(Continued)

Food

Kraft Foods (Kraft) reported mixed results in 2006. Growth in North America slowed significantly during the second half of the year, due to lower contribution from new products and declining market shares in a number of core categories. Kraft's international business saw continued strength, driven by developing markets across Latin America and Eastern Europe.

Net revenues grew approximately 2.7% when adjusted for the impact of one less shipping week in 2006.

Operating income decreased 4.8% to $4.5 billion, falling short of Kraft's expectations, primarily as a result of higher asset impairment, exit and implementation costs, including the disappointing performance of the Tassimo hot beverage system.

From my perspective, the most important development affecting Kraft in 2006 was the appointment of Irene B. Rosenfeld as Chief Executive Officer. I am confident that under Irene's leadership, Kraft will regain its luster. She is courageous, focused, decisive and responsive, as well as an excellent listener. Most importantly, I believe that Irene has the leadership skills and caliber to run Kraft as a fully independent public company. As announced in January, I will be stepping down as Chairman of Kraft and Irene will add that title after the spin-off is completed.

Improving Litigation Environment

Achievements on the litigation front were particularly noteworthy. Tobacco litigation events captured the limelight in 2006, confirming our successful record in appellate courts.

Among the three most closely watched cases, Price was concluded in 2006 and, while the United States government and Engle cases remain on appeal, they moved closer to conclusion. We continue to be optimistic that the United States and the Engle cases will be resolved favorably.

We also received a favorable ruling from the United States Supreme Court in Williams, the first case in which the high court addressed the law of punitive damages since its landmark State Farm ruling in 2003. The Williams decision should also positively impact pending and future cases, including, notably, the Schwarz case in Oregon and the Bullock case in California.

Favorable appellate decisions were also received in four class actions (Marrone, Phillips, Brown and Lowe) and in one health care cost recovery case (Glover).

In the so-called "Lights" cases, positive developments continue to advance our position. To date, courts in Arizona, California, Florida, Georgia, Illinois, Louisiana, Maine, Michigan, Ohio, Oregon and Washington have refused to certify class actions, reversed prior certifications, or entered judgments in favor of PM USA.

Only four out of the 37 "Lights" cases that have been filed are certified as class actions. They are the Curtis (Minnesota removed to federal court), Aspinall (Massachusetts state court), Craft (Missouri state court), and Schwab (nationwide class in federal court) cases. Appeals are pending in Aspinall, Curtis and Schwab, and we remain optimistic that we will ultimately prevail in all four cases.

Overall, we remain confident in the strength of our defenses, and believe that our longstanding policy of patience and perseverance will continue to prove successful. For a more complete review of litigation, I refer you to Note 19 to the Consolidated Financial Statements in this report.

Outlook

We enter 2007 with considerable momentum. There is no doubt that our businesses will continue to face a fiercely competitive environment, but I believe we have the appropriate plans in place to consistently achieve top-tier performance versus our peers.

The domestic tobacco industry offers potential for growth as PM USA begins to implement its adjacency strategy. I believe that PM USA will remain ahead of the competition with its unparalleled portfolio of strong brands and its outstanding organization.

At PMI, the worst appears to be behind us in terms of aggressive competitor price discounting. The Western European markets appear to be poised for a period of renewed stability. PMI's new product pipeline is in terrific shape and there is evidence that more rational tax structures are being implemented. Most importantly, I would remind you that less than 5% of PMI's income is derived from markets that represent nearly 60% of the international cigarette market, leaving significant opportunity for PMI to expand its business.

Kraft’s challenges are being vigorously addressed by the new management team. I firmly believe that the benefits of independence will translate into better results in the future.

Finally, I want to acknowledge that all of our accomplishments are the direct result of the dedication and determination of our employees around the world and the invaluable guidance we receive from our Board of Directors. My own sense is that the organization across the entire enterprise is in terrific shape and morale is strong. Our employees continue to set a standard of excellence that I find to be truly inspirational, and I offer my heartfelt thanks to each and every one of them.

Louis C. Camilleri
Chairman of the Board and
Chief Executive Officer
March 7, 2007