Altria Group, Inc. — 2011 Third-Quarter Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011; unaudited. Altria’s businesses include cigarettes, smokeless tobacco, cigars, wine and financial services, plus a 27.1% equity interest in SABMiller.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net revenues | $6.108 billion | $6.402 billion | $17.671 billion | $18.436 billion |
| Gross profit | $2.445 billion | $2.476 billion | $6.565 billion | $6.934 billion |
| Operating income | $1.878 billion | $1.776 billion | $4.712 billion | $4.735 billion |
| Net earnings attributable to Altria | $1.173 billion | $1.131 billion | $2.554 billion | $2.986 billion |
| Diluted EPS | $0.57 | $0.54 | $1.23 | $1.43 |
| Operating margin | 30.7% | 27.7% | 26.7% | 25.7% |
Operating margin is calculated as operating income divided by net revenues. Q3 net earnings rose 3.7%, while nine-month net earnings fell 14.5%. The nine-month comparison was affected substantially by a $627 million PMCC leveraged-lease tax charge recorded in Q2 2011. The effective tax rate for nine months rose to 41.9% from 30.8%; Q3’s rate was 34.5% versus 32.8%.
- Cash flow: Nine-month operating cash flow was $2.564 billion, versus $1.722 billion. Investing activities provided $174 million; capital expenditures were $75 million. Financing activities used $2.009 billion.
- Liquidity: Cash was $3.043 billion at September 30, 2011, up from $2.314 billion at year-end 2010. Current assets of $6.575 billion were below current liabilities of $6.979 billion; management said the working-capital deficit could be funded from operating cash flow and borrowing availability.
- Debt and credit: Total debt was approximately $13.7 billion, up from $12.2 billion at year-end 2010. Altria issued $1.5 billion of 4.75% notes due 2021. Its $3.0 billion revolving credit facility had no outstanding short-term borrowings. Debt/EBITDA and EBITDA/interest covenant ratios were 1.9x and 6.4x, respectively, against limits of 3.0x maximum and 4.0x minimum.
- Capital returns: Nine-month dividends paid were $2.379 billion; the declared dividend was $1.17 per share for the period. The quarterly rate increased 7.9% to $0.41, or $1.64 annualized. The company completed a $1.0 billion repurchase program, buying 37.6 million shares at an average $26.62, and authorized a new $1.0 billion program intended to be completed by end-2012.
Material changes and segment trends
- For nine months, revenue declined 4.1%, mainly from cigarettes and the PMCC leveraged-lease charge. Operating income was nearly flat; higher cigarette, smokeless and wine results and SABMiller earnings partly offset lower financial-services and cigar results and higher corporate costs.
- In Q3, revenue fell 4.6%, but operating income rose 5.7% and diluted EPS increased 5.6%. Cost-reduction savings, a $35 million reduction in PMCC’s credit-loss allowance, and stronger smokeless, wine and SABMiller results contributed; cigarette results were weaker.
- Cigarettes: Nine-month segment operating companies income rose 4.5% to $4.403 billion, but Q3 fell 0.8% to $1.520 billion. Domestic shipments declined 5.4% for nine months and 9.0% in Q3; management attributed the sharper Q3 comparison partly to trade inventory depletion and lower retail share. Marlboro retail share was 41.7% in Q3, down 0.9 percentage point year over year.
- Smokeless products: Nine-month operating companies income rose 12.6% to $660 million; Q3 rose 16.7% to $245 million, supported by pricing, cost savings and Copenhagen growth.
- Wine: Nine-month revenue increased 13.3% to $349 million and operating companies income rose to $54 million from $31 million, driven mainly by premium shipments and mix.
- Cigars: Nine-month operating companies income declined 15.1% to $124 million, despite Q3 growth of 27.9% to $55 million.
- Financial services: Nine-month operating companies loss was $359 million, versus income of $87 million, primarily due to the PMCC leveraged-lease charge. Q3 income was $83 million, versus $27 million.
Outlook, unusual items and risks
- On October 27, 2011, Altria lowered 2011 reported diluted EPS guidance to $1.60–$1.66 from $1.70–$1.76, primarily reflecting planned restructuring charges. It reaffirmed adjusted diluted EPS growth guidance of 6%–9% over 2010 adjusted EPS. The filing identifies adjusted EPS as a non-GAAP measure.
- A new cost-reduction program approved October 26 targets $400 million in annualized savings by end-2013. Estimated pretax charges are about $375 million, mostly cash; approximately $340 million, or $0.11 per share, was expected in Q4 2011, with the remainder in 2012.
- The $627 million PMCC charge reflects disputed tax treatment of leveraged leases. About $315 million relates to reduced cumulative lease earnings expected to be recaptured over remaining lease terms; about $312 million primarily reflects interest on tax underpayments. Altria said it may face approximately $1.0 billion of additional tax and interest payments for 2004–2009, excluding potential penalties, while disputing prior assessments and pursuing refund claims. The Second Circuit ruled against Altria on its 1996–1997 refund case in September 2011.
- Altria disclosed extensive tobacco litigation and regulatory exposure. Management stated that it had not accrued losses for pending tobacco-related cases because it did not consider losses probable and could not estimate a loss range, while warning that adverse outcomes could materially affect results or cash flows. The company had posted about $49 million of security for judgments under appeal.
- Other significant risks include declining cigarette consumption, excise taxes, FDA regulation (including required graphic warnings scheduled for 2012 and possible action on menthol), competition and down-trading, tobacco supply and quality, and PMCC lessee credit conditions. PMCC reported all lessees current on payments at quarter-end but cautioned that worsening conditions could require higher loss allowances.
- Management said it expected adequate liquidity and anticipated meeting credit covenants. Disclosure controls were judged effective, with no reported material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Reconcile reported and adjusted EPS guidance, including the restructuring and PMCC charge exclusions and the assumptions behind the 6%–9% adjusted growth target.
- Track PMCC lease-tax litigation, potential additional payments, penalties and any decision on further review of the adverse Second Circuit ruling.
- Monitor cigarette shipment and retail-share trends, including how much Q3 weakness reflected inventory timing versus ongoing category decline and competitive activity.
- Assess tobacco litigation developments, settlement-payment adjustments and regulatory actions, especially graphic warnings and potential menthol restrictions.
- Confirm the delivery and cash costs of the new savings program, and the company’s capacity to fund dividends, repurchases, debt maturities and settlement obligations.