ALTRIA GROUP, INC. quarterly report, Q2 FY2014

Altria Group, Inc. — 2014 Second-Quarter Form 10-Q

Reporting period: Three and six months ended June 30, 2014. Unaudited results cover Altria’s U.S. tobacco, wine, finance and alternative-products businesses, plus its approximately 27% equity-method investment in SABMiller.

Financial performance and position

Metric	Three months ended June 30	Six months ended June 30
Net revenues, 2014; 2013	$6.256 billion; $6.305 billion	$11.773 billion; $11.833 billion
Gross profit, 2014; 2013	$2.603 billion; $2.554 billion	$4.859 billion; $5.228 billion
Operating income, 2014; 2013	$1.975 billion; $2.001 billion	$3.709 billion; $4.153 billion
Net earnings, 2014; 2013	$1.262 billion; $1.266 billion	$2.437 billion; $2.651 billion
Diluted EPS, 2014; 2013	$0.64; $0.63	$1.23; $1.32
Dividends declared per share, 2014; 2013	$0.48; $0.44	$0.96; $0.88

• First-half operating cash flow was $759 million, versus $441 million a year earlier. Investing activities provided $102 million; financing activities used $2.843 billion. Capital expenditures were $60 million. Cash declined to $1.193 billion from $3.175 billion at year-end 2013.
• At June 30, total debt was approximately $14.0 billion, down from $14.5 billion at December 31, 2013, after repayment at maturity of $525 million in notes. Long-term debt carrying value was $13.993 billion; there were no short-term borrowings at period-end.
• Current assets were $4.475 billion and current liabilities $5.046 billion; management reported a working-capital deficit and said it expected to fund it through operating cash flow and/or short-term borrowing. The $3.0 billion revolving credit facility was fully available. Debt covenant ratios were 1.7-to-1 debt/EBITDA and 8.7-to-1 EBITDA/interest, against limits of 3.0-to-1 maximum and 4.0-to-1 minimum.
• First-half segment revenue and operating companies income: smokeable products $10.569 billion and $3.320 billion; smokeless products $879 million and $524 million; wine $275 million and $50 million. First-half SABMiller equity earnings were $425 million, down from $483 million.

Material changes versus prior periods

• For the first half, revenue fell 0.5%, operating income fell 10.7%, net earnings fell 8.1%, and diluted EPS fell 6.8%. Management attributed the decline mainly to lower smokeable-segment results, lower financial-services income and increased alternative-products investment; lower interest expense and taxes partly offset the decline.
• Second-quarter revenue declined 0.8% and operating income declined 1.3%, while net earnings were nearly unchanged and diluted EPS rose 1.6%, primarily reflecting fewer shares outstanding and lower interest expense.
• U.S. cigarette shipment volume fell 3.8% in the first half and 5.0% in the quarter; management estimated industry volume declines of approximately 4.5% in both periods. Marlboro retail share gained 0.1 and 0.3 percentage points, respectively. Smokeless shipment volume increased 3.6% and 1.6%; wine shipment volume increased 1.5% and 1.9%.
• Reported year-over-year comparisons were affected by large prior-year Non-Participating Manufacturer (NPM) settlement adjustments: first-half 2013 included $519 million of pre-tax income, versus $90 million of NPM adjustment items in first-half 2014. These items substantially affect the reported first-half operating-income comparison.

Outlook, management commentary and key risks

• In July 2014, Altria revised its 2014 reported diluted EPS forecast to $2.54–$2.59, from $2.53–$2.60. It forecast 7%–9% growth in adjusted diluted EPS over 2013 adjusted EPS; the filing does not state the adjusted EPS range in this excerpt. Management expected stronger adjusted EPS growth in the second half, particularly the fourth quarter, citing the end of federal tobacco quota buy-out payments and a lower comparative fourth-quarter tax rate.
• The company expected approximately $5 billion of 2014 charges to cost of sales for state tobacco settlements, FETRA and FDA user fees, and approximately $4.6 billion annually thereafter. FETRA obligations were expected to expire after the third quarter of 2014. These are estimates subject to volume, market share, inflation and other factors.
• Nu Mark acquired Green Smoke’s e-vapor business on April 1 for up to approximately $130 million, including contingent consideration; $93 million of cash, net of acquired cash, was reported as an investing outflow. Nu Mark began national expansion of MarkTen on June 2. FDA rules proposed in April 2014 could extend tobacco regulation to e-vapor products, cigars and other products.
• Significant litigation remains a key uncertainty. The filing says management did not consider losses probable or reasonably estimable in most pending tobacco cases and therefore generally recorded no provision for them. A notable exception is the federal government corrective-communications remedy, for which $31 million was accrued in the quarter. Separately, an Illinois appellate court ordered reinstatement of a $10.1 billion judgment in the Price case; PM USA’s appeal automatically stayed the order pending Illinois Supreme Court action.
• NPM settlement credits and interest remain subject to disputes and appeals. In April 2014, PM USA received a $116 million credit for the 2003 adjustment and $71 million in interest credits; the filing describes potential repayment exposure and uncertainty over amounts recoverable for other years.
• Other material risks include declining cigarette-industry volume, excise-tax increases, FDA and other regulation, litigation and bonding requirements, illicit trade, tobacco leaf supply and cost, competition and consumer shifts toward alternative products. The company stated it had adequate liquidity for anticipated needs and expected to meet its credit-facility covenants.

Important facts for investors to verify

• Whether Altria achieves its $2.54–$2.59 reported diluted EPS forecast and the stated 7%–9% adjusted EPS growth target.
• Actual tobacco shipments, retail-share trends and the effect of pricing, promotional spending and industry volume declines on smokeable-segment earnings.
• Developments in the Price appeal, Engle progeny cases, corrective-communications remedy and related litigation accruals or cash payments.
• Resolution of MSA NPM adjustment disputes, including possible repayment of credits and the timing and amount of any further recoveries.
• Cash generation and liquidity after dividends, repurchases and settlement payments; the filing reports $1.912 billion of first-half dividends paid and $404 million of share repurchases, with a new $1.0 billion repurchase authorization announced in July.