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 (85.4%) subsidiary, Kraft Foods Inc. (“Kraft”), are engaged in the manufacture and sale of various consumer products, including cigarettes and 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. Miller Brewing Company (“Miller”), engaged in the manufacture and sale of various beer products, was ALG’s wholly-owned subsidiary prior to the merger of Miller into South African Breweries plc (“SAB”) on July 9, 2002 (see Note 4 to the consolidated financial statements). ALG has a 33.9% economic interest and a 24.9% voting interest in SABMiller plc (“SABMiller”). 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.

In November 2004, ALG announced that, 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.

On November 15, 2004, Kraft announced the sale of substantially all of its sugar confectionery business for approximately $1.5 billion. The transaction, which is subject to regulatory approval, is expected to be completed in the second quarter of 2005. Altria Group, Inc. has reflected the results of Kraft’s sugar confectionery business 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. Accordingly, historical statements of earnings amounts included in Management’s Discussion and Analysis of Financial Condition and Results of Operations have been restated to reflect the discontinued operation.

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, 2004, from the year ended December 31, 2003, were due primarily to the following:

	Earnings		Diluted EPS
	from		from
	Continuing		Continuing
(in millions, except per share data)	Operations		Operations
For the year ended December 31, 2003	$9,121		$ 4.48
2003 Domestic tobacco legal settlement	132		0.06
2003 Domestic tobacco headquarters
relocation charges	45		0.02
2003 Gains on sales of businesses	(17	)	(0.01	)
2003 Asset impairment, exit and integration costs	48		0.03
Subtotal 2003 items	208		0.10
2004 Domestic tobacco headquarters
relocation charges	(20	)	(0.01	)
2004 International tobacco E.C. agreement	(161	)	(0.08	)
2004 Asset impairment, exit and
implementation costs	(446	)	(0.21	)
2004 Loss on sales of businesses	(2	)	—
2004 Investment impairment	(26	)	(0.01	)
2004 Provision for airline industry exposure	(85	)	(0.04	)
2004 Reversal of taxes no longer required	419		0.20
2004 Gains from investments at SABMiller	111		0.05
Subtotal 2004 items	(210	)	(0.10	)
Currency	415		0.20
Higher effective tax rate	(89	)	(0.04	)
Higher shares outstanding			(0.06	)
Operations	(25	)	(0.01	)
For the year ended December 31, 2004	$  9,420		$  4.5	7

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.

Asset Impairment, Exit and Implementation Costs

International Tobacco E.C. Agreement—On July 9, 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. During the third quarter of 2004, PMI began accruing for payments due on the first anniversary of the agreement.

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 Russian ruble.

The $419 million tax item reflects the reversal of $355 million of tax accruals that are no longer required due to foreign tax events that were resolved during the first quarter of 2004 at Kraft ($35 million) and the second quarter of 2004 at PMI ($320 million). The amount also reflects an $81 million favorable resolution of an outstanding tax item at Kraft, the majority of which occurred in the third quarter of 2004, partially offset by the minority interest impact of Kraft’s items.

Higher shares outstanding during 2004 reflect exercises of employee stock options and the impact of a higher average stock price on the number of incremental shares from the assumed conversion of outstanding employee stock options.

The decrease in results from continuing operations was due primarily to the following:

• Lower North American food income, reflecting higher commodity and benefit costs, and increased promotional programs, partially offset by higher volume/mix.
• Lower international food income, reflecting higher costs, including benefits, promotional programs and commodity costs.

These decreases were partially offset by:

• Higher domestic tobacco income, reflecting savings resulting from changes to trade programs in 2004, including PM USA’s returned goods policy and lower Wholesale Leaders program discounts.
• Higher 2004 equity earnings from SABMiller.
• Higher international tobacco income, reflecting higher pricing, the impact of acquisitions and higher volume.

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

2005 Forecasted Results—In January 2005, Altria Group, Inc. announced that it expects forecasted 2005 full-year diluted EPS from continuing operations in a range of $4.95 to $5.05. This forecast assumes current foreign exchange rates, a base income tax rate of 34.7% and approximately $0.12 per share in charges associated with the continuing Kraft restructuring program. However, it does not include any tax benefits that could arise from the repatriation of funds from international businesses under provisions of the American Jobs Creation Act, nor does it include any benefit from prior year accrued contributions to the National Tobacco Grower Settlement Trust. In addition, this forecast does not include the impact of any possible acquisitions or divestitures not previously announced. 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.