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Business Context and Reporting Period

Company: Altria Group, Inc. (ALG)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Nine months and three months ended September 30, 2005
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. (Kraft). The company manufactures and sells cigarettes, tobacco products, and packaged food products. ALG also holds a significant economic interest in SABMiller plc.

Key Financial Metrics

Note: Total Debt includes short-term borrowings ($3,412M) and long-term debt ($17,067M) for consumer products, plus financial services debt ($2,086M). Total consolidated debt was $24.7 billion.

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 9.1% year-over-year for the nine-month period, driven by higher tobacco revenues (domestic and international) and favorable currency impacts. Excluding excise taxes, revenue grew 7.3%.
• Earnings Increase: Net earnings rose 9.1% to $8.1 billion. Diluted EPS increased 7.7% to $3.90. Growth was fueled by higher operating income in tobacco segments and a lower effective tax rate (29.7% vs. 31.5% in 2004).
• Discontinued Operations: A significant loss of $233 million was recorded in discontinued operations due to the sale of Kraft's sugar confectionery business in June 2005. This contrasts with $39 million in earnings from discontinued operations in the prior year.
• Segment Performance:
  • International Tobacco: Operating income increased 22.5% due to price increases, acquisitions (Sampoerna in Indonesia, Coltabaco in Colombia), and favorable currency.
  • Domestic Tobacco: Operating income increased 5.2%, aided by lower promotional allowances and pricing, partially offset by a $138 million charge for U.S. tobacco pool losses.
  • Food (Kraft): North American food income declined slightly due to higher commodity and benefit costs. International food income rose 25.1% due to gains on business sales and lower impairment charges.
  • Financial Services: Operating income turned negative (-$10M) compared to $250M in 2004, primarily due to a $200 million provision for airline industry exposure (Delta and Northwest bankruptcies).

Guidance, Outlook, and Risks

• 2005 Full-Year Guidance: On October 19, 2005, ALG narrowed its forecast for full-year 2005 diluted EPS from continuing operations to a range of $5.05 to $5.10 (previously $5.00 to $5.10). Management expects to achieve the high end of this range.
• Key Drivers for Guidance:
  • Positive: $0.20 per share tax benefit from dividend repatriation under the American Jobs Creation Act; $0.05 per share benefit from Sampoerna acquisition; $0.03 per share from reversal of 2004 tobacco quota accrual.
  • Negative: $0.12 per share Kraft restructuring charges; $0.06 per share airline industry provision; $0.04 per share U.S. tobacco pool buy-out cost.
• Major Risks and Contingencies:
  • Litigation: Significant exposure to tobacco-related litigation, including the Price case ($10.1 billion verdict on appeal) and the Engle class action ($74 billion punitive damages on appeal). Management has not accrued for these as outcomes are uncertain.
  • Regulatory: Ongoing challenges from excise tax increases, the Master Settlement Agreement (MSA), and the Fair and Equitable Tobacco Reform Act (FETRA).
  • Financial Services: Continued risk of further losses in the airline leasing portfolio due to bankruptcies of major lessees (Delta, Northwest, United).
  • Commodity Costs: Rising costs for food raw materials (coffee, nuts, energy, packaging) impacting Kraft's margins.

Investor Verification Checklist

• Verify Litigation Reserves: Confirm that no material accruals exist for the Price and Engle verdicts and assess the potential impact of the $329 million in posted security bonds.
• Review Airline Exposure: Monitor the status of PMCC's $2.2 billion aircraft lease portfolio, specifically the risk of foreclosure on assets leased to Delta, Northwest, and United.
• Assess Tax Benefits: Validate the realization of the $413 million tax benefit from the American Jobs Creation Act repatriation and the sustainability of the lower effective tax rate.
• Monitor Kraft Restructuring: Track the progress of Kraft's $1.2 billion restructuring program and the impact of rising commodity costs on food segment margins.
• Check Dividend Sustainability: Review cash flow adequacy to support the increased quarterly dividend of $0.80 per share ($3.20 annualized) amidst high capital expenditures and litigation costs.