Management’s Discussion and Analysis of Financial Condition and Results of Operations

Description of the Company

Throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations, the term “Altria Group, Inc.” refers to the consolidated financial position, results of operations and cash flows of the Altria family of companies and the term “ALG” refers solely to the parent company. ALG’s wholly-owned subsidiaries, Philip Morris USA Inc. (“PM USA”) and Philip Morris International Inc. (“PMI”), and its majority-owned (87.2% as of December 31, 2005) subsidiary, Kraft Foods Inc. (“Kraft”), are engaged in the manufacture and sale of various consumer products, including cigarettes and other tobacco products, packaged grocery products, snacks, beverages, cheese and convenient meals. Philip Morris Capital Corporation (“PMCC”), another wholly-owned subsidiary, maintains a portfolio of leveraged and direct finance leases. In addition, ALG had a 28.7% economic and voting interest in SABMiller plc (“SABMiller”) at December 31, 2005. ALG’s access to the operating cash flows of its subsidiaries consists of cash received from the payment of dividends and interest, and the repayment of amounts borrowed from ALG by its subsidiaries.

As previously communicated, for significant business reasons, the Board of Directors is looking at a number of restructuring alternatives, including the possibility of separating Altria Group, Inc. into two, or potentially three, independent entities. Continuing improvements in the entire litigation environment are a prerequisite to such action by the Board of Directors, and the timing and chronology of events are uncertain.

In June 2005, Kraft sold substantially all of its sugar confectionery business for pre-tax proceeds of approximately $1.4 billion. Altria Group, Inc. has reflected the results of Kraft’s sugar confectionery business prior to the closing date as discontinued operations on the consolidated statements of earnings for all years presented. The assets related to the sugar confectionery business were reflected as assets of discontinued operations held for sale on the consolidated balance sheet at December 31, 2004.

In March 2005, a subsidiary of PMI acquired 40% of the outstanding shares of PT HM Sampoerna Tbk (“Sampoerna”), an Indonesian tobacco company. In May 2005, PMI purchased an additional 58%, for a total of 98%. The total cost of the transaction was $4.8 billion, including Sampoerna’s cash of $0.3 billion and debt of the U.S. dollar equivalent of $0.2 billion. The purchase price was primarily financed through a euro 4.5 billion bank credit facility arranged for PMI and its subsidiaries, consisting of a euro 2.5 billion three-year term loan facility and a euro 2.0 billion five-year revolving credit facility. These facilities are not guaranteed by ALG.

Sampoerna’s financial position and results of operations have been fully consolidated with PMI as of June 1, 2005. From March 2005 to May 2005, PMI recorded equity earnings in Sampoerna. Sampoerna contributed $315 million of operating income and $128 million of net earnings since March 2005.

Kraft’s operating subsidiaries generally report year-end results as of the Saturday closest to the end of each year. This resulted in fifty-three weeks of operating results for Kraft in the consolidated statement of earnings for the year ended December 31, 2005, versus fifty-two weeks for the years ended December 31, 2004 and 2003.

Executive Summary

The following executive summary is intended to provide significant highlights of the Discussion and Analysis that follows.

• Consolidated Operating Results—The changes in Altria Group, Inc.’s earnings from continuing operations and diluted earnings per share (“EPS”) from continuing operations for the year ended December 31, 2005, from the year ended December 31, 2004, were due primarily to the following:

     See discussion of events affecting the comparability of statement of earnings 
     amounts in the Consolidated Operating Results section of the following
     Discussion and Analysis. Amounts shown above that relate to Kraft are
     reported net of the related minority interest impact.

• Domestic Tobacco Loss on U.S. Tobacco Pool—As further discussed in Note 19. Contingencies, in October 2004, the Fair and Equitable Tobacco Reform Act of 2004 (“FETRA”) was signed into law. Under the provisions of FETRA, PM USA was obligated to cover its share of potential losses that the government may incur on the disposition of pool tobacco stock accumulated under the previous tobacco price support program. In 2005, PM USA recorded a $138 million pre-tax expense for its share of the loss.
• Domestic Tobacco Quota Buy-Out—The provisions of FETRA require PM USA, along with other manufacturers and importers of tobacco products, to make quarterly payments that will be used to compensate tobacco growers and quota holders affected by the legislation. Payments made by PM USA under FETRA will offset amounts due under the provisions of the National Tobacco Grower Settlement Trust (“NTGST”), a trust formerly established to compensate tobacco growers and quota holders. Disputes arose as to the applicability of FETRA to 2004 NTGST payments. During the third quarter of 2005, a North Carolina Supreme Court ruling determined that FETRA enactment had not triggered the offset provisions during 2004 and that tobacco companies were required to make full payment to the NTGST for the full year of 2004. The ruling, along with FETRA billings from the United States Department of Agriculture (“USDA”), established that FETRA was effective beginning in 2005. Accordingly, during the third quarter of 2005, PM USA reversed a prior year pre-tax accrual for FETRA payments in the amount of $115 million.
• Asset Impairment, Exit and Implementation Costs—In January 2004, Kraft announced a three-year restructuring program. During the years ended December 31, 2005 and 2004, Kraft recorded pre-tax charges of $297 million ($178 million after taxes and minority interest) and $633 million ($356 million after taxes and minority interest), respectively, for the restructuring plan, including pre-tax implementation costs of $87 million and $50 million, respectively. In addition, in January 2006, Kraft announced plans to expand its restructuring efforts beyond those originally contemplated. Additional pre-tax charges are anticipated to be $2.5 billion from 2006 to 2009, reflecting additional organizational streamlining and facility closures. The entire program is expected to ultimately result in $3.7 billion in pre-tax charges, the closure of up to 40 facilities and the elimination of approximately 14,000 positions. Approximately $2.3 billion of the $3.7 billion in pre-tax charges are expected to require cash payments.
  
  During 2005, Kraft incurred pre-tax asset impairment charges of $269 million ($151 million after taxes and minority interest), relating to the sale of its fruit snacks assets and the pending sales of certain assets in Canada and a small biscuit brand in the United States. In addition, during 2005, PMI and Altria Group, Inc. recorded pre-tax asset impairment and exit costs of $139 million ($97 million after taxes). For further details on the restructuring program or asset impairment, exit and implementation costs, see Note 3 to the Consolidated Financial Statements and the Food Business Environment section of the following Discussion and Analysis.
• International Tobacco E.C. Agreement—In July 2004, PMI entered into an agreement with the European Commission (“E.C.”) and 10 member states of the European Union that provides for broad cooperation with European law enforcement agencies on anti-contraband and anti-counterfeit efforts. Under the terms of the agreement, PMI will make 13 payments over 12 years, including an initial payment of $250 million, which was recorded as a pre-tax charge against its earnings in 2004.
• Gains on Sales of Businesses, net—The favorable impact is due primarily to the gain on sale of Kraft’s U.K. desserts assets in 2005.
• Provision for Airline Industry Exposure—As discussed in Note 8. Finance Assets, net, during 2005, PMCC increased its allowance for losses by $200 million, reflecting its exposure to the troubled airline industry, particularly to Delta Air Lines, Inc. (“Delta”) and Northwest Airlines, Inc. (“Northwest”), both of which filed for bankruptcy protection during 2005. During 2004, in recognition of the economic downturn in the airline industry, PMCC increased its allowance for losses by $140 million.
• Currency—The favorable currency impact on earnings from continuing operations and diluted EPS from continuing operations is due primarily to the weakness of the U.S. dollar versus the euro, Japanese yen and Central and Eastern European currencies.
• Income taxes—Altria Group, Inc.’s effective tax rate decreased by 2.5 percentage points to 29.9%. The 2005 effective tax rate includes a $372 million benefit related to dividend repatriation under the American Jobs Creation Act in 2005, the reversal of $82 million of tax accruals no longer required at Kraft, as well as other benefits, including the impact of the domestic manufacturers’ deduction under the American Jobs Creation Act and lower repatriation costs. The 2004 effective tax rate includes the reversal of $355 million of tax accruals that are no longer required due to foreign tax events that were resolved during 2004, and an $81 million favorable resolution of an outstanding tax item at Kraft.
• Shares Outstanding—Higher shares outstanding during 2005 primarily reflects exercises of employee stock options and the impact of stock options outstanding.
• Continuing Operations—The increase in results from continuing operations was due primarily to the following:

      These increases were partially offset by:

For further details, see the Consolidated Operating Results and Operating Results by Business Segment sections of the following Discussion and Analysis.

• 2006 Forecasted Results—In January 2006, Altria Group, Inc. announced that it expects forecasted 2006 full-year diluted EPS from continuing operations in a range of $4.85 to $4.95. This forecast includes approximately $0.36 per share in charges associated with the Kraft restructuring program, unfavorable currency of $0.14 per share at current exchange rates, about $0.10 per share for lower tobacco income in Spain, $0.05 per share due to higher shares outstanding, and $0.04 per share as a result of a higher base income tax rate of 33.9% versus a corresponding rate of 33.4% in 2005. It does not include any future acquisitions or divestitures, or the benefit of potential tax accrual reversals following the completion of audits in certain jurisdictions. The factors described in the Cautionary Factors That May Affect Future Results section of the following Discussion and Analysis represent continuing risks to this forecast.