusted operating companies income at a compounded annual rate of 4.2%, and expanded adjusted operating companies income margins by 8.4 percentage points.

From 2009, the year Altria acquired UST, through 2013, the smokeless products segment grew USSTC's volume at a compounded annual rate of 5.1%, increased Copenhagen and Skoal's combined retail share by an average of 0.9 share points per year, and grew adjusted operating companies income at a compounded annual rate of 12.9%.

Cost management has also been an important driver of consistent income growth. Over the past several years, Altria delivered nearly $2 billion in productivity savings. PM USA has focused on reducing its fixed infrastructure costs while efficiently managing its variable costs per pack. From 2008 through 2013, our smokeable products segment's controllable cost per 1,000 grew at a compounded annual rate of less than 1%, below the rate of input cost inflation.

Additionally, our tobacco companies' quota buyout payments will end after the third quarter of 2014, reducing costs in our smokeable products segment by about $100 million this year and $400 million in 2015. Cost reduction is part of our culture and we'll continue to carefully manage costs in the future.

Our growing alcohol assets provide diversification outside of U.S. tobacco, and historically, these assets have delivered strong income growth. Our 27% economic interest in SABMiller allows us to participate in the global beer profit pool. The earnings from our SABMiller stake have grown from $467 million in 2008 to nearly $1 billion in 2013, a compounded annual growth rate of 16.2%.

The market value of Altria's interest has grown from $7.3 billion at year-end 2008 to more than $19 billion as of January 31, 2014. Our SABMiller stake also supports our strong balance sheet. We regularly evaluate our economic interest in SABMiller and currently believe maintaining the interest is in shareholders' best interest.

Ste. Michelle is one of the fastest growing premium wine companies in the U.S. Its distinctive collection of wines continues to receive broad acclaim while delivering strong financial results. In 2013, Ste. Michelle's wines received nearly 225 90-plus ratings and Wine & Spirits magazine named Chateau Ste. Michelle 'Winery of the Year' for the 19th time. The company has grown adjusted operating companies income from $73 million in 2009 to $118 million, a compounded annual growth rate of 12.8%.

At Philip Morris Capital Corporation, we've made significant progress unwinding the financial services business, since we decided to stop making new investments in 2002. The net finance receivable has decreased from $9.4 billion in 2002 to $2 billion in 2013. We expect the income contribution from the business to be uneven going forward as underlying lease income continues to decline and the opportunity for additional asset sales diminishes.

Altria's strong balance sheet strengthens our financial performance in several ways. It provides stability and liquidity, supports our investment grade credit rating and enhances our ability to return cash to shareholders through dividends and opportunistic share repurchases.

In 2012 and 2013, our strong balance sheet and favorable capital market conditions allowed us to tender for high coupon debt and replace it with new lower cost debt. These transactions, along with scheduled debt maturities, improved our debt maturity profile and lowered our future interest expense. All of our capital markets activities helped reduce our weighted average coupon rate from 9.1% at the end of 2009 to 5.9% as of December 31, 2013.

Altria returns cash to shareholders primarily through our strong dividend. Since the PMI spin-off in early 2008, we have increased our dividend seven times and grown it at a compounded annual growth rate of 8.8%. Over this period, Altria has paid shareholders over $18 billion in dividends. Our dividend yield of 5.4% as of February 14 exceeds the 2.7% yield of 10-year U.S. Treasuries and the 2.1% yield of the S&P 500. All dividend payments are subject to the Board's discretion, we aim to increase our dividend in line with adjusted diluted EPS growth.

We also repurchase stock when we conclude that it's the best use of cash to maximize shareholder value. Since the PMI spin-off through the end of 2013, Altria has repurchased approximately $4.2 billion of shares. Through the end of 2013, we've repurchased shares valued at more than $540 million under our current $1 billion program, which we expect to complete by the end of the third quarter of 2014. The timing of share repurchases depends upon marketplace conditions and other factors.

To sum up, our diverse income streams and strong balance sheet help us achieve our long-term EPS and dividend goals. Our model differentiates Altria from other investments and our strategy has created value for shareholders. We're one of only a handful of domestic companies in the S&P Food, Beverage and Tobacco Index that delivered adjusted diluted EPS growth in excess of 7% in five of the last six years.

Altria reaffirms that it expects 2014 full-year adjusted diluted EPS to increase by 6% to 9% to a range of $2.52 to $2.59 from an adjusted diluted base of $2.38 per share in 2013. Our core tobacco businesses are positioned to deliver strong income growth by focusing on their leading premium brands and cost reduction. We also expect that our 2014 earnings will benefit from lower interest expense, a lower effective tax rate and a reduction in shares from the current share repurchase program. However, we plan to continue making disciplined and incremental investments to build Nu Mark's e-vapor business and expect continued variability in adjusted operating companies income at PMCC.

Now, I'll turn the presentation over to Jim who will discuss our regulatory affairs capabilities.

James E. Dillard

Thank you, Howard, and good morning everyone. I've met many of you, but for those I haven't met, I'm Jim Dillard. I'm responsible for leading the Regulatory Affairs department. I've been with the Altria family of companies for five years. Before joining Altria, I spent seven years at UST, where I was Senior Vice President of Manufacturing, Science and Technology. Prior to joining the tobacco industry, I held various positions at FDA for over 14 years, including the Director of the Division of Cardiovascular and Respiratory Devices.

We've worked hard to create and improve our strong regulatory capabilities to support Altria's tobacco operating companies. We're focused on three areas, building a constructive and enduring relationship with FDA, compliance, and effective engagement and advocacy. We see FDA regulation as a marathon, not a sprint. So we're taking a long-term approach to our work.

Since the passage of FDA regulation, we have been building our relationship with FDA through engagement and information sharing. We've shared our experience and expertise in various ways, including through more than 85 submissions to dockets, dozens of meetings with FDA, presentations to the Tobacco Products Scientific Advisory Committee and public workshops. In 2013 alone, we published eight scientific papers and presented at five scientific and public health conferences. We'll continue to engage with FDA with science and evidence-based information to help the agency implement its statutory authority.

Altria's compliance with current regulations is important for protecting our shareholders' investments and creating a strong relationship with FDA. We've built strong systems and processes to support compliance, including registering our manufacturing facilities, listing our tobacco products and submitting all necessary ingredient information. Our registered facilities have been inspected by FDA, and we have hosted FDA through tours of all of our manufacturing facilities. We have also conducted extensive regulatory training with hundreds of Altria employees.

We've also been working with FDA on substantial equivalence, which FDA has said is a priority. Substantial equivalence is one of the regulatory pathways for us to market and sell our products. It's important to remember that for PM USA and USSTC, we have substantial equivalence applications pending for both products that are currently in the market and for products not yet introduced. So far, FDA has completed review of 40 substantial equivalence submissions across the entire industry and we expect to see additional progress in 2014. We will of course continue to engage with the agency on this important topic.

We are also proactively advocating on behalf of Altria's tobacco operating companies on a host of issues. I'll share an update on two important issues, menthol and the deeming regulation. Regarding menthol, last summer FDA released its preliminary scientific evaluation and issued an advance notice of proposed rulemaking regarding the potential regulation of menthol in cigarettes. In November 2013, we submitted comments raising a number of concerns with the information raised and released by FDA. We provided further evidence that regulatory actions or restrictions related to the use of menthol in cigarettes are neither necessary nor justified. We demonstrated that the recent scientific literature strengthens our original assessment that menthol cigarettes do not affect population harm differently than non-menthol cigarettes.

The agency is reviewing nearly 200,000 comments from various stakeholders. The agency has also made clear that it satisfied its statutory obligation to review the use of menthol in cigarettes. If FDA ultimately decides to take future action to regulate the sale or distribution of menthol cigarettes or establish a product standard for menthol cigarettes, it must do that through rulemaking and public comment. We will continue to monitor this issue and engage with the agency appropriately.

FDA has said that it will issue proposed deeming regulations very soon. In October 2013, the agency sent proposed regulation to the Office of Management and Budget for review. We've engaged with FDA and OMB on several occasions to discuss our perspective on FDA's efforts to extend its authority to other tobacco products. We met with FDA to discuss regulation of cigars and pipe tobacco and the regulation of e-vapor and other tobacco products containing tobacco-derived nicotine.

We support FDA's efforts to extend its authority to all tobacco products for many of the same compelling reasons we supported passage of the Act originally. FDA regulation of newly deemed products will provide a framework to evaluate tobacco products that are potentially less harmful than conventional cigarettes. It will also create clear principles for accurate and scientifically grounded communications to adult tobacco consumers.

We support FDA's desire to impose general controls, including those relating to registration, product listing, ingredient listing, and good manufacturing practices requirements, among others. General controls for newly deemed products should help establish a common set of standards for all manufacturers and importers of deemed products in the U.S.

We firmly believe FDA has an unprecedented opportunity to advance public health goals by recognizing that some types of tobacco products may have significantly lower risk compared to cigarettes. We believe FDA should adopt a regulatory framework that recognizes the differences in tobacco products and fosters innovation that may have the potential to benefit public health. The framework must be grounded in science and evidence.

The process of implementing deeming regulations is likely to play out over the next couple of years, starting with the FDA's publication of a draft regulation, followed by a notice-and-comment period. This is an important issue for us and for the tobacco industry. Of course, we will continue to share our perspectives with FDA as the process unfolds.

In 2014, we expect FDA will continue to focus on deeming, menthol and substantial equivalence. Additionally, we expect FDA will announce new appointments to the Tobacco Products Scientific Advisory Committee, as several members terms ended in late January. Earlier this month, the Center for Tobacco Products launched a youth tobacco prevention campaign, starting the first phase of its five-year, $600 million advertising and communications initiative.

In conclusion, we have built strong capabilities to help our tobacco companies successfully compete under FDA regulation. We will continue to build a constructive relationship with FDA that is grounded in compliance and effective advocacy.

I'll now turn the presentation back over to Marty.

Martin J. Barrington

Thanks, Jim. So to sum up our presentation, Altria has delivered consistent financial performance over time by using our strategies and capabilities to achieve our long-term EPS and dividend goals. We're maximizing income from our core tobacco businesses, we're investing in innovative products to grow new income streams, and we're using our diverse business model and strong balance sheet to deliver consistent performance.

Altria has produced a strong track record of creating value for shareholders. From 2007 through 2013, we grew our adjusted diluted EPS at a compounded annual rate of 7.9% as compared with the S&P 500's estimated operating EPS growth of 4.6%, which excludes corporate and unusual items in a manner similar to our adjusted diluted EPS measure. Altria's current dividend yield of 5.4% is more than twice the yield of the S&P 500 and one of the highest ratios in the index.

Our adjusted diluted EPS growth, together with our large and growing dividend, has produced excellent total returns to shareholders. From the end of 2007 through 2013, Altria's total shareholder return of 137% outperformed the S&P Food, Beverage and Tobacco Index's return of 91% and the S&P 500's return of 44%. Thanks to our talented and dedicated employees, Altria has delivered terrific results for shareholders. We believe our goals, strategies and capabilities position us to produce strong results in the future.

Many thanks for your attention, and we'll now be happy to take your questions.

Question-and-Answer Session

Judy Hong - Goldman Sachs

So on MarkTen, just wanted to get a little bit more color just in terms of the test in Arizona, how that was different versus Indianapolis because the market share performance certainly seemed more impressive there? You talked about wanting to be an established leadership in e-vapor category, so how quickly can you get there when you have some of the established players already in the e-cigarette category and the investment needed to really become the leader in that category?

Martin J. Barrington

Good questions. Thanks Judy. We did a number of things different in Arizona. I think I've described previously how we are going about innovation which is we have a hypothesis, you study your consumer, you make a product, you have an offering around our value equation which is price and product and packaging and so forth, and then you take it to them and you find out, and we have a process for sort of fast learning and adapting what we learn. We took the learnings from Indiana and we applied them very quickly when we went out to Arizona because we weren't out very long as you know. We offered a different flavor system. We put the USB charger in the pack. We tried different promotional techniques to try to see if we could generate some trial. So, all of those were different in Arizona, and I have to tell you, we're really happy with the performance. It's early, okay, it's seven weeks, but you saw the share number and we think we learned a lot and we'll use all that learning as we go forward.

With respect to the category itself, I would say that leadership is going to be established over time. It really is early days in e-vapor and I know that it's exciting and people are talking about e-vapor a lot, which is understandable, but it's really early. Consumers are still choosing, they're trying to find their product, they're trying to find their brand, distribution is proceeding with the majors now getting in. So, it's early. We are completely confident that we can meet the aspiration we've set for ourselves, which is depending on how big the category turns at vapers but we're leaders in every category in which we compete and we have exactly the same aspiration for e-vapor.

I'll give the president's privilege to Chris.

Christopher Growe - Stifel Nicolaus

The one perk of the president I guess.

Martin J. Barrington

I didn't want to ditch the president.

Christopher Growe - Stifel Nicolaus

So I do have a couple of e-cigarette questions related. I'm just curious with the Green Smoke acquisition and maybe what that brings to your total e-vapor technology or strategy and then is that necessary for MarkTen to go national, is there anything you got from that that would benefit MarkTen?

Martin J. Barrington

No, it's not, is the answer to your second question, Chris. Green Smoke is a really terrific little company. We were so pleased to announce our intention to acquire them. They've been in business as we pointed out in remarks since 2009. They have very talented team of people. They have supply-chain people on the ground in China. They have a very entrepreneurial culture. They have established a nice suite of products including in formats, Chris, that are different than the MarkTen. I mean I think it's pretty obvious to everyone who's been studying e-vapor that, as I just pointed out with Judy, they're choosing their products now, some like a closer-in cigarette experience, someone a different kind of a device. We're now able to supplement Nu Mark with Green Smoke's portfolio and its people and its capability. I think it's going to be a terrific combination.

Nik Modi - RBC Capital Markets

Marty, I think a couple of years ago when special blends was launched, it was really a function of kind of provide value to your existing consumers and it seems that things have started to stabilize, at least for the core tobacco consumer. So I'm just curious what happened to the mix within the portfolio of special blends over the last let's say six to nine months? And then the second question is, now that you'll have two different e-cigarette brands, is there going to be a different pricing architecture between those two, meaning one is going to be at a lower price? And then the third question is the test in Arizona, my understanding is the price point didn't change but you added a lot of stuff, extra stuff into the pack, was curious on the margin. And then my fifth, sixth – no, that's it.

Martin J. Barrington

Alright, it seems our time has expired here with Nik's questions. Let me start back with special blends. I mean the purpose of special blends in the portfolio is, as you know, we expanded the Marlboro SKUs so we could have a price point for consumers who were under pressure. As we said in our remarks, the macro economy, there are some signs of improvement but I have to tell you they are not improving all that differently for the adult tobacco consumer. You can go through the factors, whether it's unemployment rates or total unemployment rate or labor participation rates or housing starts, then you have a bump in the minimum wage in states, but when you sort through it all, it's not that we're discouraged about that, it just looks to us like the status quo is going to persist for a while. That's the role of special blends, just to keep those consumers who want to be in the Marlboro franchise to offer them the value that they need to stay in the franchise. That's their purpose. What we do as you know is we move the promotional levels around as we believe we're able to execute and we do that on basically a state by state basis.

With regard to two e-cigarette brands, we haven't closed on Green Smoke yet, so I want to be cautious about what I tell you about that. It won't surprise you though I think to know that we have integration teams working on answering the key questions so that when we close, as I expect we will, although I guess it's why they call it closings because you don't know [indiscernible], but I think it's going quite smoothly. We'll be ready with the brand strategy at closing. I shouldn't probably get ahead of that closing, if you'll forgive me.

And I got lost with the third one, what was Arizona, the margin? Yes, the margin structure is early in e-vapor. I think that's true in Arizona or Indiana or Colorado or anywhere. Everybody is investing into e-vapor. Everybody is trying to build both distribution and brand equity. And so until I think the investment base sorts itself out, I think anything I say to you about margin would be speculation. Here again I can tell you our aspiration. Our aspiration is to have good margins there like we do in our other product categories. It's just early days.

David?

David Adelman - Morgan Stanley

Thank you, Marty. A few things. First, if you compare the test market in Arizona, would you envision on a national basis having the same levels of sort of promotion support, trade execution and so forth or was there something special in Arizona that you wouldn't be able to replicate either in terms of resources or financially on a national basis?

Martin J. Barrington

I won't get into particulars as you might expect but I can tell you that we set up the test in both Indiana and Arizona to answer questions we had about our promotional strategy as we headed towards national.

David Adelman - Morgan Stanley

Okay. Secondly, you mentioned in your prepared remarks on Skoal on the classic line selectively increasing the promotional spend rate in certain geographies. Can you quantify that at all, how much you envision bringing the price point down and approximately what percent of your volume that might be?

Martin J. Barrington

I could but I won't. It's competitive as you know. I can tell you how we're thinking about it though, to try to give you some color, which is, as you know when you look to the smokeless markets, they do tend to vary by state, they vary by where brands have strength. Skoal has states of strength, as does Copenhagen, as do some other brands. The excise tax structure can vary significantly in the states. So what we'll have is, we'll have a plan to execute in those places in that way that makes sense to close the gap. As you know and what we've learned and I guess everyone has learned that you can demand a premium for products but you have to have your value equation right. We're trying to get the Skoal value equation right in those geographies, and David, it's hard to give you one number because it's going to be that kind of a tailored strategy.

David Adelman - Morgan Stanley

Okay, and then lastly maybe for you or for Jim, is there a little bit of tension in simultaneously highlighting with respect to the FDA that on the one hand they've completed their congressional mandate with respect to menthol by issuing or having TPSAC Act, and then on the other hand saying that you highlight menthol as a likely area of FDA action in 2014?

Martin J. Barrington

Jim, you want to take that question?

James E. Dillard

I actually, David, don't think it's attention. I think the fact of the matter is that the agency has statutorily completed its obligations and we certainly know that there are a number of research projects that continue to go on the PATH Study. They are funding NIH projects, CTP is, and we know that there's going to be continual study on menthol. So I don't think the fact that all the 200,000 comments came into FDA, that they are going to sit there and not look at them. So I believe work will continue on menthol. I don't necessarily believe that we will see something in public but I think the work will continue on the FDA's part.

Unidentified Analyst

Under the savings from the lower – from the farm payments going away, don't start this year until 4Q but you plan and budget and give guidance on a full year basis, is there anything you're already doing differently in anticipation of those savings in terms of promotional discounting or marketing investments or pace of share repurchases? And then just secondly, in terms of getting to e-cigarette leadership, is your current portfolio sufficient for that or could you imagine still further additions in terms of M&A?

Martin J. Barrington

Okay, let me start with FETRA, I'll turn it over to Howard to make a comment about cost savings because I think that's [indiscernible], and then I'll come back and talk about the e-cigarette portfolio. Look, I think the FETRA answer for us is, we're trying to maximize income in this segment and so you have a cost in the fourth quarter that's going away of $100 million and $400 million in 2015, so it's an opportunity obviously from our perspective to take the cost out of our business and to try to advance our strategy of maximizing the income. I won't get into the executional details of all that but I think that gives you a pretty good sense of how we're thinking about it. You want to say something more about that, Howard?

Howard A. Willard III

Yes, the only thing I would say is, obviously we put together an annual plan which takes into account all the variables that we think we can apply, and that goes into our kind of annual guidance. But certainly the impact you're going to see from the FETRA program is going to be largest once it starts to come through, and so I think that's factored into the way you'll see things flow this year.

Martin J. Barrington

With respect to the e-cigarette portfolio, I think it's maybe one level up, which is the way we think about our businesses is we follow our consumer. So over time, if the consumer wants different products, then obviously we'll try to develop products for the consumer. So I think strategically that's important to recognize. With respect to 2014 though, I would say with the national launch of MarkTen and when we close we can add Green Smoke to our portfolio, we're pretty well-positioned for 2014.

Connie?

Constance Maneaty - BMO Capital

Thanks. My first question is on your guidance. You left it unchanged, yet you did announce taking your products, your e-vapor products national this year, so could you help us understand when we should expect to see these products be accretive to earnings, could it be this year or possibly next year? That's my first question. And then in terms of your combustible portfolio, how would you characterize the level of innovation this year versus next year, what should we expect to see there?

Martin J. Barrington

Okay, let me take the second half, and then maybe Howard, you want to take the first on the question of guidance. Well, we continue to innovate. As you know, when we talk about innovation, we try to talk about it as an enterprise. It's not just products, you see it in the packaging. I always call out to people Marlboro.com. I think it may be one of the best examples, right. In a category where we have to have responsible age-restricted marketing, you need to go on Marlboro.com for people who are in the category that have been age verified. They've just done a terrific job there, just connecting in all different kinds of ways. I would point out particularly the Marlboro Black section there. So whether it's products or promotion or packaging, we didn't have time to put it all in this year's remarks for you, we continue to have innovation at the center of how we satisfy our consumers. So I would expect more of the same. Howard, you want to pick up the other?

Howard A. Willard III

Sure. I think with regard to e-vapor, given that we are just moving to a national launch, I would say it's probably too early to be thinking about when does the business become accretive. I think we called out what is probably our primary focus now, which is moving towards leadership in the category in the long-term. I think opportunities to improve the margins and improve the profitability of that category I think are going to unfold here over the next several years and are going to be impacted by things that are pretty hard to forecast today, what happens to the number of players in the industry, what happens with regulation, what happens with taxation. What we're really focused on is positioning Nu Mark to be able to take advantage of all those opportunities in a positive way and ultimately get to our end goal. So that's how we're thinking about it.

Unidentified Participant

After you acquired UST and you improved the performance of Copenhagen, I think you did it with a combination of both innovation and more aggressive pricing, and with Skoal now, it seems like pricing is driving that a lot more, and to paraphrase what I think you just said, you need to have the product if you want to have to price that, [indiscernible] that innovation in Skoal, does the Skoal lends itself to innovation?

Martin J. Barrington

Sure. I'm not sure about the paraphrase but let me try to address the thrust of your question which is, the way we think about our brands as you know is at the value equation and it's a combination of factors such as the product and its price and its promotion and its packaging and they all come together, and you know to try to pull one out than the other, but you're right, the product has to be satisfying to consumers, but then all the other factors come into play. That's what we're working on with Skoal.

Remember when we came out with Copenhagen, we gated SKUs in the Wintergreen segment and who else was in the Wintergreen segment, Skoal was too. So Skoal has got a bit of a tough chore, doesn't it. It's got a competitor at a price point in the Wintergreen segment, it's also competing with Copenhagen. So I think it's a combination. It's one of the reasons we're going to try the new equity campaign of 'A Pinch Better' which we like a lot, as we'll add equity, we'll try to work on the price gaps and we're very optimistic that we can get Skoal to stabilize its share this year.

We have a question here. I'm watching your eminence, Chris. Okay.

Unidentified Participant

You showed the tobacco profit pool and how it's grown and you have to be complimented on that, but does it matter that the customers of the pool, I mean obviously CVS generated a lot of attention the last couple of weeks, but I follow the convenience stores and drugstore and some of the others complain that as the pack of cigarettes gone up, certainly their percentage profit has not, and even in declines, but does it matter?

Martin J. Barrington

Sure, it matters that your trade is aligned I think with your business and we work really hard to do that. And it's natural I think in our category and in other category where people talk about the relative margins throughout the chain. Our strategy with the trade, whether it's convenience stores or pharmacy or grocery, is we try to offer programs that are good for their business and good for our business, and we spend an awful lot of time with customers working on that. And the nature of the relationship I guess is, no one is satisfied all the time, but the answer to your question is, yes, it does matter, you want them to be aligned with your business and that's what we're trying to do.

Christopher Growe - Stifel Nicolaus

Thank you, Marty, and thank you, Altria, for your presentation and thank you again for what should be a great dinner tonight. Thank you.

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Source: Altria Group's CEO Presents at CAGNY 2014 Conference (Transcript)

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