PMI achieved market share gains in a number of important markets including France, Germany, Spain, the United Kingdom, Austria, Greece, Poland, Russia, the Ukraine, Turkey, Japan and Singapore.
The following discussion compares tobacco operating results for the third quarter of 2003 with the third quarter of 2002.
Operating companies income decreased $371 million (24.4%), due primarily to higher price promotions to narrow price gaps, net of lower costs under State Settlement Agreements (aggregating $334 million), lower volume ($44 million) and pre-tax charges in 2003 for the headquarters relocation ($27 million), partially offset by lower marketing, administration and research costs.
PM USA’s retail share of both the premium and discount segments each increased 0.2 share points to 61.3% and 15.8%, respectively, in the third quarter of 2003 versus the second quarter of 2003. Total industry retail market share for the discount segment decreased from the second quarter of 2003 to the third quarter of 2003 by 0.2 share points to 27.4%, while growth of the deep-discount segment was essentially flat, down 0.1 share point to 9.9%.
International tobacco. International tobacco net revenues, which include excise taxes billed to customers, increased $1.3 billion (16.6%). Excluding excise taxes, net revenues increased $379 million (9.8%), due primarily to favorable currency ($293 million), higher pricing and higher volume/mix ($56 million).
Operating companies income increased $197 million (12.9%), due primarily to favorable currency ($150 million), price increases ($84 million), higher volume/mix ($24 million), pre-tax charges for asset impairment and exit costs in 2002 ($33 million) and the impact of acquisitions ($11 million), partially offset by higher marketing, administration and research costs.
PMI’s volume of 189.4 billion units increased 1.6 billion units (0.8%). Volume comparisons benefited from a double-digit decline in Japan for the third quarter of 2002, due to the timing of shipments to that market caused by the shutdown of U.S. West Coast shipping ports, which was partially offset by a trade inventory reduction following a price increase in July 2003. In Western Europe, volume declined due primarily to decreases in Germany, Italy and France, partially offset by increases in Spain and the United Kingdom. In Germany, volume declined, reflecting a lower total market and consumer down-trading to low-priced tobacco portions, which currently benefit from an excise tax favorability. PMI has filed an unfair competition claim and the European Union has itself challenged the legality of such differing tax treatment. In Italy, volume decreased 19.3% and market share fell 8.1 share points to 53.1%, as PMI’s brands remained under pressure from low-priced competitive brands. Shipment volume decreased in France, reflecting contraction of the entire market following tax-driven price increases. However, market share in France increased during the third quarter. In Central and Eastern Europe, Middle East and Africa, volume increased strongly due to continued gains in Russia, Turkey and the Ukraine, higher volume in Greece, and an acquisition in Serbia, partially offset by lower volume resulting from intense price competition in Lithuania, Poland and the Slovak Republic. In Asia, volume increased, as gains in Japan, Korea, Malaysia, Taiwan and Vietnam, were partially offset by declines in Indonesia and the Philippines. In Latin America, volume increased, driven by gains in Argentina, Mexico and Central America.
PMI achieved market share gains in a number of important markets including Argentina, Austria, France, Japan, Korea, Mexico, Russia, Saudi Arabia, Spain, Turkey, the Ukraine and the United Kingdom.
Volume forMarlboro declined 3.0%, due primarily to declines in France, Germany and Italy. However,Marlboro share increased in Japan and other important markets, including Austria, the Czech Republic, Mexico, the Slovak Republic, Spain, Poland, Portugal, the Ukraine and the United Kingdom.
Food
Business Environment
Kraft Foods Inc. (“Kraft”) is the largest branded food and beverage company headquartered in the United States and conducts its global business through two subsidiaries. KFNA, which represents the North American food segment, manufactures and markets a wide variety of snacks, beverages, cheese, grocery products and convenient meals in the United States, Canada and Mexico. KFI, which represents the international food segment, manufactures and markets a wide variety of snacks, beverages, cheese, grocery products and convenient meals in Europe, the Middle East and Africa, as well as the Latin America and Asia Pacific regions.
KFNA and KFI are subject to a number of challenges that may adversely affect their businesses. These challenges, which are discussed below, include:
•
fluctuations in commodity prices;
•
movements of foreign currencies against the U.S. dollar;
•
competitive challenges in various products and markets, including price gaps with competitor products;
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•
a trend toward increasing consolidation in the retail trade and consequent inventory reductions;
•
changing consumer preferences;
•
competitors with different profit objectives and less susceptibility to currency exchange rates; and
•
consumer concerns about food safety, quality and health, including concerns about genetically modified organisms, trans fatty acids and obesity.
To confront these challenges, Kraft continues to take steps to build the value of its brands, to improve its food business portfolio with new product and marketing initiatives, to reduce costs through productivity, and to address consumer concerns about food safety, quality and health, including obesity. In July 2003, Kraft announced a range of initiatives addressing product nutrition, marketing practices, consumer information and public advocacy and dialogue.
During the second quarter of 2003, several factors contributed to lower than anticipated volume growth. These factors included trade inventory reductions resulting from several customers experiencing financial difficulty, warehouse consolidations, store closings and retailers’ stated initiatives to reduce working capital, as well as the combined adverse effect of global economic weakness and higher price gaps in some key categories and countries. To improve volume and share trends, Kraft announced that it would increase spending behind certain U.S. businesses in the remainder of 2003. The incremental investment is expected to be approximately $200 million higher than previously planned amounts, of which approximately $45 million has been spent through September 30, 2003. Kraft also anticipates increased spending behind certain U.S. businesses in 2004.
Fluctuations in commodity prices can cause retail price volatility and intensive price competition, and can influence consumer and trade buying patterns. The North American and international food businesses are subject to fluctuating commodity costs, including dairy, coffee and cocoa costs. In 2003, Kraft’s commodity costs on average were higher than in 2002.
On December 11, 2000, Altria Group, Inc., through Kraft, acquired all of the outstanding shares of Nabisco Holdings Corp. (“Nabisco”). The closure of a number of Nabisco domestic and international facilities resulted in severance and other exit costs of $379 million, which were included in the adjustments for the allocation of the Nabisco purchase price. The closures will require total cash payments of $373 million, of which approximately $220 million has been spent through September 30, 2003. Substantially all of the closures are completed, and the remaining payments relate to salary continuation for severed employees and lease payments.
The integration of Nabisco into the operations of Kraft also resulted in the closure or reconfiguration of several existing Kraft facilities. KFNA incurred pre-tax integration costs of $27 million and $75 million during the first and second quarters of 2002, respectively. KFI incurred pre-tax integration costs of $17 million during the second quarter of 2002. In addition, during the first quarter of 2002, approximately 700 employees accepted the benefits offered by a separation program for certain salaried employees. Pre-tax charges of $135 million and $7 million were recorded in the operating results of the North American and international food segments, respectively, for these exit costs.
During the third quarter of 2003, KFNA acquired trademarks associated with a small natural foods business and during the second quarter of 2003, KFI acquired a biscuits business in Egypt. During the third quarter of 2002, KFI acquired a snacks business in Turkey and during the first quarter of 2002, acquired a biscuits business in Australia. The total cost of these and smaller businesses purchased by Kraft during the first nine months of 2003 and 2002 was $97 million and $119 million, respectively.
During the third quarter of 2003, KFI sold a European rice business and recorded a pre-tax gain of $23 million. See Note 7.Acquisitions and Divestitures for a discussion of this and other smaller divestitures and acquisitions affecting KFNA and KFI. The operating results of businesses acquired and sold were not material to Altria Group, Inc.’s consolidated financial position, results of operations or cash flows in any of the periods presented.
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During the third quarter of 2003, KFI recorded pre-tax charges of $6 million for asset impairment and exit costs related to the closure of a Nordic snacks plant.
In November 2003, Kraft was advised by the Fort Worth District Office of the Securities and Exchange Commission (“SEC”) that the Staff is considering recommending that the SEC bring a civil injunctive action against Kraft. The notice alleges that Kraft employees signed documents requested by the Fleming Companies (“Fleming”), which Fleming used in order to accelerate its revenue recognition. The notice does not contain any allegations or statements regarding Kraft’s accounting for transactions with Fleming. Kraft believes that it properly recorded the transactions in accordance with generally accepted accounting principles. Prior to the time that the Staff makes a formal enforcement recommendation, if any, to the SEC, Kraft will have the opportunity to respond to this notice and submit reasons why it believes that the civil injunctive action should not be brought. Kraft intends to respond to this notice fully and promptly and to cooperate with the SEC with respect to this matter and the SEC's investigation of Fleming.
Operating Results – Nine Months Ended September 30, 2003
The following discussion compares food operating results for the nine months ended September 30, 2003 with the nine months ended September 30, 2002.
| | For the Nine Months Ended September 30, | |
| |
| |
| | Net Revenues | | Operating
Companies Income | |
| |
| |
| |
| | (in millions) | |
| | 2003 | | 2002 | | 2003 | | 2002 | |
| |
| |
| |
| |
| |
North American food | | $ | 16,350 | | $ | 16,087 | | $ | 3,832 | | $ | 3,770 | |
International food | | | 6,330 | | | 5,789 | | | 840 | | | 851 | |
| |
|
| |
|
| |
|
| |
|
| |
Total food | | $ | 22,680 | | $ | 21,876 | | $ | 4,672 | | $ | 4,621 | |
| |
|
| |
|
| |
|
| |
|
| |
North American food. Net revenues increased $263 million (1.6%), due primarily to higher volume/mix ($154 million), favorable currency ($58 million) and higher pricing, partially offset by higher promotional spending and the divestiture of a small confectionery business in the fourth quarter of 2002.
Operating companies income increased $62 million (1.6%), due primarily to the 2002 pre-tax charges for asset impairment and exit costs, and integration costs (aggregating $237 million) and lower marketing, administration and research expenses, partially offset by cost increases, net of higher pricing ($90 million, including higher commodity costs and increased promotional spending) and higher fixed manufacturing costs.
Volume increased 1.6%. Volume gains were achieved in Beverages, Desserts and Cereals, driven primarily by new product momentum in ready-to-drink beverages, partially offset by lower shipments of coffee and cereal. In Oscar Mayer and Pizza, volume increased, due primarily to higher shipments of frozen pizza, bacon, lunch combinations and soy-based meat alternatives, partially offset by lower shipments of cold cuts. In Cheese, Meals and Enhancers, volume increased, due primarily to higher shipments in Canada and Mexico, partially offset by trade inventory reductions in certain cheese and enhancers businesses. Volume in KFNA’s food service business in the United States increased, due to higher shipments to national accounts and increased demand for ingredient products. Volume decreased in Biscuits, Snacks and Confectionery, due primarily to weakness in cookies and the divestiture of a small confectionery business in 2002.
International food. Net revenues increased $541 million (9.3%), due primarily to favorable currency ($382 million), higher pricing ($248 million, reflecting higher commodity and currency devaluation-driven costs in Latin America) and the impact of acquisitions ($43 million), partially offset by lower volume/mix ($68 million) and the impact of divestitures.
Operating companies income decreased $11 million (1.3%), due primarily to higher marketing, administration and research costs ($97 million), lower volume/mix ($33 million) and the impact of divestitures, partially offset by higher pricing, net of cost increases ($47 million), favorable currency ($40 million), the 2003 gain on the sale of a European rice business and the impact of the previously discussed pre-tax charges in 2003 and 2002 (aggregating $18 million).
Volume decreased 2.4%, due primarily to the impact of divestitures in 2003 and 2002, partially offset by growth in developing markets, new product introductions and the impact of acquisitions.
In Europe, Middle East and Africa, volume increased, driven by growth across the Central and Eastern Europe, Middle East and Africa region, benefiting from the impact of acquisitions and new product introductions, partially offset by the adverse impact of the summer heat wave across Europe, price competition and a
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divestiture. Snacks volume increased, benefiting from acquisitions and growth in confectionery in Russia, Poland and Romania, partially offset by the adverse impact of the summer heat wave on confectionery shipments and price competition. Beverages volume declined, due primarily to the adverse impact of the summer heat wave on coffee shipments, price competition and trade inventory reductions, partially offset by increased coffee shipments in Poland and Russia. In convenient meals, volume declined, due primarily to the divestiture of the European rice business, partially offset by higher shipments of canned meats in Italy. In cheese, volume decreased, due primarily to the impact of price competition in Germany and Spain, and lower shipments in the Middle East, partially offset by higher shipments of cream cheese in Italy.
Volume decreased in the Latin America and Asia Pacific region, due primarily to the divestiture of a Latin American bakery ingredients business in 2002, political and economic instability in Venezuela and economic weakness in Brazil, partially offset by growth in Argentina and across most Asia Pacific markets. Snacks volume decreased, due primarily to political and economic instability in Venezuela and a confectionery market decline in Brazil, partially offset by biscuits volume growth in many markets, including Brazil, Colombia, Central America, China, Australia and Southeast Asia. In grocery, volume declined in Latin America, due primarily to the divestiture of a bakery ingredients business. In beverages, volume increased, driven by coffee and refreshment beverages. Coffee volume increased due primarily to higher shipments to China, and refreshment beverages volume increased, due to growth in most markets, including Brazil, Venezuela, China and the Philippines, aided by new product introductions. In cheese, volume increased due to higher shipments to Japan, the Philippines and Australia, partially offset by declines in Venezuela and Indonesia. Convenient meals volume also grew, benefiting from gains in Argentina.
Operating Results – Three Months Ended September 30, 2003
The following discussion compares food operating results for the third quarter of 2003 with the third quarter of 2002.
| | For the Three Months Ended September 30, | |
| |
| |
| | Net Revenues | | Operating
Companies Income | |
| |
| |
| |
| | (in millions) | |
| | 2003 | | 2002 | | 2003 | | 2002 | |
| |
| |
| |
| |
| |
North American food | | $ | 5,326 | | $ | 5,225 | | $ | 1,152 | | $ | 1,303 | |
International food | | | 2,154 | | | 1,991 | | | 307 | | | 300 | |
| |
|
| |
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| |
|
| |
|
| |
Total food | | $ | 7,480 | | $ | 7,216 | | $ | 1,459 | | $ | 1,603 | |
| |
|
| |
|
| |
|
| |
|
| |
North American food. Net revenues increased $101 million (1.9%), due primarily to favorable currency ($46 million), higher volume/mix ($36 million) and higher pricing, partially offset by higher promotional spending, including investments to manage price gaps and improve share trends on cheese, cold cuts, coffee and biscuits, and the divestiture of a small confectionery business in the fourth quarter of 2002.
Operating companies income decreased $151 million (11.6%), due primarily to cost increases, net of higher pricing (aggregating $112 million, including higher commodity costs and increased promotional spending in certain categories), unfavorable volume/mix ($14 million) and higher fixed manufacturing costs, partially offset by favorable currency.
Volume increased 0.9%. Volume gains were achieved in Beverages, Desserts and Cereals, driven primarily by new products in ready-to-drink beverages and higher shipments of powdered soft drinks. In Cheese, Meals and Enhancers, volume increased, due primarily to increased merchandising in dinners, salad dressing and barbeque sauce. Volume in KFNA’s food service business in the United States increased due to higher shipments to national accounts. In Oscar Mayer and Pizza, volume increased, due primarily to higher shipments of cold cuts, hot dogs, bacon, lunch combinations and soy-based meat alternatives. Volume decreased in Biscuits, Snacks and Confectionery, due primarily to weakness in cookies and the divestiture of a small confectionery business in the fourth quarter of 2002.
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International food. Net revenues increased $163 million (8.2%), due primarily to favorable currency ($167 million), higher pricing ($77 million, reflecting higher commodity and currency devaluation-driven costs in Latin America) and the impact of acquisitions ($22 million), partially offset by lower volume/mix ($78 million) and the impact of divestitures.
Operating companies income increased $7 million (2.3%), due primarily to higher pricing, net of cost increases ($31 million), favorable currency ($18 million) and the gain on the sale of a European rice business ($23 million), partially offset by lower volume/mix ($29 million), higher marketing, administration and research costs ($27 million, including higher benefit costs and infrastructure investment in developing markets) and the impact of divestitures.
Volume decreased 3.2%, due primarily to the impact of divestitures and the summer heat wave across Europe, as well as price competition, partially offset by the impact of acquisitions.
In Europe, Middle East and Africa, volume decreased, due primarily to the European rice divestiture and the adverse impact of the summer heat wave across Europe on the chocolate and coffee businesses, partially offset by the impact of acquisitions and growth in Poland, Russia, Romania and the Ukraine. In beverages and confectionery, volume decreased, adversely impacted by the summer heat wave. In addition, coffee volume was affected by price competition in Germany, partially offset by expanded distribution in Russia and new product launches in Poland. Snacks volume increased, with gains in biscuits and salted snacks, benefiting from acquisitions more than offsetting the confectionery decline. In convenient meals, volume decreased, due primarily to the European rice divestiture, partially offset by higher shipments of canned meats in Italy.
Volume decreased in the Latin America and Asia Pacific region, impacted by the divestiture of a Latin American bakery ingredients business in 2002, partially offset by growth in most Asia Pacific markets. Beverages volume increased, driven by gains in Brazil, Venezuela and China. In grocery, volume declined, due primarily to the divestiture of a Latin American bakery ingredients business in the fourth quarter of 2002. Snacks volume decreased, due primarily to economic weakness and trade inventory reductions in Brazil and raw material unavailability in Venezuela, partially offset by new product launches in Argentina, Australia and China. In cheese, volume increased, driven by higher shipments in Australia and the Philippines.
Financial Services
Business Environment
In the second quarter of 2003, Philip Morris Capital Corporation (“PMCC”) shifted its strategic focus from an emphasis on the growth of its portfolio of finance leases through new investments to one of maximizing investment gains and generating cash flows from its diversified portfolio of leased assets. Accordingly, PMCC’s operating companies income will continue to decrease as lease investments mature or are sold.
In July 2003, PMCC refinanced the nonrecourse debt ($158 million) of a real estate leveraged lease transaction at a lower interest rate than the existing debt. In addition, PMCC issued $156 million of nonrecourse notes. The note holders have recourse to the receivables due under the aforementioned leveraged lease, as well as the underlying leased asset. Transaction costs were $15 million. At September 30, 2003, the nonrecourse notes are reflected as “Nonrecourse debt” on the Altria Group, Inc. condensed consolidated balance sheet.
During the third quarter of 2003, PMCC received proceeds from asset sales of $269 million and recorded a gain in operating companies income of $17 million. For the first nine months of 2003, PMCC received proceeds from asset sales of $350 million and recorded a gain of $34 million in operating companies income.
Among its leasing activities, PMCC leases a number of aircraft, predominantly to major United States carriers. At September 30, 2003, approximately 26%, or $2.3 billion of PMCC’s investment in finance leases related to aircraft. In recognition of the economic downturn in the airline industry, PMCC increased its allowance for
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losses by $290 million in the fourth quarter of 2002. It is possible that further adverse developments in the airline industry may occur that may require PMCC to increase its allowance for losses in future periods.
PMCC leases a Boeing 747-400 freighter aircraft to Atlas Air, Inc. (“Atlas”) under a long-term leveraged lease. The aircraft represents an investment in a finance lease of $42 million, which equals 0.5% of PMCC’s portfolio of finance assets at September 30, 2003. Atlas defaulted on certain of its lease payments in July 2003, including a portion of the lease payments due under its lease with PMCC. Atlas is currently negotiating a restructuring plan with its creditors and has announced its plan to file a pre-packaged bankruptcy in December 2003. PMCC continues to negotiate with Atlas in its effort to restructure.
During May 2003, in connection with the efforts of American Airlines, Inc. (“American”) to avoid a bankruptcy filing, PMCC, American and the leveraged lease lenders entered into an agreement to restructure the leases on fourteen of PMCC’s twenty-eight MD-80 aircraft currently under long-term leveraged leases with American. This agreement resulted in a $28 million charge against PMCC’s allowance for losses during the second quarter of 2003 and a reduction of $30 million of lease income over the remaining terms of the leases. Leases on the remaining fourteen aircraft were unchanged. As of September 30, 2003, PMCC’s aggregate exposure to American totaled $212 million, which equals 2.4% of PMCC’s portfolio of finance assets.
On March 31, 2003, US Airways Group, Inc. (“US Airways”) emerged from Chapter 11 bankruptcy protection. PMCC currently leases 16 Airbus A319 aircraft to US Airways under long-term leveraged leases, which expire in 2018 and 2019. The leased aircraft represent an investment in finance leases of $142 million, or 1.6% of PMCC’s portfolio of finance assets at September 30, 2003. Pursuant to an agreement reached between US Airways and PMCC, US Airways affirmed these leases when it emerged from bankruptcy. This agreement resulted in a $13 million charge against PMCC’s allowance for losses during the first quarter of 2003 and a reduction of $7 million of lease income over the remaining terms of the leases.
On December 9, 2002, United Air Lines Inc. (“UAL”) filed for Chapter 11 bankruptcy protection. At that time, PMCC leased 24 Boeing 757 aircraft to UAL, 22 under long-term leveraged leases and two under long-term single investor leases. Subsequently, PMCC purchased $239 million of senior nonrecourse debt on 16 of the aircraft under leveraged leases, which were then treated as single investor leases for accounting purposes. As of February 28, 2003, PMCC entered into an agreement with UAL to amend these 16 leases, as well as the two single investor leases. Among other modifications, the subordinated debt outstanding on these 16 leveraged leases was cancelled. As of September 30, 2003, PMCC’s aggregate exposure to UAL totaled $603 million, which equals 6.9% of PMCC’s portfolio of finance assets at September 30, 2003. PMCC continues to negotiate with UAL in its efforts to restructure and emerge from bankruptcy.
Operating Results
| | 2003 | | 2002 | |
| |
| |
| |
| | (in millions) | |
Net revenues: | | | | | | | |
Nine months ended September 30, | | $ | 327 | | $ | 379 | |
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|
| |
Three months ended September 30, | | $ | 107 | | $ | 114 | |
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| | | | | | | |
Operating companies income: | | | | | | | |
Nine months ended September 30, | | $ | 241 | | $ | 257 | |
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| |
Three months ended September 30, | | $ | 76 | | $ | 82 | |
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| |
PMCC’s net revenues for the first nine months of 2003 decreased $52 million (13.7%) from the comparable period in 2002, due primarily to a significant gain during 2002 from the early termination of a lease and lower income from leasing activities. PMCC’s operating companies income for the first nine months of 2003 decreased $16 million (6.2%) from the comparable period of 2002, due primarily to a significant gain during 2002 from the early termination of a lease, partially offset by a lower provision for losses. During the third quarter of 2003, net revenues and operating companies income decreased $7 million (6.1%) and $6 million
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(7.3%), respectively, from the comparable period in 2002, due primarily to lower lease portfolio revenues, partially offset by higher asset management gains.
Financial Review
Net Cash Provided by Operating Activities
During the first nine months of 2003, net cash provided by operating activities was $8.9 billion compared with $9.9 billion during the comparable 2002 period. The decrease of $1.0 billion was due primarily to an increase of $371 million for pension contributions in 2003 and includes a decrease in taxes payable ($676 million), which is principally attributable to the 2002 gain on the Miller transaction combined with 2003 lower taxable earnings and a lower effective tax rate.
Net Cash Used in Investing Activities
One element of the growth strategy of ALG’s subsidiaries is to strengthen their brand portfolios through active programs of selective acquisitions and divestitures. ALG’s subsidiaries are constantly investigating potential acquisition candidates and from time to time sell businesses that are outside their core categories or that do not meet their growth or profitability targets.
During the first nine months of 2003, net cash used in investing activities was $1.6 billion, compared with $1.4 billion during the first nine months of 2002. The increase over the first nine months of 2002 reflects a higher level of acquisitions made in 2003, partially offset by fewer investments in finance assets during 2003.
Net Cash Used in Financing Activities
During the first nine months of 2003, net cash used in financing activities was $1.8 billion, compared with $8.6 billion during the first nine months of 2002. The decrease of $6.8 billion was due primarily to a lower level of Altria Group, Inc. common stock repurchases in 2003 ($3.8 billion) and the net issuance of consumer products debt in 2003, as compared to the net repayment of debt in 2002.
Debt and Liquidity
Debt - Altria Group, Inc.’s total debt (consumer products and financial services) was $26.6 billion and $23.3 billion at September 30, 2003 and December 31, 2002, respectively. Total consumer products debt was $24.5 billion and $21.2 billion at September 30, 2003 and December 31, 2002, respectively. The increase in total debt and consumer products debt reflects borrowings made on existing revolving credit facilities after access to the commercial paper markets was eliminated for ALG and Kraft during the first quarter of 2003. By the end of May 2003, Kraft regained access to the commercial paper markets. In September 2003, Kraft issued $1.5 billion of notes under an existing shelf registration statement. The borrowings include $700 million of 5-year notes bearing interest at a rate of 4.0% and $800 million of 10-year notes bearing interest at a rate of 5.25%. The net proceeds from the notes were used by Kraft to repay a portion of the short-term borrowings from Altria Group, Inc. At September 30, 2003 and December 31, 2002, Altria Group, Inc.’s ratio of consumer products debt to total equity was 1.07 and 1.09, respectively, and the ratio of total debt to total equity was 1.16 and 1.20, respectively. In November 2003, ALG completed the issuance of $1.5 billion in long-term notes under an existing shelf registration statement. The borrowings include $500 million of 5-year notes bearing interest at a rate of 5.625% and $1.0 billion of 10-year notes bearing interest at a rate of 7.0%. The net proceeds from this transaction are being used to retire borrowings on the ALG revolving credit facilities.
Cash and Cash Equivalents - Altria Group, Inc.’s cash and cash equivalents were $6.0 billion and $565 million at September 30, 2003 and December 31, 2002, respectively. The increase in cash and cash equivalents reflects, in part, the previously discussed borrowings made on existing revolving credit facilities and the proceeds received from the repayment of intercompany borrowings by Kraft. The cash is being used to meet ongoing working capital requirements, as well as debt maturities.
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Credit Ratings- Following a $10.1 billion judgment on March 21, 2003 against PM USA in thePrice litigation which is discussed in Note 10, the three major credit rating agencies took a series of ratings actions resulting in the lowering of ALG’s short-term and long-term debt ratings. Moody’s lowered ALG’s short-term debt rating from “P-1” to “P-2” and subsequently to “P-3,” and its long-term debt rating from “A2” to “Baa2.” S&P lowered ALG’s short-term debt rating from “A-1” to “A-2” and its long-term debt rating from “A-” to “BBB.” Fitch lowered ALG’s short-term debt rating from “F-1” to “F-2” and its long-term debt rating from “A” to “BBB.”
While Kraft is not a party to, and has no exposure to, this litigation, its credit ratings were also lowered, but to a lesser degree. As a result of the rating agencies’ actions, borrowing costs for ALG and Kraft have increased. None of ALG’s or Kraft’s debt agreements requires accelerated repayment as a result of a decrease in credit ratings.
Credit Lines- ALG and Kraft each maintain separate revolving credit facilities that they have historically used to support the issuance of commercial paper. However, as a result of the rating agencies’ actions discussed above, ALG’s and Kraft’s access to the commercial paper market was eliminated. Subsequently, in April 2003, ALG and Kraft began to borrow against existing credit facilities to repay maturing commercial paper and to fund normal working capital needs. By the end of May 2003, Kraft regained its access to the commercial paper markets.
The ALG multi-year revolving credit facility requires the maintenance of a fixed charges coverage ratio. The Kraft multi-year revolving credit facility, which is for the sole use of Kraft, requires the maintenance of a minimum net worth. ALG and Kraft met their respective covenants at September 30, 2003 and expect to continue to meet their respective covenants. The multi-year facilities both expire in July 2006. In July 2003, ALG and Kraft replaced their respective 364-day revolving credit facilities which were expiring. The new ALG 364-day revolving credit facility in the amount of $2.0 billion expires in July 2004. It requires the maintenance of a fixed charges coverage ratio and prohibits share repurchases while borrowings are outstanding against either ALG’s 364-day or multi-year facility. In addition, the size of ALG’s 364-day facility will be reduced by 50% of the net proceeds of any long-term capital markets transactions completed by ALG. As a result of the previously mentioned debt issuance in November 2003, the ALG 364-day facility was reduced to approximately $1.3 billion. The new Kraft 364-day revolving credit facility in the amount of $2.5 billion also expires in July 2004. It requires the maintenance of a minimum net worth. Neither of these facilities, nor the multi-year facilities, includes any additional financial tests, any credit rating triggers or any provisions that could require the posting of collateral.
In the table below, information is provided as of September 30, 2003 and November 7, 2003 to provide the most current information available. At September 30, 2003 and at November 7, 2003, credit lines for ALG and Kraft, and the related activity were as follows (in billions of dollars):
ALG | | September 30, 2003 | | November 7, 2003 | |
| |
| |
| |
Type | | Credit
Lines | | Amount
Drawn | | Commercial
Paper
Outstanding | | Lines
Available | | Credit
Lines | | Amount
Drawn | | Commercial
Paper
Outstanding | | Lines
Available | |
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| | | | | | | | | | | | | | | | | | | | | | | | | |
364-day | | $ | 2.0 | | $ | — | | $ | — | | $ | 2.0 | | $ | 1.3 | | $ | — | | $ | — | | $ | 1.3 | |
Multi-year | | | 5.0 | | | 3.3 | | | | | | 1.7 | | | 5.0 | | | 2.0 | | | | | | 3.0 | |
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|
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| | $ | 7.0 | | $ | 3.3 | | $ | — | | $ | 3.7 | | $ | 6.3 | | $ | 2.0 | | $ | — | | $ | 4.3 | |
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Kraft | | September 30, 2003 | | November 7, 2003 | |
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| |
| |
Type | | Credit
Lines | | Amount
Drawn | | Commercial
Paper
Outstanding | | Lines
Available | | Credit
Lines | | Amount
Drawn | | Commercial
Paper
Outstanding | | Lines
Available | |
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364-day | | $ | 2.5 | | $ | — | | $ | 1.7 | | $ | 0.8 | | $ | 2.5 | | $ | — | | $ | 1.5 | | $ | 1.0 | |
Multi-year | | | 2.0 | | | | | | 1.2 | | | 0.8 | | | 2.0 | | | | | | 1.2 | | | 0.8 | |
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In addition to the above, certain international subsidiaries of ALG and Kraft maintain uncommitted credit lines to meet the short-term working capital needs of PMI and KFI. These credit lines, which amounted to approximately $1.4 billion for ALG subsidiaries (other than Kraft) and approximately $0.6 billion for Kraft subsidiaries, are for the sole use of these international businesses. At September 30, 2003, borrowings on these lines amounted to approximately $0.4 billion.
Guarantees- As discussed in Note 10, Altria Group, Inc. had third-party guarantees, which are primarily derived from acquisition and divestiture activities, approximating $250 million, of which $210 million have no specified expiration dates. The remainder expire through 2023, with $22 million expiring through September 30, 2004. Altria Group, Inc. is required to perform under these guarantees in the event that a third-party fails to make contractual payments or achieve performance measures. Altria Group, Inc. has recorded a liability of $90 million at September 30, 2003 relating to these guarantees. In addition, in the ordinary course of business, certain subsidiaries of ALG have agreed to indemnify a limited number of third parties in the event of future litigation. At September 30, 2003, subsidiaries of ALG were also contingently liable for $1.1 billion of guarantees related to their own performance, consisting of the following:
•
$0.9 billion of guarantees of excise tax and import duties related primarily to international shipments of tobacco products. In these agreements, a financial institution provides a guarantee of tax payments to respective governments. PMI then issues a guarantee to the respective financial institution for the payment of the taxes. These are revolving facilities that are integral to the shipment of tobacco products in international markets, and the underlying taxes payable are recorded on Altria Group, Inc.’s consolidated balance sheet.
•
$0.2 billion of other guarantees related to the tobacco and food businesses.
Although Altria Group, Inc.’s guarantees of its own performance are frequently short-term in nature, the short-term guarantees are expected to be replaced, upon expiration, with similar guarantees of similar amounts. Guarantees do not have, and are not expected to have, a significant impact on Altria Group, Inc.’s liquidity.
Litigation Escrow Deposits - As discussed in Note 10, in connection with obtaining a stay of execution in May 2001 in theEngle class action, PM USA placed $1.2 billion into an interest-bearing escrow account. The $1.2 billion escrow account and a deposit of $100 million related to the bonding requirement are included in the September 30, 2003 and December 31, 2002 condensed consolidated balance sheets as other assets. These amounts will be returned to PM USA should it prevail in its appeal of the case. Interest income on the $1.2 billion escrow account is paid to PM USA quarterly and is being recorded as earned in interest and other debt expense, net, in the condensed consolidated statements of earnings.
As discussed in Note 10, in connection with obtaining a stay of execution in thePrice case, PM USA placed a pre-existing 7.0%, $6 billion long-term note from ALG to PM USA into an escrow account with an Illinois financial institution. (Since this note is the result of an intercompany financing arrangement, it does not appear on the condensed consolidated balance sheet of Altria Group, Inc.) In addition, PM USA agreed to make cash deposits with the clerk of the Madison County Circuit Court in the following amounts: beginning October 1, 2003, an amount equal to the interest earned by PM USA on the ALG note ($210 million every six months), an additional $800 million in four equal quarterly installments between September 2003 and June 2004 and the payments of the principal of the note which are due in April 2008, 2009 and 2010. Through September 30,
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2003, PM USA paid $200 million of the cash payments due under the judge’s order. (Cash payments into the account will be presented as other assets on the consolidated balance sheet.) If PM USA prevails on appeal, the escrowed note and all cash deposited with the court will be returned to PM USA, with accrued interest less administrative fees payable to the court.
In addition, with respect to certain adverse verdicts currently on appeal (excluding amounts relating to theEngle case and thePrice case discussed above), as of September 30, 2003, PM USA has posted various forms of security totaling $366 million, the majority of which have been collateralized with cash deposits, to obtain stays of judgments pending appeals. These cash deposits are included in other assets on the condensed consolidated balance sheets.
Tobacco Litigation Settlement Payments - - PM USA, along with other domestic tobacco companies, has entered into State Settlement Agreements that require the domestic tobacco industry to make substantial annual payments in the following amounts (excluding future annual payments contemplated by the agreement with tobacco growers discussed below), subject to adjustment for several factors, including inflation, market share and industry volume: 2003, $10.9 billion; 2004 through 2007, $8.4 billion each year; and thereafter, $9.4 billion each year. In addition, the domestic tobacco industry is required to pay settling plaintiffs’ attorneys’ fees, subject to an annual cap of $500 million, as well as an additional $250 million in 2003. These payment obligations are the several and not joint obligations of each settling defendant. 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. Accordingly, PM USA records its portion of ongoing settlement payments as part of cost of sales as product is shipped.
PM USA and the other settling defendants also agreed to make payments to a trust fund to provide aid to tobacco growers and quota-holders. The trust will be funded by four of the major domestic tobacco product manufacturers, including PM USA, over 12 years with payments, prior to application of various adjustments, scheduled to total $5.15 billion. Future industry payments (in 2003 through 2008, $500 million each year; and 2009 and 2010, $295 million each year) are subject to adjustment for several factors, including inflation, industry volume and certain other contingent events, and, in general, are to be allocated based on each manufacturer’s relative market share. PM USA records its portion of these payments as part of cost of sales as product is shipped.
During the nine months ended September 30, 2003 and 2002, and the quarters ended September 30, 2003 and 2002, PM USA recognized $3.3 billion and $4.1 billion, respectively, and $1.1 billion and $1.3 billion, respectively, as part of cost of sales attributable to the foregoing settlement obligations.
As discussed above under “Tobacco—Business Environment,” the present legislative and litigation environment is substantially uncertain and could result in material adverse consequences for the business, financial condition, cash flows or results of operations of ALG, PM USA and PMI. Assuming there are no material adverse developments in the legislative and litigation environment, Altria Group, Inc. expects its cash flow from operations to provide sufficient liquidity to meet the ongoing needs of the business.
Leases- PMCC holds investments in leveraged leases and direct finance leases. At September 30, 2003, PMCC’s net finance receivable of $7.7 billion in leveraged leases, which is included in Altria Group, Inc.’s condensed consolidated balance sheet as part of finance assets, net, consists of total lease receivables ($28.4 billion) and the residual value of assets under lease ($2.3 billion), reduced by nonrecourse third-party debt ($19.2 billion) and unearned income ($3.8 billion). PMCC has no obligation for the payment of the nonrecourse third-party debt issued to purchase the assets under lease. The payment of such debt is collateralized only by lease payments receivable and the leased property, and is nonrecourse to all other assets of PMCC or Altria Group, Inc. As required by accounting standards generally accepted in the United States of America (“U.S. GAAP”), the nonrecourse third-party debt has been offset against the related rentals receivable and has been presented on a net basis, within finance assets, net, in Altria Group, Inc.’s condensed consolidated balance sheets. The net finance receivable for leveraged leases of $7.7 billion does not include certain notes
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($156 million), representing the securitization of rents on a real estate leveraged lease, which are reflected as “Nonrecourse debt” on Altria Group, Inc.’s condensed consolidated balance sheet as required by U.S. GAAP.
At September 30, 2003, PMCC’s net finance receivable in direct finance leases of $1.2 billion, which is also included in finance assets, net, in Altria Group, Inc.’s condensed consolidated balance sheet, consists of lease receivables ($1.4 billion) and the residual value of assets under lease ($0.1 billion) reduced by unearned income ($0.3 billion). Finance assets, net, at September 30, 2003 also includes an allowance for losses ($0.4 billion).
Equity and Dividends
During the first nine months of 2003 and 2002, ALG repurchased 18.7 million and 93.5 million shares, respectively, of its common stock at a cost of $689 million and $4.6 billion, respectively. During the first quarter of 2003, ALG completed its three-year, $10 billion share repurchase program and began a one-year, $3 billion share repurchase program. At September 30, 2003, cumulative repurchases under the $3 billion authority totaled 7.0 million shares at an aggregate cost of $241 million. Following the rating agencies’ actions in the first quarter of 2003, discussed above in “Credit Ratings,” ALG suspended its share repurchase program.
On June 21, 2002, Kraft’s Board of Directors approved the repurchase from time to time of up to $500 million of Kraft’s Class A common stock solely to satisfy the obligations of Kraft to provide shares under its 2001 Performance Incentive Plan and its 2001 Compensation Plan for non-employee directors. During the first nine months of 2003, Kraft repurchased 5.2 million shares of its Class A common stock at a cost of $156 million.
Concurrent with Kraft’s initial public offering (“IPO”), certain employees of Altria Group, Inc. (other than Kraft and its subsidiaries) received a one-time grant of options to purchase shares of Kraft’s Class A common stock held by Altria Group, Inc. at the IPO price of $31.00 per share. At September 30, 2003, employees held options to purchase approximately 1.6 million shares of Kraft’s Class A common stock from Altria Group, Inc. In order to completely satisfy the obligation, Altria Group, Inc. purchased approximately 1.6 million shares of Kraft’s Class A common stock in open market transactions during 2002.
In January 2003, Altria Group, Inc. granted approximately 2.3 million shares of restricted stock to eligible U.S.-based employees of Altria Group, Inc. and also issued to eligible non-U.S. employees rights to receive approximately 1.5 million equivalent shares. Restrictions on the shares lapse in the first quarter of 2006.
Dividends paid in the first nine months of 2003 and 2002 were $3.9 billion and $3.7 billion, respectively, an increase of 4.7%, reflecting a higher dividend rate in 2003, partially offset by a lower number of shares outstanding as a result of share repurchases. During the third quarter of 2003, Altria Group, Inc.’s Board of Directors approved a 6.3% increase in the quarterly dividend rate to $0.68 per share. As a result, the present annualized dividend rate is $2.72 per share.
Market Risk
Altria Group, Inc. operates globally, with manufacturing and sales facilities in numerous locations around the world, and utilizes certain financial instruments to manage its foreign currency and commodity exposures, which primarily relate to forecasted transactions and debt. Derivative financial instruments are used by Altria Group, Inc., principally to reduce exposures to market risks resulting from fluctuations in foreign exchange rates and commodity prices, by creating offsetting exposures. Altria Group, Inc. is not a party to leveraged derivatives and, by policy, does not use derivative financial instruments for speculative purposes.
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A substantial portion of Altria Group, Inc.’s derivative financial instruments are effective as hedges under U.S. GAAP. Hedging activity affected accumulated other comprehensive earnings (losses), net of income taxes, as follows:
| | For the Nine Months Ended
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(Loss) gain at beginning of period | | $ | (77 | ) | $ | 33 | | $ | 14 | | $ | (94 | ) |
Derivative (gains) losses transferred to earnings | | | (44 | ) | | 71 | | | (5 | ) | | (8 | ) |
Change in fair value | | | 49 | | | (143 | ) | | (81 | ) | | 63 | |
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Loss as of September 30 | | $ | (72 | ) | $ | (39 | ) | $ | (72 | ) | $ | (39 | ) |
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The fair value of all derivative financial instruments has been calculated based on market quotes.
Foreign exchange rates. Altria Group, Inc. uses forward foreign exchange contracts and foreign currency options to mitigate its exposure to changes in exchange rates from third-party and intercompany forecasted transactions. The primary currencies to which Altria Group, Inc. is exposed include the Japanese yen, the Swiss franc and the euro. At September 30, 2003 and December 31, 2002, Altria Group, Inc. had option and forward foreign exchange contracts with aggregate notional amounts of $8.1 billion and $10.1 billion, respectively, which were comprised of contracts for the purchase and sale of foreign currencies. Included in the foreign currency aggregate notional amounts at September 30, 2003 and December 31, 2002, were $1.1 billion and $2.6 billion, respectively, of equal and offsetting foreign currency positions, which do not qualify as hedges and will not result in any net gain or loss. In addition, Altria Group, Inc. uses foreign currency swaps to mitigate its exposure to changes in exchange rates related to foreign currency denominated debt. These swaps typically convert fixed-rate foreign currency denominated debt to fixed-rate debt denominated in the functional currency of the borrowing entity. A substantial portion of the foreign currency swap agreements are accounted for as cash flow hedges. The unrealized gain (loss) relating to foreign currency swap agreements that do not qualify for hedge accounting treatment under U.S. GAAP was insignificant as of September 30, 2003 and December 31, 2002. At September 30, 2003 and December 31, 2002, the notional amounts of foreign currency swap agreements aggregated $2.4 billion and $2.5 billion, respectively.
Altria Group, Inc. also designates certain foreign currency denominated debt as net investment hedges of foreign operations. For the nine months ended September 30, 2003 and 2002, losses of $37 million, net of income taxes, and $127 million, net of income taxes, respectively, which represented effective hedges of net investments, were reported as a component of accumulated other comprehensive earnings (losses) within currency translation adjustments.
Commodities. Kraft is exposed to price risk related to forecasted purchases of certain commodities used as raw materials. Accordingly, Kraft uses commodity forward contracts as cash flow hedges, primarily for coffee, cocoa, milk and cheese. Commodity futures and options are also used to hedge the price of certain commodities, including milk, coffee, cocoa, wheat, corn, sugar and soybean oil. At September 30, 2003 and December 31, 2002, Kraft had net long commodity positions of $351 million and $544 million, respectively. In general, commodity forward contracts qualify for the normal purchase exception under U.S. GAAP. The effective portion of unrealized gains and losses on commodity futures and option contracts is deferred as a component of accumulated other comprehensive earnings (losses) and is recognized as a component of cost of sales when the related inventory is sold. Unrealized gains or losses on net commodity positions were immaterial at September 30, 2003 and December 31, 2002.
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Use of the above-mentioned financial instruments has not had a material impact on Altria Group, Inc.’s consolidated financial position at September 30, 2003 and December 31, 2002, or Altria Group, Inc.’s consolidated results of operations and cash flows for the nine months and three months ended September 30, 2003 and September 30, 2002.
Contingencies
See Note 10 to the Condensed Consolidated Financial Statements for a discussion of contingencies.
New Accounting Standards
See Note 3 to the Condensed Consolidated Financial Statements for a discussion of recently adopted accounting standards.
Cautionary Factors That May Affect Future Results
Forward-Looking and Cautionary Statements
We* may from time to time make written or oral forward-looking statements, including statements contained in filings with the SEC, in reports to stockholders and in press releases and investor webcasts. You can identify these forward-looking statements by use of words such as “strategy,” “expects,” “continues,” “plans,” “anticipates,” “believes,” “will,” “estimates,” “intends,” “projects,” “goals,” “targets” and other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts.
We cannot guarantee that any forward-looking statement will be realized, although we believe we have been prudent in our plans and assumptions. Achievement of future results is subject to risks, uncertainties and inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from those anticipated, estimated or projected. Investors should bear this in mind as they consider forward-looking statements and whether to invest in or remain invested in Altria Group, Inc.’s securities. In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, we are identifying important factors that, individually or in the aggregate, could cause actual results and outcomes to differ materially from those contained in any forward-looking statements made by us; any such statement is qualified by reference to the following cautionary statements. We elaborate on these and other risks we face throughout this document, particularly in the “Business Environment” sections preceding our discussion of operating results of our subsidiaries’ businesses. You should understand that it is not possible to predict or identify all risk factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties. We do not undertake to update any forward-looking statement that we may make from time to time.
Tobacco-Related Litigation. There is substantial litigation related to tobacco products in the United States and certain foreign jurisdictions. We anticipate that new cases will continue to be filed. Damages claimed in some of the tobacco-related litigation range into the billions of dollars. Although, to date, our tobacco subsidiaries have never had to pay a judgment in a tobacco related case, there are presently 13 cases on appeal in which verdicts were returned against PM USA, including a compensatory and punitive damages verdict totaling approximately $10.1 billion in thePrice case in Illinois. Generally, in order to prevent a plaintiff from seeking to collect a judgment while the verdict is being appealed, the defendant must post an appeal bond, frequently in
*
This section uses the terms “we,” “our” and “us” when it is not necessary to distinguish among ALG and its various operating subsidiaries or when any distinction is clear from the context.
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the amount of the judgment or more, or negotiate an alternative arrangement with plaintiffs. In the event of future losses at trial, we may not always be able to obtain the required bond or to negotiate an acceptable alternative arrangement.
The present litigation environment is substantially uncertain, and it is possible that our business, volume, results of operations, cash flows or financial position could be materially affected by an unfavorable outcome of pending litigation, including certain of the verdicts against us that are on appeal. We intend to continue vigorously defending all tobacco-related litigation, although we may enter into settlement discussions in particular cases if we believe it is in the best interest of our stockholders to do so. See Note 10 for a discussion of pending tobacco-related litigation.
Anti-Tobacco Action in the Public and Private Sectors. Our tobacco subsidiaries face significant governmental action aimed at reducing the incidence of smoking and seeking to hold them responsible for the adverse health effects associated with both smoking and exposure to environmental tobacco smoke. Governmental actions, combined with the diminishing social acceptance of smoking and private actions to restrict smoking, have resulted in reduced industry volume, and we expect this decline to continue.
Excise Taxes. Cigarettes are subject to substantial local, state and federal excise taxes in the United States and to similarly substantial taxes in foreign markets. Significant increases in excise and other cigarette-related taxes have been proposed or enacted and are likely to continue to be proposed or enacted at the local, state and federal levels within the United States, the EU and in other foreign jurisdictions.
These tax increases are expected to continue to have an adverse impact on sales of cigarettes by our tobacco subsidiaries, due to lower consumption levels and to a shift in sales from the premium to the non-premium or discount segments or to sales outside of legitimate channels.
Increased Competition in the Domestic Tobacco Market. Settlements of certain tobacco litigation in the United States, have resulted in substantial cigarette price increases. PM USA faces increased competition from lowest priced brands sold by certain domestic and foreign manufacturers that have cost advantages because they are not subject to these settlements or related state escrow legislation. Additional competition has resulted from diversion into the United States market of cigarettes intended for sale outside the United States, the sale of counterfeit cigarettes by third parties, the sale of cigarettes by third parties over the Internet and by other means designed to avoid the collection of applicable taxes and increased imports of foreign lowest priced brands. The competitive environment has been characterized by weak economic conditions, erosion of consumer confidence, a continued influx of cheap products, and higher prices due to higher state excise taxes and list price increases. As a result, the lowest priced products of manufacturers of numerous small share brands have increased their market share, putting pressure on the industry’s premium segment.
Governmental Investigations. From time to time, ALG and its tobacco subsidiaries are subject to governmental investigations on a range of matters. Ongoing investigations include allegations of contraband shipments of cigarettes, allegations of unlawful pricing activities within certain international markets and allegations of false and misleading usage of descriptors, such as “Lights” and “Ultra Lights.” We cannot predict the outcome of those investigations or whether additional investigations may be commenced, and it is possible that our business could be materially affected by an unfavorable outcome of pending or future investigations.
New Tobacco Product Technologies. Our tobacco subsidiaries continue to seek ways to develop and to commercialize new product technologies that may reduce the risk of smoking. Their goal is to reduce harmful constituents in tobacco smoke while continuing to offer adult smokers products that meet their taste expectations. We cannot guarantee that our tobacco subsidiaries will succeed in these efforts. If they do not succeed, but one or more of their competitors do, our tobacco subsidiaries may be at a competitive disadvantage.
Foreign Currency. Our international food and tobacco subsidiaries conduct their businesses in local currency and, for purposes of financial reporting, their results are translated into U.S. dollars based on average exchange
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rates prevailing during a reporting period. During times of a strengthening U.S. dollar, our reported net revenues and operating companies income will be reduced because the local currency will translate into fewer U.S. dollars.
Competition and Economic Downturns. Each of our consumer products subsidiaries is subject to intense competition, changes in consumer preferences and local economic conditions. To be successful, they must continue to:
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promote brand equity successfully;
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anticipate and respond to new consumer trends;
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develop new products and markets and to broaden brand portfolios in order to compete effectively with lower priced products in a consolidating environment at the retail and manufacturing levels;
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improve productivity; and
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respond effectively to changing prices for their raw materials.
The willingness of consumers to purchase premium cigarette brands and premium food and beverage brands depends in part on local economic conditions. In periods of economic uncertainty, consumers tend to purchase more private label and other economy brands and the volume of our consumer products subsidiaries could suffer accordingly.
Our finance subsidiary, PMCC, holds investments in finance leases, principally in transportation, power generation and manufacturing equipment and facilities. Its lessees are also subject to intense competition and economic conditions. If counterparties to PMCC’s leases fail to manage through difficult economic and competitive conditions, PMCC may have to increase its allowance for losses, which would adversely affect our profitability.
Grocery Trade Consolidation. As the retail grocery trade continues to consolidate and retailers grow larger and become more sophisticated, they demand lower pricing and increased promotional programs. Further, these customers are reducing their inventories and increasing their emphasis on private label products. If Kraft fails to use its scale, marketing expertise, branded products and category leadership positions to respond to these trends, its volume growth could slow or it may need to lower prices or increase promotional support of its products, any of which would adversely affect profitability.
Continued Need to Add Food and Beverage Products in Faster Growing and More Profitable Categories. The food and beverage industry’s growth potential is constrained by population growth. Kraft’s success depends in part on its ability to grow its business faster than populations are growing in the markets that it serves. One way to achieve that growth is to enhance its portfolio by adding products that are in faster growing and more profitable categories. If Kraft does not succeed in making these enhancements, its volume growth may slow, which would adversely affect our profitability.
Strengthening Brand Portfolios Through Acquisitions and Divestitures. One element of the growth strategy of Kraft and PMI is to strengthen their brand portfolios through active programs of selective acquisitions and divestitures. These subsidiaries are constantly investigating potential acquisition candidates and from time to time sell businesses that are outside their core categories or that do not meet their growth or profitability targets. Acquisition opportunities are limited and acquisitions present risks of failing to achieve efficient and effective integration, strategic objectives and anticipated revenue improvements and cost savings. There can be no assurance that we will be able to continue to acquire attractive businesses on favorable terms or that all future acquisitions will be quickly accretive to earnings.
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Raw Material Prices. The raw materials used by our consumer products subsidiaries are largely commodities that experience price volatility caused by external conditions, commodity market fluctuations, currency fluctuations and changes in governmental agricultural programs. Commodity price changes may result in unexpected increases in raw material and packaging cost, and our operating subsidiaries may be unable to increase their prices to offset these increased costs without suffering reduced volume, net revenue and operating companies income. We do not fully hedge against changes in commodity prices and our hedging procedures may not work as planned.
Food Safety, Quality and Health Concerns. We could be adversely affected if consumers in Kraft’s principal markets lose confidence in the safety and quality of certain food products. Adverse publicity about these types of concerns, like the recent publicity about genetically modified organisms and “mad cow disease” in Europe, whether or not valid, may discourage consumers from buying Kraft’s products or cause production and delivery disruptions. Recent publicity concerning the health implications of obesity and trans fatty acids could also reduce consumption of certain of Kraft’s products. In addition, Kraft may need to recall some of its products if they become adulterated or misbranded. Kraft may also be liable if the consumption of any of its products causes injury. A widespread product recall or a significant product liability judgment could cause products to be unavailable for a period of time and a loss of consumer confidence in Kraft’s food products and could have a material adverse effect on Kraft’s business.
No Access to Commercial Paper Market. As a result of recent actions by credit rating agencies, ALG currently is unable to access the commercial paper market, and must rely on its revolving credit facilities instead.
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Item 4. Controls and Procedures.
Altria Group, Inc. carried out an evaluation, with the participation of Altria Group, Inc.’s management, including ALG’s Chairman and Chief Executive Officer, and Chief Financial Officer, of the effectiveness of Altria Group, Inc.’s disclosure controls and procedures (pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, ALG’s Chairman and Chief Executive Officer, and Chief Financial Officer concluded that Altria Group, Inc.’s disclosure controls and procedures are effective in timely alerting them to material information relating to Altria Group, Inc. (including its consolidated subsidiaries) required to be included in ALG’s periodic SEC filings. There has been no change in Altria Group, Inc.’s internal control over financial reporting during the quarter ended September 30, 2003 that has materially affected, or is reasonably likely to materially affect, Altria Group, Inc.’s internal control over financial reporting.
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Part II - OTHER INFORMATION
Item 1.
Legal Proceedings.
See Note 10.Contingencies, of the Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this report for a discussion of legal proceedings pending against Altria Group, Inc. and its subsidiaries. See alsoTobacco-Business Environment –Governmental Investigations and Exhibits 99.1 and 99.2 to this report.
Item 6.
Exhibits and Reports on Form 8-K.
(a)
Exhibits
3
Amended By-Laws.
12
Statement regarding computation of ratios of earnings to fixed charges.
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.1
Certain Pending Litigation Matters and Recent Developments.
99.2
Trial Schedule for Certain Cases.
(b)
Reports on Form 8-K. The Registrant (i) furnished a Current Report on Form 8-K on July 17, 2003 covering Item 7 (Financial Statements and Exhibits) and Item 12 (Results of Operations and Financial Condition) containing Altria Group, Inc.’s earnings release dated July 17, 2003; (ii) filed a Current Report on Form 8-K on October 16, 2003 covering Item 5 (Other Events and Required FD Disclosure) and Item 7 (Financial Statements, Pro Forma Financial Information and Exhibits) containing Altria Group, Inc.’s earnings release dated October 16, 2003; (iii) filed a Current Report on Form 8-K on November 4, 2003 covering Item 5 (Other Events and Required FD Disclosure) and Item 7 (Financial Statements, Pro Forma Financial Information and Exhibits), which contained the terms agreement and certain other documents related to its public debt offering; and (iv) furnished a Current Report on Form 8-K on November 6, 2003 covering Item 7 (Financial Statements, Pro Forma Financial Information and Exhibits), Item 9 (Regulation FD Disclosure) and Item 12 (Results of Operations and Financial Condition), containing Altria Group, Inc.’s press release dated November 5, 2003, remarks by Louis Camilleri, Chairman and Chief Executive Officer, Altria Group, Inc. and a reconciliation to generally accepted accounting principles of certain financial data.
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Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| ALTRIA GROUP, INC. |
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| /s/ DINYAR S. DEVITRE |
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| Dinyar S. Devitre, Senior Vice President and
Chief Financial Officer |
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| November 13, 2003 |
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