Business Context and Reporting Period
Company: Altria Group, Inc. (ALG)
Filing Type: Form 10-Q (Unaudited)
Period Ended: March 31, 2006
Business Overview: ALG operates through wholly-owned subsidiaries Philip Morris USA (PM USA) and Philip Morris International (PMI), and majority-owned subsidiary Kraft Foods Inc. (87.6% ownership). The company manufactures and sells tobacco products, packaged food, snacks, beverages, and cheese. It also maintains a financial services portfolio through Philip Morris Capital Corporation (PMCC). The Board is evaluating restructuring alternatives, including potential separation into independent entities, contingent on improvements in the litigation environment.
Key Financial Metrics
| Metric | Q1 2006 | Q1 2005 |
|---|---|---|
| Net Revenues | $24,355 million | $23,618 million |
| Operating Income | $4,079 million | $4,176 million |
| Net Earnings | $3,477 million | $2,596 million |
| Diluted EPS (Continuing Ops) | $1.65 | $1.24 |
| Diluted EPS (Net Earnings) | $1.65 | $1.25 |
| Cash and Cash Equivalents | $2,491 million | $4,208 million |
| Total Debt (Consumer Products) | $21.4 billion | $21.9 billion |
| Net Cash Used in Operating Activities | ($691 million) | ($483 million) |
Margins: The effective tax rate decreased significantly to 7.5% in Q1 2006 from 33.1% in Q1 2005, primarily due to a non-cash tax benefit.
Material Changes vs. Prior Period
- Earnings Growth: Net earnings increased 33.9% ($881 million) year-over-year. This increase was driven primarily by a $1.0 billion non-cash tax benefit resulting from the reversal of tax reserves following the conclusion of an IRS examination of returns from 1996-1999.
- Revenue Increase: Net revenues rose 3.1% ($737 million). Excluding excise taxes, revenue increased 2.1%, driven by tobacco and food business growth and acquisitions, partially offset by unfavorable currency impacts (stronger U.S. dollar).
- Operating Income Decline: Operating income decreased 2.3% ($97 million) despite higher segment performance in tobacco and financial services. This was due to a $61 million Italian antitrust charge, higher asset impairment and exit costs at Kraft, and unfavorable currency translation.
- Segment Performance:
- Domestic Tobacco: Operating income increased 7.5% due to lower promotional allowances and higher volume.
- International Tobacco: Operating income decreased 5.2% due to the Italian antitrust charge, unfavorable currency, and volume/mix issues, offset by price increases and acquisitions.
- North American Food: Operating income decreased 1.5% due to higher commodity costs and asset impairment charges related to the pending sale of pet snacks assets.
- Financial Services: Operating income doubled (100% increase) due to higher gains from asset sales.
Guidance, Outlook, and Risks
2006 Full-Year Guidance: On April 20, 2006, ALG reaffirmed its projection for 2006 full-year diluted EPS from continuing operations in the range of $5.25 to $5.35. This forecast includes the Q1 tax benefit of $0.46 per share and anticipates approximately $0.36 per share in charges related to Kraft's restructuring program, $0.14 per share in unfavorable currency impact, and other specific charges.
Management Commentary & Unusual Items:
- Tax Benefit: The $1.0 billion tax reversal was a non-cash item. ALG reimbursed Kraft $337 million in cash for its portion of the benefit.
- Kraft Restructuring: Kraft expanded its restructuring program through 2008, expecting total pre-tax charges of $3.7 billion, including the closure of up to 40 facilities and elimination of 14,000 positions.
- Asset Impairments: Kraft recorded an $86 million pre-tax charge for the pending sale of its pet snacks brand and a $24 million charge for intangible asset impairments.
- Italian Antitrust: PMI recorded a $61 million charge related to an antitrust action in Italy.
Risks and Contingencies:
- Tobacco Litigation: Significant uncertainty remains regarding pending litigation, including the Engle class action (Florida) and the Price case (Illinois, recently reversed by the Illinois Supreme Court). Management cannot estimate the range of potential losses.
- IRS Challenges: The IRS disallowed benefits for certain PMCC leveraged lease transactions, assessing approximately $150 million in tax and interest. ALG intends to contest this.
- Financial Services Risk: PMCC faces potential losses from leases with airline lessees (Delta, Northwest, United) and a power plant lessee (Calpine) currently in bankruptcy. PMCC recorded $189 million in charges to its allowance for losses in Q1 2006.
- Regulatory Environment: Ongoing risks include excise tax increases, restrictions on marketing, and ingredient disclosure laws globally.
Investor Verification Checklist
- Tax Benefit Sustainability: Verify the non-recurring nature of the $1.0 billion tax benefit and its impact on the 2006 EPS guidance.
- Kraft Restructuring Costs: Monitor the execution of Kraft's expanded restructuring program and the associated cash outflows ($2.3 billion expected total).
- PMCC Lease Exposure: Assess the potential for further write-downs in PMCC's finance assets related to bankrupt airline and power plant lessees.
- Litigation Outcomes: Track the status of the Engle appeal in Florida and any new developments in the Price case or other major tobacco litigation.
- Divestiture Progress: Confirm the closing of the pet snacks brand sale and the associated tax implications ($60 million expected).
- Currency Impact: Evaluate the sensitivity of international earnings to fluctuations in the U.S. dollar versus the euro and yen.