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

(Continued)

Discussion and Analysis > Financial Review

• Net Cash Provided by Operating Activities: During 2006, net cash provided by operating activities was $13.6 billion, compared with $11.1 billion during 2005. The increase in cash provided by operating activities was due primarily to the return of the escrow bond deposit related to the Price domestic tobacco case, lower pension plan contributions and higher earnings from continuing operations, partially offset by a higher use of cash to fund working capital.
  
  During 2005, net cash provided by operating activities was $11.1 billion, compared with $10.9 billion during 2004. The increase in cash provided by operating activities was due primarily to higher earnings from continuing operations and lower escrow bond deposits related to the Price domestic tobacco case, partially offset by a higher use of cash to fund working capital and increased pension plan contributions.
• Net Cash Used in Investing Activities: One element of the growth strategy of ALG's subsidiaries is to strengthen their brand portfolios and/or expand their geographic reach through active programs of selective acquisitions and divestitures. These subsidiaries are constantly investigating potential acquisition candidates and from time to time they may sell businesses that are outside their core categories or that do not meet their growth or profitability targets. The impact of future acquisitions or divestitures could have a material impact on Altria Group, Inc.'s consolidated cash flows.
  
  During 2006, 2005 and 2004, net cash used in investing activities was $0.6 billion, $4.9 billion and $1.4 billion, respectively. The net cash used in 2005 reflects the purchase of 98% of the outstanding shares of Sampoerna. Proceeds from sales of businesses in 2005 of $1,668 million were primarily from the sale of Kraft's sugar confectionery business. In 2006, proceeds from sales of businesses of $1,466 million were primarily from the sales of Kraft's pet snacks brand and assets, Kraft's rice brand and assets, and PMI's interest in a beer business in the Dominican Republic.
  
  In November 2006, a subsidiary of PMI exchanged its 47.5% interest in E. León Jimenes, C. por. A. ("ELJ"), which included a 40% indirect interest in ELJ's beer subsidiary, Cerveceria Nacional Dominicana, C. por. A., for 100% ownership of ELJ's cigarette subsidiary, Industria de Tabaco León Jimenes, S.A. ("ITLJ") and $427 million of cash, which was contributed to ITLJ prior to the transaction. As a result of the transaction, PMI now owns 100% of the cigarette business and no longer holds an interest in ELJ's beer business. The exchange of PMI's interest in ELJ's beer subsidiary resulted in a pre-tax gain on sale of $488 million, which increased Altria Group, Inc.'s 2006 net earnings by $0.15 per diluted share. The operating results of ELJ's cigarette subsidiary from November 2006 to December 31, 2006, the amounts of which were not material, were included in Altria Group, Inc.'s operating results.
  
  In September 2006, Kraft acquired the Spanish and Portuguese operations of United Biscuits ("UB"), and rights to all Nabisco trademarks in the European Union, Eastern Europe, the Middle East and Africa, which UB has held since 2000, for a total cost of approximately $1.1 billion. The Spanish and Portuguese operations of UB include its biscuits, dry desserts, canned meats, tomato and fruit juice businesses as well as seven UB manufacturing facilities and 1,300 employees. From September 2006 to December 31, 2006, these businesses contributed net revenues of approximately $111 million. The non-cash acquisition was financed by Kraft's assumption of approximately $541 million of debt issued by the acquired business immediately prior to the acquisition, as well as $530 million of value for the redemption of Kraft's outstanding investment in UB, primarily deep-discount securities. The redemption of Kraft's investment in UB resulted in a $251 million pre-tax gain on closing, benefiting Altria Group, Inc. by approximately $0.06 per diluted share.
  
  Capital expenditures for 2006 increased 11.2% to $2.5 billion (of which $1.2 billion related to Kraft). The expenditures were primarily for modernization and consolidation of manufacturing facilities, and expansion of research and development, and certain production capacity. Excluding Kraft, 2007 capital expenditures are expected to be slightly below 2006 expenditures, and are expected to be funded by operating cash flows.
• Net Cash Used in Financing Activities: During 2006, net cash used in financing activities was $14.4 billion, compared with $5.1 billion in 2005 and $8.0 billion in 2004. The increase of $9.3 billion over 2005 was due primarily to the repayment of short and long-term debt in 2006 and higher dividends paid on Altria Group, Inc. common stock. The decrease of $2.9 billion from 2004 was due primarily to increased borrowings in 2005, which were primarily related to the acquisition of Sampoerna, partially offset by higher dividends paid on Altria Group, Inc. common stock and an increase in share repurchases at Kraft.
• Debt and Liquidity:
  
  Credit Ratings: At December 31, 2006, ALG’s debt ratings by major credit rating agencies were as follows:
  
                                                          
  
  ALG's credit quality, measured by 5 year credit default swaps, has improved dramatically over the past year with swap levels now approaching that of Single-A rated issuers.
  
  Credit Lines: ALG, Kraft and PMI maintain separate revolving credit facilities. ALG and Kraft intend to use their revolving credit facilities to support the issuance of commercial paper.
  
  As discussed in Note 5. Acquisitions, the purchase price of the Sampoerna acquisition was primarily financed through a euro 4.5 billion bank credit facility arranged for PMI and its subsidiaries in May 2005, consisting of a euro 2.5 billion three-year term loan facility (which, through repayments has been reduced to euro 1.5 billion) and a euro 2.0 billion five-year revolving credit facility. At December 31, 2006, borrowings under the term loan were included in long-term debt. These facilities, which are not guaranteed by ALG, require PMI to maintain an earnings before interest, taxes, depreciation and amortization ("EBITDA") to interest ratio of not less than 3.5 to 1.0. At December 31, 2006, PMI's ratio calculated in accordance with the agreements was 29.0 to 1.0.
  
  ALG has a 364-day revolving credit facility in the amount of $1.0 billion, which expires on March 30, 2007. In addition, ALG maintains a multi-year credit facility in the amount of $4.0 billion, which expires in April 2010. The ALG facilities require the maintenance of an earnings to fixed charges ratio, as defined by the agreement, of not less than 2.5 to 1.0. At December 31, 2006, the ratio calculated in accordance with the agreement was 11.6 to 1.0.
  
  Kraft maintains a multi-year revolving credit facility, which is for its sole use, in the amount of $4.5 billion, which expires in April 2010 and requires the maintenance of a minimum net worth of $20.0 billion. At December 31, 2006, Kraft's net worth was $28.6 billion.
  
  ALG, PMI and Kraft expect to continue to meet their respective covenants. These facilities do not include any credit rating triggers or any provisions that could require the posting of collateral. The multi-year facilities enable the respective companies to reclassify short-term debt on a long-term basis.
  
  At December 31, 2006, credit lines for ALG, Kraft and PMI, and the related activity, were as follows:
  
  
                                                                 
  
  In addition to the above, certain international subsidiaries of ALG and Kraft maintain credit lines to meet their respective working capital needs. These credit lines, which amounted to approximately $2.2 billion for ALG subsidiaries (other than Kraft) and approximately $1.1 billion for Kraft subsidiaries, are for the sole use of these international businesses. Borrowings on these lines amounted to approximately $0.6 billion and $1.0 billion at December 31, 2006 and 2005, respectively. At December 31, 2006, Kraft also had approximately $0.3 billion of outstanding short-term debt related to its United Biscuits acquisition discussed in Note 5. Acquisitions.
  
  Debt: Altria Group, Inc.'s total debt (consumer products and financial services) was $18.7 billion and $23.9 billion at December 31, 2006 and 2005, respectively. Total consumer products debt was $17.6 billion and $21.9 billion at December 31, 2006 and 2005, respectively. Total consumer products debt includes third-party debt in Kraft's consolidated balance sheet of $10.2 billion and $10.5 billion, at December 31, 2006 and 2005, respectively, and PMI thirdparty debt of $2.8 billion and $4.9 billion at December 31, 2006 and 2005, respectively. At December 31, 2006 and 2005, Altria Group, Inc.'s ratio of consumer products debt to total equity was 0.44 and 0.61, respectively. The ratio of total debt to total equity was 0.47 and 0.67 at December 31, 2006 and 2005, respectively. Fixed-rate debt constituted approximately 75% of total consumer products debt at December 31, 2006 and 2005. The weighted average interest rate on total consumer products debt, including the impact of swap agreements, was approximately 5.8% and 5.4% at December 31, 2006 and 2005, respectively.
  
  Kraft has a Form S-3 shelf registration statement on file with the SEC, under which Kraft may sell debt securities and/or warrants to purchase debt securities in one or more offerings. At December 31, 2006, Kraft had $3.5 billion of capacity remaining under its shelf registration.
  
  At December 31, 2006, ALG had approximately $2.8 billion of capacity remaining under its existing shelf registration statement.
  
  ALG does not guarantee the debt of Kraft or PMI.
  
  Taxes: The IRS concluded its examination of Altria Group, Inc.'s consolidated tax returns for the years 1996 through 1999, and issued a final RAR on March 15, 2006. Altria Group, Inc. agreed with the RAR, with the exception of certain leasing matters discussed below. Consequently, in March 2006, Altria Group, Inc. recorded non-cash tax benefits of $1.0 billion, which principally represented the reversal of tax reserves following the issuance of and agreement with the RAR. Although there was no impact to Altria Group, Inc.'s consolidated operating cash flow, Altria Group, Inc. reimbursed $337 million in cash to Kraft for its portion of the $1.0 billion in tax benefits, as well as pre-tax interest of $46 million. The tax reversal, adjusted for Kraft’s minority interest, resulted in an increase to net earnings of approximately $960 million for the year ended December 31, 2006.
  
  Altria Group, Inc. has agreed with all conclusions of the RAR, with the exception of the disallowance of benefits pertaining to several PMCC leveraged lease transactions for the years 1996 through 1999. PMCC will continue to assert its position regarding these leveraged lease transactions and contest approximately $150 million of tax and net interest assessed and paid with regard to them. The IRS may in the future challenge and disallow more of PMCC's leveraged leases based on recent Revenue Rulings, a recent IRS Notice and subsequent case law addressing specific types of leveraged leases (lease-in/ lease-out ("LILO") and sale-in/lease-out ("SILO") transactions). PMCC believes that the position and supporting case law described in the RAR, Revenue Rulings and the IRS Notice are incorrectly applied to PMCC's transactions and that its leveraged leases are factually and legally distinguishable in material respects from the IRS's position. PMCC and ALG intend to vigorously defend against any challenges based on that position through litigation. In this regard, on October 16, 2006, PMCC filed a complaint in the U.S. District Court for the Southern District of New York to claim refunds for a portion of these tax payments and associated interest and intends to file complaints for the remainder. However, should PMCC's position not be upheld, PMCC may have to accelerate the payment of significant amounts of federal income tax and significantly lower its earnings to reflect the recalculation of the income from the affected leveraged leases, which could have a material effect on the earnings and cash flows of Altria Group, Inc. in a particular fiscal quarter or fiscal year. PMCC considered this matter in its adoption of FIN 48 and FASB Staff Position No. FAS 13-2.