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 2004, net cash provided by operating activities was $10.9 billion, compared with $10.8 billion during 2003. The increase of $74 million was due primarily to higher net earnings in 2004, partially offset by higher escrow deposits for the Price domestic tobacco case and lower cash from the financial services business.

During 2003, net cash provided by operating activities of $10.8 billion was $204 million higher than 2002, due primarily to a lower use of cash to fund working capital, partially offset by a use of cash to fund the Price escrow.

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. These subsidiaries are constantly investigating potential acquisition candidates and from time to time Kraft sells businesses that are outside its core categories or that do not meet its growth or profitability targets. The impact of any future acquisition or divestiture could have a material impact on Altria Group, Inc.’s consolidated cash flows.

During 2004, 2003 and 2002, net cash used in investing activities was $1.4 billion, $2.4 billion and $2.5 billion, respectively. The decrease in 2004 primarily reflects lower amounts used for the purchase of businesses in 2004. The discontinuation of finance asset investments, as well as the increased proceeds from finance asset sales also contributed to a lower level of cash used in investing activities.

Capital expenditures for 2004 decreased 3.1% to $1.9 billion. Approximately 45% related to tobacco operations and approximately 55% related to food operations; the expenditures were primarily for modernization and consolidation of manufacturing facilities, and expansion of certain production capacity. In 2005, capital expenditures are expected to be approximately 10% to 15% above 2004 expenditures and are expected to be funded by operating cash flows.

Net Cash Used in Financing Activities: During 2004, net cash used in financing activities was $8.0 billion, compared with $5.5 billion in 2003 and $8.2 billion in 2002. The increase of $2.5 billion over 2003 was due primarily to the repayment of debt in 2004, as compared with 2003 when ALG and Kraft borrowed against their revolving credit facilities, while their access to commercial paper markets was temporarily eliminated following a $10.1 billion judgment against PM USA. The decrease in net cash used in financing activities in 2003 from 2002 was due primarily to a lower level ($5.4 billion) of ALG payments for common stock repurchases in 2003, partially offset by a lower net issuance of consumer products debt in 2003.

Debt and Liquidity

Credit Ratings: Following a $10.1 billion judgment on March 21, 2003, against PM USA in the Price litigation, which is discussed in Note 19, 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. During 2003, Moody’s lowered ALG’s short-term debt rating from “P-1” to “P-3” and its long-term debt rating from “A2” to “Baa2.” Standard & Poor’s lowered ALG’s short-term debt rating from “A-1” to “A-2” and its long-term debt rating from “A–” to “BBB.” Fitch Rating Services 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 require accelerated repayment as a result of a decrease in credit ratings. The credit rating downgrades by Moody’s, Standard & Poor’s, and Fitch Rating Services had no impact on any of ALG’s or Kraft’s other existing third-party contracts.

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 in 2003. 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 market, and in November 2003, ALG regained limited access to the commercial paper market.



At December 31, 2004, credit lines for ALG and Kraft, and the related activity were as follows (in billions of dollars):

		ALG
Type		Credit Lines		Amount Drawn			Commerical Paper Outstanding		Lines Available
Multi-year		$ 5.0		$ —			$ —		$ 5.0
		Kraft
Type		Credit Lines		Amount Drawn			Commerical Paper Outstanding		Lines Available
364-day		$ 2.5		$ —			$  —		$ 2.5
Multi-year		2.0					1.7		0.3
		$ 4.5		$ —			$1.7		$ 2.8

The ALG multi-year revolving credit facility requires the maintenance of an earnings to fixed charges ratio, as defined by the agreement, of 2.5 to 1.0. At December 31, 2004, the ratio calculated in accordance with the agreement was 9.7 to 1.0. The Kraft multi-year revolving credit facility, which is for the sole use of Kraft, requires the maintenance of a minimum net worth of $18.2 billion. At December 31, 2004, Kraft’s net worth was $29.9 billion. ALG and Kraft expect to continue to meet their respective covenants. The multi-year facilities, which expire in July 2006, enable the respective companies to reclassify short-term debt on a long-term basis.

After a review of projected borrowing requirements, ALG’s management determined that its revolving credit facilities provided liquidity in excess of its needs. As a result, ALG’s 364-day revolving credit facility was not renewed when it expired in July 2004. In July 2004, Kraft replaced its 364-day facility, which was expiring. The new Kraft 364-day revolving credit facility, in the amount of $2.5 billion, expires in July 2005, although it contains a provision allowing Kraft to extend the maturity of outstanding borrowings for up to one additional year. It also requires the maintenance of a minimum net worth of $18.2 billion. These facilities do not include any additional financial tests, any credit rating triggers or any provisions that could require the posting of collateral.

In addition to the above, certain international subsidiaries of ALG and Kraft maintain uncommitted credit lines to meet their respective working capital needs. These credit lines, which amounted to approximately $2.0 billion for ALG subsidiaries (other than Kraft) and approximately $0.6 billion for Kraft subsidiaries, are for the sole use of these international businesses. Borrowings on these lines amounted to approximately $0.9 billion at December 31, 2004.

Debt: Altria Group, Inc.’s total debt (consumer products and financial services) was $23.0 billion and $24.5 billion at December 31, 2004 and 2003, respectively. Total consumer products debt was $20.8 billion and $22.3 billion at December 31, 2004 and 2003, respectively. At December 31, 2004 and 2003, Altria Group, Inc.’s ratio of consumer products debt to total equity was 0.68 and 0.89, respectively. The ratio of total debt to total equity was 0.75 and 0.98 at December 31, 2004 and 2003, respectively. Fixed-rate debt constituted approximately 90% and 80% of total consumer products debt at December 31, 2004 and 2003, respectively. The weighted average interest rate on total consumer products debt, including the impact of swap agreements, was approximately 5.4% and 5.2% at December 31, 2004 and 2003, respectively.

In November 2004, Kraft issued $750 million of 5-year notes bearing interest at 4.125%. The net proceeds of the offering were used by Kraft to refinance maturing debt. 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, 2004, Kraft had $3.5 billion of capacity remaining under its shelf registration.

In November 2003, ALG completed the issuance of $1.5 billion in long-term notes under an existing shelf registration statement. The borrowings included $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 were used to retire borrowings against the ALG revolving credit facilities. At December 31, 2004, ALG had approximately $2.8 billion of capacity remaining under its shelf registration.

ALG does not guarantee the debt of Kraft.