ALTRIA GROUP, INC. quarterly report, Q3 FY2010

Altria Group, Inc. — Q3 2010 Form 10-Q

Business context and reporting period

Unaudited results cover the three and nine months ended September 30, 2010, compared with the same periods in 2009. Altria’s businesses included cigarettes, smokeless products, cigars, wine and financial services, plus a 27.1% interest in SABMiller. Dollar amounts below are in millions unless otherwise noted.

Financial results and liquidity

Metric	Nine months 2010	Nine months 2009	Q3 2010	Q3 2009
Net revenues	$18,436	$17,542	$6,402	$6,300
Operating income	$4,735	$4,262	$1,776	$1,394
Net earnings attributable to Altria	$2,986	$2,481	$1,131	$882
Diluted EPS	$1.43	$1.19	$0.54	$0.42
Operating cash flow	$1,722	$2,007	Not stated	Not stated

• Nine-month revenue rose 5.1%, operating income 11.1% and attributable earnings 20.4%; Q3 revenue rose 1.6%, operating income 27.4% and attributable earnings 28.2%.
• Calculated operating margin was approximately 25.7% for the nine-month period versus 24.3% in 2009, and 27.7% in Q3 versus 22.1%. Calculated gross margin was 37.6% versus 38.7% for nine months and 38.7% versus 36.3% for Q3. Revenue includes excise taxes, which materially affect these ratios.
• Operating cash flow less capital expenditures was approximately $1,606, compared with $1,835 in 2009; this is a simple derived measure, not a filing-defined non-GAAP metric. The decrease in operating cash flow primarily reflected a $945 IRS payment, partly offset by lower settlement payments.
• At September 30, cash was $1,700; current assets were $5,506 and current liabilities $6,349, a working-capital deficit of $843. Long-term debt was $12,194, with no current portion reported. Total debt was approximately $12.2 billion, versus $12.0 billion at year-end 2009.
• Altria had $3.0 billion of revolving credit availability and no short-term borrowings outstanding at quarter-end. It reported covenant ratios of debt to EBITDA of 1.8:1 and EBITDA to interest expense of 6.0:1, against limits of 3.0:1 maximum and 4.0:1 minimum.
• Dividends declared were $1.08 per share for the first nine months, versus $0.98 in 2009. The annualized rate was raised to $1.52 per share in August.

Material changes versus prior periods

• For nine months, cigarette segment operating companies income increased to $4,213 from $3,902, and smokeless products increased to $586 from $302. Cigarette revenue benefited from pricing, including the impact of the 2009 federal excise tax increase, while shipment volume declined 4.7% (approximately 6% after inventory adjustments). Marlboro shipment volume fell 3.0%.
• Smokeless revenue rose 13.4% and segment operating income nearly doubled, supported by higher volume, lower costs and fewer acquisition/integration charges. Combined domestic shipment volume increased 15.6% (approximately 10% after inventory adjustments); total retail share rose to 55.6% from 54.7%.
• Cigars revenue increased 13.2% over nine months, but volume declined 1.4% and retail share fell to 28.7% from 30.2%. Wine revenue increased 13.7% and operating income rose to $31 from $22 for nine months; management noted slower Q3 volume growth as wholesalers reduced inventories built earlier in the year.
• Financial services operating income fell to $87 from $260 for nine months, primarily because gains on finance-asset sales were substantially lower. Reported SABMiller equity earnings were $437 versus $442 for nine months, but rose to $186 from $119 in Q3.
• Operating income improvement also reflected lower restructuring and implementation costs and the absence of 2009 UST transaction costs. The UST acquisition closed in January 2009; management said pro forma 2009 results would not have differed materially from reported results.

Outlook, management commentary, risks and unusual items

• In October 2010, Altria raised 2010 reported diluted EPS guidance to $1.83–$1.87, including estimated net charges of $0.04 per share. It reaffirmed expected adjusted EPS growth of 7%–9% over 2009 adjusted EPS. Adjusted EPS is non-GAAP; the filing identifies continuing risks to the forecast.
• Management reported $1.29 billion in cost savings achieved since January 2007 through September 2010 and expected a further $210 million by the end of 2011, targeting $1.5 billion total savings versus 2006. The restructuring program was largely complete; additional costs were expected in 2010.
• Altria paid approximately $945 million of tax and interest in July 2010 related to PMCC leveraged-lease transactions, recorded the payment as an asset, and intends to seek a refund. The company anticipated IRS rejection and possible federal litigation. It disclosed potential additional tax and interest exposure of approximately $1.0 billion for 2004–2010, excluding possible penalties; the IRS was auditing 2004–2006.
• Significant tobacco litigation remains a key uncertainty. Management said losses in pending tobacco-related cases were not considered probable or reasonably estimable, apart from specifically discussed recorded provisions. The filing describes large verdicts, appeals, Engle progeny cases, the Scott class action and challenges to appeal-bond caps. Approximately $103 million of security had been posted for judgments on appeal.
• State settlement, FETRA and FDA user-fee costs totaled $3,763 for the first nine months of 2010. The company estimated these charges at about $5.1 billion for 2010 and roughly $5.2 billion annually for 2011–2014, subject to volume, market-share, inflation and other adjustments. Possible MSA reductions for 2003–2009 remained unresolved.
• Other risks include FDA regulation under the 2009 tobacco-control law, excise-tax increases, declining cigarette consumption, down-trading and illicit trade. The filing states that FDA requirements or enforcement could raise costs, restrict marketing or products, and adversely affect sales and results.
• PMCC’s portfolio had a $202 million allowance for finance-asset losses, which management considered adequate; 75% of the portfolio was investment grade. The company cautioned that worsening economic or lessee conditions could require a higher allowance.

Important facts for investors to verify

• Whether reported EPS guidance and expected adjusted EPS growth are achieved, and how much results depend on tax benefits and other excluded items.
• Developments in the $945 million IRS refund claim and the separate potential tax exposure related to PMCC leases.
• Progress and financial effects of major tobacco litigation, especially Engle progeny and Scott, and the status of appeal bonds and MSA adjustment proceedings.
• Whether cigarette volume declines, smokeless share gains and wine inventory trends persist, and whether pricing offsets volume and excise-tax pressures.
• Actual settlement, FETRA and FDA-related costs versus the estimates, and delivery of the remaining cost savings.