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

(Continued)

Discussion and Analysis > 2007 compared with 2006

The following discussion compares consolidated operating results for the year ended December 31, 2007, with the year ended December 31, 2006.

Net revenues, which include excise taxes billed to customers, increased $6.8 billion (10.1%). Excluding excise taxes, net revenues increased $2.1 billion (5.8%), due primarily to the favorable impact of currency and higher revenues from the Eastern Europe, Middle East and Africa segment, the European Union segment, the Latin America segment and the Asia segment, and the impact of acquisitions at PMI, partially offset by lower revenues from the financial services segment.

Excise taxes on products increased $4.7 billion (15.0%) due primarily to currency movements ($2.3 billion) and higher excise tax rates ($2.4 billion). As discussed in Tobacco Business Environment, there is a trend toward governments’ increasing excise taxes in all of the markets in which Altria Group, Inc. operates. Excise taxes are expected to continue to rise.

Cost of sales increased $1.0 billion (6.5%), due primarily to higher ongoing resolution costs ($489 million), currency movements ($447 million) and acquisitions ($85 million). Generally, tobacco and materials costs have not increased significantly and productivity initiatives have tended to offset higher depreciation and salary expenses.

Marketing, administration and research costs increased $141 million (1.8%), due primarily to currency movements ($260 million), acquisitions and divestitures ($124 million), expenses related to the termination of a distributor relationship in Indonesia ($30 million), and higher research and development costs ($27 million), partially offset by lower marketing expenses and lower general and administrative costs. Generally, research and development costs have tended to increase, reflecting efforts to develop products that may reduce the risk of tobacco use. Marketing and selling expenses were lower, reflecting regulatory restrictions on advertising and promotion activities, and productivity initiatives.

Operating income increased $348 million (2.7%), due primarily to higher operating results from the Eastern Europe, Middle East and Africa segment, the European Union segment, the Latin America segment and the U.S. Tobacco segment; an increase at PMCC due to cash recoveries in 2007 from assets which had previously been written down versus a provision in 2006 for its airline industry exposure; the favorable impact of currency; and the 2006 Italian antitrust charge. These items were partially offset by higher charges for asset impairment, exit and implementation costs, and the 2006 gain on sale of a business.

Currency movements increased net revenues by $3,513 million ($1,178 million, after excluding the impact of currency movements on excise taxes) and operating income by $471 million. These increases were due primarily to the weakness versus prior year of the U.S. dollar against the euro, Russian ruble and the Turkish lira, partially offset by the strength of the U.S. dollar against the Japanese yen.

Interest and other debt expense, net, of $215 million decreased $152 million, due primarily to lower average debt levels throughout most of 2007.

Altria Group, Inc.’s effective tax rate increased 4.3 percentage points to 31.5%. The 2007 effective tax rate includes net tax benefits of $111 million related to the reversal of tax reserves and associated interest resulting from the expiration of statutes of limitations ($55 million in the third quarter and $56 million in the fourth quarter) and $42 million related to the reduction of deferred tax liabilities resulting from future lower tax rates enacted in Germany in the third quarter. The tax provision in 2007 also includes the reversal of tax accruals of $98 million no longer required in the fourth quarter. The 2006 effective tax rate includes $631 million of non-cash tax benefits principally representing the reversal of tax reserves after the U.S. IRS concluded its examination of Altria Group, Inc.’s consolidated tax returns for the years 1996 through 1999 in the first quarter of 2006. The 2006 rate also includes the reversal of foreign tax reserves no longer required at PMI of $105 million.

Equity earnings and minority interest, net, was $237 million for 2007, compared with $209 million for 2006. The change primarily reflected higher equity earnings from SABMiller.

Earnings from continuing operations of $9.2 billion decreased $168 million (1.8%), due primarily to a higher effective tax rate, partially offset by higher operating income and lower interest and other debt expense, net. Diluted and basic EPS from continuing operations of $4.33 and $4.36, respectively, decreased by 2.3% and 2.5%, respectively.

Earnings from discontinued operations, net of income taxes and minority interest (which represent the results of Kraft prior to the spin-off), decreased $2.1 billion.

Net earnings of $9.8 billion decreased $2.2 billion (18.6%). Diluted and basic EPS from net earnings of $4.62 and $4.66, respectively, decreased by 19.1%. These decreases reflect the spin-off of Kraft at the end of March 2007.

2006 compared with 2005

The following discussion compares consolidated operating results for the year ended December 31, 2006, with the year ended December 31, 2005.

Net revenues, which include excise taxes billed to customers, increased $3.3 billion (5.2%). Excluding excise taxes, net revenues increased $1.2 billion (3.3%), due primarily to increases from the Asia segment (including the impact of acquisitions), Eastern Europe, Middle East and Africa segment, U.S. tobacco segment and Latin America segment (including the impact of acquisitions), partially offset by lower revenues from the European Union segment and unfavorable currency.

Excise taxes on products increased $2.1 billion (7.4%), due primarily to higher excise tax rates ($1.9 billion) and acquisitions ($571 million), partially offset by currency movements ($311 million).

Cost of sales increased $621 million (4.2%), due primarily to acquisitions ($290 million), higher volume ($231 million) and higher product costs ($135 million).

Marketing, administration and research costs were flat, due primarily to favorable currency ($153 million) and lower marketing expenses, offset by acquisitions ($115 million), higher general and administrative expenses, and higher research and development costs.

Operating income increased $1,047 million (8.8%), due primarily to the 2006 gain on sale of a business, higher operating results from all segments except the European Union segment, the 2005 charge for PM USA’s portion of the losses incurred by the federal government on disposition of its pool tobacco stock, and a lower provision for airline industry exposure at PMCC. These increases were partially offset by the unfavorable impact of currency, an unfavorable comparison with 2005, when PM USA benefited from the reversal of a 2004 accrual related to the tobacco quota buy-out legislation, and the 2006 Italian antitrust charge in the European Union segment.

Currency movements decreased net revenues by $651 million ($340 million after excluding the impact of currency movements on excise taxes) and operating income by $183 million. These decreases were due primarily to the strength versus prior year of the U.S. dollar against the Japanese yen and the Turkish lira.

Interest and other debt expense, net, of $367 million decreased $154 million (29.6%), due primarily to lower debt levels and higher interest income.

Altria Group, Inc.’s effective tax rate decreased by 2.9 percentage points to 27.2%. The 2006 effective tax rate includes $631 million of non-cash tax benefits principally representing the reversal of tax reserves after the U.S. IRS concluded its examination of Altria Group, Inc.’s consolidated tax returns for the years 1996 through 1999 in the first quarter of 2006. The 2006 rate also includes the reversal of foreign tax accruals no longer required at PMI of $105 million in the fourth quarter. The 2005 effective tax rate includes a $344 million benefit related to dividend repatriation under the Jobs Act, as well as other benefits, including lower repatriation costs.

Equity earnings and minority interest, net, was $209 million for 2006, compared with $260 million for 2005. The change primarily reflected higher minority interest in earnings in Turkey and Mexico, partially offset by higher equity earnings from SABMiller.

Earnings from continuing operations of $9.3 billion increased $1.2 billion (14.2%), due primarily to higher operating income, lower interest and other debt expense, net, and a lower effective tax rate. Diluted and basic EPS from continuing operations of $4.43 and $4.47, respectively, increased by 13.3% and 13.2%, respectively.

Earnings from discontinued operations, net of income taxes and minority interest, of $2.7 billion increased $428 million (18.9%), due to higher net earnings at Kraft.

Net earnings of $12.0 billion increased $1.6 billion (15.2%). Diluted and basic EPS from net earnings of $5.71 and $5.76, respectively, increased by 14.4% and 14.3%, respectively.