Altria Group, Inc. — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; unaudited. Altria’s businesses include U.S. cigarettes, smokeless tobacco, cigars, wine and finance leases, plus a 27.1% equity-method interest in SABMiller.
Financial performance and liquidity
Amounts are in millions of dollars except per-share data. Revenue includes excise taxes billed to customers.
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Net revenues | $5,643 | $5,760 | (2.0%) |
| Gross profit | $2,148 | $2,084 | 3.1% |
| Operating income | $1,539 | $1,430 | 7.6% |
| Earnings before income taxes | $1,450 | $1,281 | 13.2% |
| Net earnings attributable to Altria | $937 | $813 | 15.3% |
| Diluted EPS | $0.45 | $0.39 | 15.4% |
| Net cash from operating activities | $2,062 | $2,041 | 1.0% |
Gross, operating and net margins were approximately 38.1%, 27.3% and 16.6%, respectively, versus 36.2%, 24.8% and 14.1% in Q1 2010. These margins use reported net revenues, which include excise taxes.
- Cash flow: Investing activities used $8 million, including $13 million of capital expenditures; financing activities used $936 million, principally reflecting $794 million of common dividends paid. Cash increased $1,118 million to $3,432 million.
- Debt and liquidity: Long-term debt was $12,194 million, unchanged from year-end 2010; debt fair value was $15.4 billion. No short-term borrowings or commercial paper were outstanding at March 31. Undrawn revolving credit lines totaled $3.0 billion. Debt/EBITDA and EBITDA/interest covenant ratios were 1.7x and 6.4x, respectively, against limits of no more than 3.0x and no less than 4.0x.
- Balance sheet: Total assets were $38,584 million and total liabilities $33,096 million. Current assets were $6,988 million versus current liabilities of $7,884 million; management said it expected to fund working-capital deficits with operating cash flow and/or borrowing availability. Accrued settlement charges were $4,568 million, up from $3,535 million at year-end.
- Dividends and buybacks: Quarterly dividend declared was $0.38 per share, compared with $0.35 a year earlier; the annualized rate was $1.52. The board authorized a one-year $1.0 billion repurchase program, but no shares were purchased under it in Q1.
Material changes and segment performance
- Revenue declined mainly due to lower cigarette and cigar revenues. Lower excise taxes and cost of sales, together with lower marketing and administrative costs, helped lift operating income.
- SABMiller equity earnings rose to $189 million from $138 million, reflecting higher ongoing equity earnings and gains related to a hotel and gaming transaction, partly offset by lower gains from SABMiller share issuances. Net interest and debt expense declined to $278 million from $287 million.
- Cigarettes: Revenue fell 1.9% to $5,026 million, while operating companies income rose 9.5% to $1,347 million, supported by pricing, lower promotional allowances and lower restructuring costs. Shipment volume declined 6.4%; adjusted for estimated trade inventories, domestic volume was down about 5%. Total retail share fell 1.2 percentage points to 49.0%, and Marlboro share fell 0.5 points to 42.2%.
- Smokeless products: Revenue decreased 0.5% to $379 million, while operating companies income increased 8.4% to $193 million. Combined shipment volume declined 1.3%, but management estimated volume was up about 6% after adjusting for product-launch comparisons. Retail share declined 0.6 points to 54.7%.
- Cigars: Revenue declined 13.3% to $117 million and operating companies income fell 53.2% to $22 million, primarily due to promotional spending amid competition from low-priced imports. Shipment volume increased 1.9% and retail share rose to 29.1%.
- Wine: Revenue increased 6.3% to $101 million and operating companies income rose to $12 million from $7 million; shipment volume was nearly flat at 1.443 million cases.
- Financial services: Revenue declined to $20 million from $26 million, while operating companies income remained $21 million. All finance-lease lessees were current on payments; the $202 million allowance for losses was unchanged.
Outlook, commentary and significant risks
- Management reaffirmed 2011 reported diluted EPS guidance of $2.00–$2.06. Adjusted diluted EPS, excluding specified items, was expected to grow 6%–9% over 2010 adjusted EPS. Management cautioned that Q1 adjusted EPS exceeded expectations partly because of trade inventory dynamics, which could reverse, and expected uneven quarterly growth weighted toward the second half.
- Management described the 2011 business environment as challenging, citing consumer economic pressure, cigarette competition and uncertainty about state excise taxes; it also noted a difficult cigar market. Cost savings were $35 million in Q1, with about $110 million of additional savings expected by year-end.
- Payments under state tobacco settlements, FETRA and FDA user fees totaled about $1.2 billion in Q1 and were estimated to generate approximately $5 billion of cost-of-sales charges in 2011 and each year thereafter, subject to volume, market-share, inflation and other adjustments.
- Litigation: The company disclosed extensive tobacco-related litigation, including approximately 7,225 Florida Engle progeny cases pending as of April 25, 2011, and numerous other tobacco cases. Management said losses in pending tobacco-related cases generally were not considered probable or reasonably estimable and therefore were not accrued, except for specified matters. PM USA had posted about $45 million of security for judgments on appeal. The Louisiana Scott case had an appellate judgment of approximately $241 million plus interest; Altria recorded $26 million plus approximately $3.7 million of accrued interest for the case.
- Tax contingency: Altria disputes IRS disallowances of tax benefits on PMCC leveraged lease transactions. It filed refund claims for approximately $945 million of tax and interest paid for 1996–2003. The company estimated potential federal and state tax and interest disallowances for 2004–2011 at approximately $1.1 billion, excluding penalties; an adverse resolution could require a one-time earnings charge of about $650 million, excluding potential penalties.
- Regulatory and operating risks: FDA authority under the FSPTCA may affect product design, marketing, warnings and product approvals; the FDA’s scientific advisory committee recommended removing menthol cigarettes, though no regulatory action had been taken. Other risks include tobacco excise-tax increases, declining cigarette consumption, illicit trade, litigation and bonding exposure, tobacco-leaf supply and cost, and economic and competitive pressure. The filing also disclosed ongoing MSA payment-adjustment proceedings.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the 2011 EPS outlook and 6%–9% adjusted EPS growth target remain achievable, particularly if first-quarter trade inventory gains unwind.
- Underlying cigarette volume and market-share trends, and whether pricing and cost savings can offset volume pressure and tobacco settlement and FDA costs.
- Developments in major litigation, including Engle progeny trials, the Scott judgment and the federal RICO injunction, and related cash, bonding or accrual effects.
- Outcomes and timing of the IRS lease-tax disputes, including the refund claims and potential tax, interest and earnings impacts.
- Actual settlement, FETRA and FDA user-fee payments and any recoveries from MSA payment-adjustment proceedings.
- Liquidity, covenant headroom and dividend capacity, including the distinction between the authorized repurchase program and employee-related share tenders.