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MO > SEC Filings for MO > Form 10-K on 26-Feb-2014All Recent SEC Filings

Show all filings for ALTRIA GROUP, INC.

Form 10-K for ALTRIA GROUP, INC.


26-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with the other sections of this Annual Report on Form 10-K, including the consolidated financial statements and related notes contained in Item 8, and the discussion of cautionary factors that may affect future results in Item 1A. Risk Factors of this Annual Report on Form 10-K ("Item 1A"). Description of the Company
At December 31, 2013, Altria Group, Inc.'s direct and indirect wholly-owned subsidiaries included PM USA, which is engaged in the manufacture and sale of cigarettes and certain smokeless tobacco products in the United States; Middleton, which is engaged in the manufacture and sale of machine-made large cigars and pipe tobacco, and is a wholly-owned subsidiary of PM USA; and UST, which through its direct and indirect wholly-owned subsidiaries, including USSTC and Ste. Michelle, is engaged in the manufacture and sale of smokeless tobacco products and wine. Nu Mark, an indirect wholly-owned subsidiary of Altria Group, Inc., is engaged in the development and marketing of innovative tobacco products for adult tobacco consumers. PMCC, another wholly-owned subsidiary of Altria Group, Inc., maintains a portfolio of leveraged and direct finance leases. In addition, Altria Group, Inc. held approximately 26.8% of the economic and voting interest of SABMiller at December 31, 2013, which Altria Group, Inc. accounts for under the equity method of accounting. Altria Group, Inc.'s access to the operating cash flows of its wholly-owned subsidiaries consists of cash received from the payment of dividends and distributions, and the payment of interest on intercompany loans by its subsidiaries. At December 31, 2013, Altria Group, Inc.'s principal wholly-owned subsidiaries were not limited by long-term debt or other agreements in their ability to pay cash dividends or make other distributions with respect to their common stock. In addition, Altria Group, Inc. receives cash dividends on its interest in SABMiller if and when SABMiller pays such dividends.
Effective January 1, 2013, Altria Group, Inc.'s reportable segments are smokeable products, smokeless products and wine. The financial services and the alternative products businesses have been combined in an all other category due to the continued reduction of the lease portfolio of PMCC and the relative financial contribution of Altria Group, Inc.'s alternative products businesses to Altria Group Inc.'s consolidated results. In addition, due to the continued reduction of the lease portfolio of PMCC, Altria Group, Inc.'s balance sheet accounts are no longer segregated by consumer products and financial services, and all balance sheet accounts are classified as either current or non-current. Prior years' amounts have been reclassified to conform with the current year's presentation.

Executive Summary
The following executive summary is intended to provide significant highlights of
the Discussion and Analysis that follows.
Consolidated Results of Operations
The changes in Altria Group, Inc.'s net earnings and diluted earnings per share
("EPS") attributable to Altria Group, Inc. for the year ended December 31, 2013,
from the year ended December 31, 2012, were due primarily to the following:
                                                            Net       Diluted
(in millions, except per share data)                   Earnings           EPS
For the year ended December 31, 2012                 $    4,180     $    2.06
2012 Asset impairment, exit and implementation costs         35          0.01
2012 Tobacco and health judgments                             4             -
2012 SABMiller special items                               (161 )       (0.08 )
2012 Loss on early extinguishment of debt                   559          0.28
2012 PMCC leveraged lease benefit                           (68 )       (0.03 )
2012 Tax items 1                                            (66 )       (0.03 )
Subtotal 2012 special items                                 303          0.15
2013 NPM Adjustment Items 2                                 427          0.21
2013 Asset impairment, exit and
implementation costs                                         (7 )           -
2013 Tobacco and health judgments                           (14 )       (0.01 )
2013 SABMiller special items                                (20 )       (0.01 )
2013 Loss on early extinguishment of debt                  (678 )       (0.34 )
2013 Tax items                                               64          0.03
Subtotal 2013 special items                                (228 )       (0.12 )
Fewer shares outstanding                                      -          0.03
Change in tax rate                                           69          0.03
Operations                                                  211          0.11
For the year ended December 31, 2013                 $    4,535     $    2.26

1 Excludes the tax impact included in the PMCC leveraged lease benefit. 2 Reflects the impact of the NPM Adjustment Settlement ($0.16) and the NPM Arbitration Panel Decision ($0.05).
See the discussion of events affecting the comparability of statement of earnings amounts in the Consolidated Operating Results section of the following Discussion and Analysis.
? Fewer Shares Outstanding: Fewer shares outstanding during 2013 compared with 2012 were due primarily to shares repurchased by Altria Group, Inc. under its share repurchase programs.

? Change in Tax Rate: The change in tax rate was due primarily to an increased recognition of foreign tax credits in 2013, primarily associated with SABMiller dividends.

? Operations: The increase of $211 million in operations shown in the table above was due primarily to the following:

?higher income from the smokeable products and smokeless products segments;


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?lower interest and other debt expense, net; and ?higher earnings from Altria Group, Inc.'s equity investment in SABMiller (excluding special items).
For further details, see the Consolidated Operating Results and Operating Results by Business Segment sections of the following Discussion and Analysis. 2014 Forecasted Results
In January 2014, Altria Group, Inc. forecasted that its 2014 full-year reported diluted EPS is expected to be in the range of $2.51 to $2.58. This forecast includes estimated expenses of $0.01 per share as detailed in the table below, as compared with 2013 full-year reported diluted EPS of $2.26, which included $0.12 per share of net expenses, as detailed in the table below. Expected 2014 full-year adjusted diluted EPS, which excludes the expenses in the table below, represents a growth rate of 6% to 9% over 2013 full-year adjusted diluted EPS, which excludes the net expenses in the table below.
Altria Group, Inc.'s core tobacco businesses are positioned to deliver income growth through their leading premium brands. Altria Group, Inc. also expects its 2014 earnings to benefit from lower interest expense, a lower effective tax rate and a reduction in shares from the April 2013 share repurchase program. However, Altria Group, Inc. plans to continue making disciplined and incremental investments to build its alternative products businesses and expects continued variability in gains from asset sales at PMCC. Finally, although some economic indicators are improving, adult tobacco consumers continue to face challenges. The factors described in Item 1A represent continuing risks to this forecast.

Expense (Income), Net Included in Reported Diluted EPS

                                       2014       2013
NPM Adjustment Items 1               $    -    $ (0.21 )
Tobacco and health judgments              -       0.01
SABMiller special items                0.01       0.01
Loss on early extinguishment of debt      -       0.34
Tax items                                 -      (0.03 )
                                     $ 0.01    $  0.12

1 Reflects the impact of the NPM Adjustment Settlement ($0.16) and the NPM Arbitration Panel Decision ($0.05).
Adjusted diluted EPS is a financial measure that is not consistent with accounting principles generally accepted in the United States of America ("U.S. GAAP"). Altria Group, Inc.'s management reviews diluted EPS on an adjusted basis, which excludes certain income and expense items that management believes are not part of underlying operations. These items may include, for example, loss on early extinguishment of debt, restructuring charges, SABMiller special items, certain PMCC leveraged lease items, certain tax items, tobacco and health judgments, and settlements of, and determinations made in, disputes with certain states related to the Non-Participating Manufacturer ("NPM") adjustment provision ("NPM

Adjustment") under the 1998 Master Settlement Agreement (the "MSA"). Altria Group, Inc.'s management does not view any of these special items to be part of its sustainable results as they may be highly variable and difficult to predict and can distort underlying business trends and results. Altria Group, Inc.'s management believes it is appropriate to disclose this non-GAAP financial measure to provide useful insight into underlying business trends and results, and to provide a more meaningful comparison of year-over-year results. Adjusted measures are used by management and regularly provided to Altria Group, Inc.'s chief operating decision maker for planning, forecasting and evaluating business and financial performance, including allocating resources and evaluating results relative to employee compensation targets. This information should be considered as supplemental in nature and not considered in isolation or as a substitute for the related financial information prepared in accordance with U.S. GAAP. Discussion and Analysis
Critical Accounting Policies and Estimates Note 2 includes a summary of the significant accounting policies and methods used in the preparation of Altria Group, Inc.'s consolidated financial statements. In most instances, Altria Group, Inc. must use an accounting policy or method because it is the only policy or method permitted under U.S. GAAP. The preparation of financial statements includes the use of estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities at the dates of the financial statements and the reported amounts of net revenues and expenses during the reporting periods. If actual amounts are ultimately different from previous estimates, the revisions are included in Altria Group, Inc.'s consolidated results of operations for the period in which the actual amounts become known. Historically, the aggregate differences, if any, between Altria Group, Inc.'s estimates and actual amounts in any year have not had a significant impact on its consolidated financial statements.
The following is a review of the more significant assumptions and estimates, as well as the accounting policies and methods, used in the preparation of Altria Group, Inc.'s consolidated financial statements:
?Consolidation: The consolidated financial statements include Altria Group, Inc., as well as its wholly-owned and majority-owned subsidiaries. Investments in which Altria Group, Inc. exercises significant influence are accounted for under the equity method of accounting. All intercompany transactions and balances have been eliminated.
?Revenue Recognition: Altria Group, Inc.'s businesses recognize revenues, net of sales incentives and sales returns, and including shipping and handling charges billed to customers, upon shipment or delivery of goods when title and risk of loss pass to customers. Payments received in advance of revenue recognition are deferred and recorded in other accrued


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liabilities until revenue is recognized. Altria Group, Inc.'s businesses also include excise taxes billed to customers in net revenues. Shipping and handling costs are classified as part of cost of sales.
?Depreciation, Amortization, Impairment Testing and Asset Valuation: Altria Group, Inc. depreciates property, plant and equipment and amortizes its definite-lived intangible assets using the straight-line method over the estimated useful lives of the assets. Machinery and equipment are depreciated over periods up to 25 years, and buildings and building improvements over periods up to 50 years. Definite-lived intangible assets are amortized over their estimated useful lives up to 25 years.
Altria Group, Inc. reviews long-lived assets, including definite-lived intangible assets, for impairment whenever events or changes in business circumstances indicate that the carrying value of the assets may not be fully recoverable. Altria Group, Inc. performs undiscounted operating cash flow analyses to determine if an impairment exists. These analyses are affected by general economic conditions and projected growth rates. For purposes of recognition and measurement of an impairment for assets held for use, Altria Group, Inc. groups assets and liabilities at the lowest level for which cash flows are separately identifiable. If an impairment is determined to exist, any related impairment loss is calculated based on fair value. Impairment losses on assets to be disposed of, if any, are based on the estimated proceeds to be received, less costs of disposal. Altria Group, Inc. also reviews the estimated remaining useful lives of long-lived assets whenever events or changes in business circumstances indicate the lives may have changed.
Goodwill and indefinite-lived intangible assets recorded by Altria Group, Inc. at December 31, 2013 relate primarily to the acquisitions of UST in 2009 and Middleton in 2007. Altria Group, Inc. conducts a required annual review of goodwill and indefinite-lived intangible assets for potential impairment, and more frequently if an event occurs or circumstances change that would require Altria Group, Inc. to perform an interim review. If the carrying value of goodwill exceeds its fair value, which is determined using discounted cash flows, goodwill is considered impaired. The amount of impairment loss is measured as the difference between the carrying value and the implied fair value. If the carrying value of an indefinite-lived intangible asset exceeds its fair value, which is determined using discounted cash flows, the intangible asset is considered impaired and is reduced to fair value.
Goodwill and indefinite-lived intangible assets, by reporting unit at December 31, 2013 were as follows:

                                    Indefinite-Lived
(in millions)        Goodwill      Intangible Assets
Cigarettes         $        -    $                 2
Smokeless products      5,023                  8,801
Cigars                     77                  2,640
Wine                       74                    258
Total              $    5,174    $            11,701

During 2013, 2012 and 2011, Altria Group, Inc. completed its quantitative annual impairment test of goodwill and indefinite-lived intangible assets, and no impairment charges resulted.
At December 31, 2013, the estimated fair value of the smokeless products reporting unit, as well as the estimated fair values of the indefinite-lived intangible assets within the smokeless products and wine reporting units, substantially exceeded their carrying values. In addition, at December 31, 2013, the estimated fair values of the cigars trademarks (primarily Black & Mild) exceeded their carrying values by approximately 18%. Middleton continues to observe significant competitive activity, including higher levels of imported, low-priced machine-made large cigars. As a result, management concluded after the 2013 review that while the fair values for the cigars trademarks exceeded their carrying values, they did not substantially exceed their carrying values. In 2013, Altria Group, Inc. used an income approach to estimate the fair values of its reporting units and its indefinite-lived intangible assets. The income approach reflects the discounting of expected future cash flows to their present value at a rate of return that incorporates the risk-free rate for the use of those funds, the expected rate of inflation and the risks associated with realizing expected future cash flows. The average discount rate used in performing the valuations was 10%.
In performing the 2013 discounted cash flow analysis, Altria Group, Inc. made various judgments, estimates and assumptions, the most significant of which were volume, income, growth rates and discount rates. The analysis incorporated assumptions used in Altria Group, Inc.'s long-term financial forecast and also included market participant assumptions regarding the highest and best use of Altria Group, Inc.'s indefinite-lived intangible assets. Assumptions are also made for perpetual growth rates for periods beyond the long-term financial forecast. Fair value calculations are sensitive to changes in these estimates and assumptions, some of which relate to broader macroeconomic conditions outside of Altria Group, Inc.'s control.
Although Altria Group, Inc.'s discounted cash flow analysis is based on assumptions that are considered reasonable and based on the best available information at the time that the discounted cash flow analysis is developed, there is significant judgment used in determining future cash flows. The following factors have the most potential to impact expected future cash flows and, therefore, Altria Group, Inc.'s impairment conclusions: general economic conditions; federal, state and local regulatory developments; changes in category growth rates as a result of changing consumer preferences; success of planned new product introductions; competitive activity; and tobacco-related taxes.
While Altria Group, Inc.'s management believes that the estimated fair values of each reporting unit and indefinite-lived intangible asset are reasonable, actual performance in the short-term or long-term could be significantly different from


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forecasted performance, which could result in impairment charges in future periods.
For additional information on goodwill and other intangible assets, see Note 3. ?Marketing Costs: Altria Group, Inc.'s businesses promote their products with consumer engagement programs, consumer incentives and trade promotions. Such programs include, but are not limited to, discounts, coupons, rebates, in-store display incentives, event marketing and volume-based incentives. Consumer engagement programs are expensed as incurred. Consumer incentive and trade promotion activities are recorded as a reduction of revenues, a portion of which is based on amounts estimated as being due to customers and consumers at the end of a period, based principally on historical utilization and redemption rates. For interim reporting purposes, consumer engagement programs and certain consumer incentive expenses are charged to operations as a percentage of sales, based on estimated sales and related expenses for the full year.
?Contingencies: As discussed in Note 18 and Item 3, legal proceedings covering a wide range of matters are pending or threatened in various United States and foreign jurisdictions against Altria Group, Inc. and its subsidiaries, including PM USA and UST and its subsidiaries, as well as their respective indemnitees. In 1998, PM USA and certain other U.S. tobacco product manufacturers entered into the MSA with 46 states and various other governments and jurisdictions to settle asserted and unasserted health care cost recovery and other claims. PM USA and certain other U.S. tobacco product manufacturers had previously settled similar claims brought by Mississippi, Florida, Texas and Minnesota (together with the MSA, the "State Settlement Agreements"). PM USA's portion of ongoing adjusted payments and legal fees is based on its relative share of the settling manufacturers' domestic cigarette shipments, including roll-your-own cigarettes, in the year preceding that in which the payment is due. PM USA also entered into a trust agreement to provide certain aid to U.S. tobacco growers and quota holders, but PM USA's obligations under this trust expired on December 15, 2010 (these obligations had been offset by the obligations imposed on PM USA by FETRA, which expires after the third quarter of 2014). USSTC and Middleton are also subject to obligations imposed by FETRA. In addition, in June 2009, PM USA and a subsidiary of USSTC became subject to quarterly user fees imposed by the FDA as a result of the FSPTCA. The State Settlement Agreements, FETRA and the FDA user fees call for payments that are based on variable factors, such as volume, market share and inflation, depending on the subject payment. Altria Group, Inc.'s subsidiaries account for the cost of the State Settlement Agreements, FETRA and FDA user fees as a component of cost of sales. As a result of the State Settlement Agreements, FETRA and FDA user fees, Altria Group, Inc.'s subsidiaries recorded approximately $4.4 billion, $5.1 billion and $5.0 billion of charges to cost of sales for the years ended December 31, 2013, 2012 and 2011, respectively. The 2013

amount included reductions to cost of sales of $664 million related to certain NPM Adjustment items discussed further below and in Health Care Cost Recovery Litigation - Possible Adjustments in MSA Payments for 2003 - 2012 in Note 18. Altria Group, Inc. and its subsidiaries record provisions in the consolidated financial statements for pending litigation when they determine that an unfavorable outcome is probable and the amount of the loss can be reasonably estimated. Except to the extent discussed in Note 18 and Item 3, at the present time, while it is reasonably possible that an unfavorable outcome in a case may occur, (i) management has concluded that it is not probable that a loss has been incurred in any of the pending tobacco-related cases; (ii) management is unable to estimate the possible loss or range of loss that could result from an unfavorable outcome in any of the pending tobacco-related cases; and (iii) accordingly, management has not provided any amounts in the consolidated financial statements for unfavorable outcomes, if any. Litigation defense costs are expensed as incurred and are included in marketing, administration and research costs on the consolidated statements of earnings. ?Employee Benefit Plans: As discussed in Note 16. Benefit Plans to the consolidated financial statements in Item 8 ("Note 16"), Altria Group, Inc. provides a range of benefits to its employees and retired employees, including pensions, postretirement health care and postemployment benefits (primarily severance). Altria Group, Inc. records annual amounts relating to these plans based on calculations specified by U.S. GAAP, which include various actuarial assumptions, such as discount rates, assumed rates of return on plan assets, compensation increases, turnover rates and health care cost trend rates. Altria Group, Inc. reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends when it is deemed appropriate to do so. Any effect of the modifications is generally amortized over future periods.
Altria Group, Inc. recognizes the funded status of its defined benefit pension and other postretirement plans on the consolidated balance sheet and records as a component of other comprehensive earnings (losses), net of deferred income taxes, the gains or losses and prior service costs or credits that have not been recognized as components of net periodic benefit cost.
At December 31, 2013, Altria Group, Inc.'s discount rate assumptions for its pension and postretirement plans increased to 4.9% and 4.8%, respectively, from 4.0% and 3.9%, respectively, at December 31, 2012. Altria Group, Inc. presently anticipates a decrease of approximately $146 million in its 2014 pre-tax pension and postretirement expense versus 2013, not including amounts in each year related to termination, settlement and curtailment. This anticipated decrease is due primarily to lower amortization of unrecognized losses, which includes the impact of the higher discount rate and higher return on plan assets in 2013. A 50 basis point decrease (increase) in Altria Group, Inc.'s discount rates would increase (decrease) Altria Group, Inc.'s pension and postretirement expense by


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approximately $45 million. Similarly, a 50 basis point decrease (increase) in the expected return on plan assets would increase (decrease) Altria Group, Inc.'s pension expense by approximately $32 million. See Note 16 for a sensitivity discussion of the assumed health care cost trend rates. ?Income Taxes: Significant judgment is required in determining income tax provisions and in evaluating tax positions. Altria Group, Inc.'s deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Altria Group, Inc. records a valuation allowance when it is more-likely-than-not that some portion or all of a deferred tax asset will not be realized. Altria Group, Inc. recognizes a benefit for uncertain tax positions when a tax position taken or expected to be taken in a tax return is more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. Altria Group, Inc. recognizes accrued interest and penalties associated with uncertain tax positions as part of the provision for income taxes on its consolidated statements of earnings. As discussed in Note 14. Income Taxes to the consolidated financial statements in Item 8 ("Note 14"), Altria Group, Inc. recognized income tax benefits and charges in the consolidated statements of earnings during 2013, 2012 and 2011 as a result of various tax events.
?Leasing: Substantially all of PMCC's net revenues in 2013 related to income on leveraged leases and related gains on asset sales. Income relating to leveraged leases is recorded initially as unearned income, which is included in the line item finance assets, net, on Altria Group, Inc.'s consolidated balance sheets, and is subsequently recognized as revenue over the terms of the respective leases at constant after-tax rates of return on the positive net investment balances. As discussed in Note 7, PMCC lessees are affected by bankruptcy filings, credit rating changes and financial market conditions.
PMCC's investment in leases is included in the line item finance assets, net, on the consolidated balance sheets as of December 31, 2013 and 2012. At December 31, 2013, PMCC's net finance receivables of approximately $1.9 billion in leveraged leases, which are included in finance assets, net, on

Altria Group, Inc.'s consolidated balance sheet, consisted of rents receivable ($4.2 billion) and the residual value of assets under lease ($1.1 billion), reduced by third-party nonrecourse debt ($2.8 billion) and unearned income ($0.6 billion). The repayment of the nonrecourse debt is collateralized by lease payments receivable and the leased property, and is nonrecourse to the general assets of PMCC. As required by U.S. GAAP, the third-party nonrecourse debt has been offset against the related rents receivable and has been presented on a net basis within finance assets, net, on Altria Group, Inc.'s consolidated balance sheets. Finance assets, net, of $2.0 billion at December 31, 2013 also included net finance receivables for direct finance leases and an allowance for losses. Estimated residual values represent PMCC's estimate at lease inception as to the fair values of assets under lease at the end of the non-cancelable lease terms. The estimated residual values are reviewed annually by PMCC's management, which . . .

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