Altria Group, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Financial statements are unaudited. Altria’s businesses include smokeable and smokeless tobacco, wine, financial services, and an approximately 27% equity-method investment in SABMiller.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net revenues | $6.242B | $6.108B | $18.376B | $17.671B |
| Gross profit | $2.484B | $2.445B | $7.180B | $6.565B |
| Operating income | $1.969B | $1.878B | $5.488B | $4.712B |
| Net earnings attributable to Altria | $657M | $1.173B | $3.077B | $2.554B |
| Diluted EPS | $0.32 | $0.57 | $1.51 | $1.23 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $2.120B | $2.564B |
Revenue includes excise taxes billed to customers. Nine-month revenue increased 4.0%; operating income rose 16.5%, and diluted EPS rose 22.8%. Q3 revenue increased 2.2% and operating income 4.8%, but GAAP net earnings fell 44.0% and EPS fell 43.9%, primarily due to an $874M pretax debt-extinguishment loss ($559M after tax). Excluding that and other specified special items, management reported underlying operational improvement.
- Margins: Nine-month gross margin was approximately 39.1% versus 37.1%; operating margin was approximately 29.9% versus 26.7%. Q3 gross margin was approximately 39.8% versus 40.0%; operating margin was approximately 31.5% versus 30.7%.
- Cash flow and investment: Nine-month operating cash flow declined $444M, mainly reflecting the $456M IRS payment and a $500M voluntary pension contribution (versus $200M in the prior-year period), partly offset by higher earnings. Investing activities provided $728M, including $813M of proceeds from finance assets. Capital expenditures were $77M.
- Debt and liquidity: Long-term debt was $13.878B at September 30, versus $13.089B at year-end 2011; cash was $2.186B, down from $3.270B. Current assets of $5.934B were below current liabilities of $6.348B. The company reported no short-term borrowings at quarter-end and had a $3.0B undrawn revolving credit facility. Covenant ratios were 1.8x debt/EBITDA and 6.7x EBITDA/interest, within stated limits.
- Capital returns: Nine-month dividends declared were $1.26 per share; the quarterly rate increased 7.3% to $0.44, or $1.76 annualized. Altria repurchased $622M of shares in the first nine months. In October, the board expanded the buyback authorization to $1.5B, with approximately $550M remaining and expected completion by June 30, 2013.
Segments and material changes
- Smokeable products: Nine-month revenue was $16.616B and operating companies income $4.716B, up 0.7% and 4.2%. Pricing and cost savings outweighed lower volume, unfavorable mix, and higher settlement charges. Total shipment volume declined 0.4% for the nine months; Marlboro retail share increased 0.5 percentage points to 42.6%.
- Smokeless products: Nine-month revenue was $1.243B and operating companies income $678M, up 2.8% and 2.7%. Total volume increased 1.9%, with Copenhagen growth partly offset by declines elsewhere.
- Wine: Nine-month revenue of $381M and operating companies income of $63M increased 9.2% and 16.7%, respectively, supported by pricing, volume, and premium mix.
- Financial services: Nine-month operating companies income was $166M versus a $359M loss. The comparison reflects the $490M pretax component of the 2011 PMCC leveraged-lease charge, as well as 2012 asset-sale proceeds and recoveries. PMCC’s finance assets, net, declined to $2.805B from $3.559B.
- Altria combined its former cigarettes and cigars businesses into the smokeable products segment effective January 1, 2012; prior segment figures were recast. The 2011 cost-reduction program is expected to generate $400M of annualized savings by the end of 2013. Cumulative net pretax charges were $264M through September 30, against an expected total of approximately $300M by year-end 2012.
Outlook, unusual items, and risks
- Guidance: Management reaffirmed full-year 2012 reported diluted EPS guidance of $2.03–$2.07 and adjusted diluted EPS growth of 7%–9% over 2011 adjusted EPS. The reported forecast includes estimated net expenses of $0.16 per share, including $0.28 per share for the debt-extinguishment loss, partly offset by other items.
- Debt transaction: Altria issued $2.8B of notes at 2.850% due 2022 and 4.250% due 2042, and tendered for $2.0B of higher-coupon notes. The tender generated the $874M pretax loss. UST also repaid $600M of notes at maturity.
- Tax resolution: An IRS closing agreement resolved federal tax treatment of certain PMCC leveraged leases for prior and future years. Altria paid $456M of federal tax and estimated interest and expected to pay approximately $50M in state tax and interest. The agreement produced a one-time $68M net earnings benefit in Q2, mainly from lower-than-estimated interest.
- Litigation and contingencies: Tobacco-related litigation remains a material uncertainty. Management stated it had not concluded that losses in pending tobacco cases were probable and could not estimate possible losses; accordingly, no provision was recorded for those cases. The filing describes potentially significant verdicts, appeals, and risks associated with bonding requirements. Tobacco settlement and FETRA charges were approximately $3.6B for the first nine months, and management estimated charges of about $5B in 2012 and each year thereafter, subject to adjustments. PMCC’s $99M allowance for finance-asset losses was considered adequate, but could rise if credit conditions worsen.
- Operating risks: Management highlighted declining cigarette-category volume, excise-tax increases, competition and consumer down-trading, FDA regulation and possible product restrictions, illicit trade, tobacco litigation, and changes in tobacco-leaf supply and cost. FDA action on menthol and tobacco-product requirements remained uncertain. The 2012 cigarette category was estimated to have declined approximately 3% in the first nine months and 3.5% in Q3.
Most important facts for investors to verify
- Reconcile GAAP EPS and reported guidance with the debt-tender loss and the company’s non-GAAP adjusted EPS definition.
- Track operating cash flow, cash balances, debt levels, and the funding of dividends and share repurchases, particularly after the IRS payment and pension contribution.
- Assess whether pricing and cost reductions can offset falling cigarette-category volume, discount-brand growth, and higher settlement and manufacturing costs.
- Monitor tobacco litigation developments, including Engle progeny appeals and potential judgments, as well as disputed MSA payment adjustments; outcomes and possible losses remain uncertain.
- Follow FDA actions and regulatory litigation, particularly regarding menthol, graphic warnings, and new-product authorization, and verify whether those developments affect product availability or compliance costs.