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

(Continued)

Discussion and Analysis Operating Results by Business Segment Food Business Environment

Kraft is the largest branded food and beverage company headquartered in the United States and conducts its global business through two subsidiaries. KFNA, which represents the North American food segment, manufactures and markets a wide variety of snacks, beverages, cheese, grocery products and convenient meals in the United States, Canada, Mexico and Puerto Rico. KFI, which represents the international food segment, manufactures and markets a wide variety of snacks, beverages, cheese, grocery products and convenient meals in Europe, the Middle East and Africa, as well as the Latin America and Asia Pacific regions. During January 2004, Kraft announced a new global organization structure. Beginning in 2004, results for the Mexico and Puerto Rico businesses, which were previously included in the North American food segment, will be included in the international food segment and historical amounts will be restated.

KFNA and KFI are subject to a number of challenges that may adversely affect their businesses. These challenges, which are discussed below and under the “Forward-Looking and Cautionary Statements” section include:

• fluctuations in commodity prices;
• movements of foreign currencies against the U.S. dollar;
• competitive challenges in various products and markets, including price gaps with competitor products and the increasing price-consciousness of consumers;
• a rising cost environment;
• a trend toward increasing consolidation in the retail trade and consequent inventory reductions;
• changing consumer preferences;
• competitors with different profit objectives and less susceptibility to currency exchange rates; and
• consumer concerns about food safety, quality and health, including concerns about genetically modified organisms, trans-fatty acids and obesity.

To confront these challenges, Kraft continues to take steps to build the value of its brands, to improve its food business portfolio with new product and marketing initiatives, to reduce costs through productivity, and to address consumer concerns about food safety, quality and health. In July 2003, Kraft announced a range of initiatives addressing product nutrition, marketing practices, consumer information, and public advocacy and dialogue.

During 2003, several factors contributed to lower than anticipated volume growth. These factors included higher price gaps in some key categories and countries, trade inventory reductions resulting from several customers experiencing financial difficulty, warehouse consolidations, store closings and retailers’ stated initiatives to reduce working capital, as well as the combined adverse affect of global economic weakness. To improve volume and share trends, Kraft increased spending behind certain businesses during the second half of 2003 by approximately $200 million more than had previously been planned. Kraft also anticipates $500 million to $600 million of increased spending in 2004 over 2003 across all its businesses.

In January 2004, Kraft announced a three-year restructuring program with the objectives of leveraging Kraft’s global scale, realigning and lowering the cost structure, and optimizing capacity utilization. As part of this program, Kraft anticipates the closing or sale of up to twenty plants and the elimination of approximately six thousand positions. Over the next three years, Kraft expects to incur up to $1.2 billion in pre-tax charges, reflecting asset disposals, severance and other implementation costs, including an estimated range of $750 million to $800 million in 2004. Approximately one-half of the pre-tax charges are expected to require cash payments. In addition, Kraft expects to spend approximately $140 million in capital over the next three years to implement the program, including approximately $50 million in 2004. Cost savings as a result of this program in 2004 are expected to be approximately $120 million to $140 million and are anticipated to reach annual cost savings of approximately $400 million by 2006, all of which are expected to be used in supporting brand-building initiatives.

Fluctuations in commodity costs can cause retail price volatility and intensive price competition, and can influence consumer and trade buying patterns. The North American and international food businesses are subject to fluctuating commodity costs, including dairy, coffee and cocoa costs. In 2003, Kraft’s commodity costs on average were higher than those incurred in 2002 and adversely affected earnings.

During 2003, KFNA acquired trademarks associated with a small natural foods business and KFI acquired a biscuits business in Egypt. The total cost of these and other smaller businesses purchased by Kraft during 2003 was $98 million. During 2002, KFI acquired a snacks business in Turkey and a biscuits business in Australia. The total cost of these and smaller businesses purchased by Kraft during 2002 was $122 million. During 2001, KFI purchased coffee businesses in Romania, Morocco and Bulgaria and also acquired confectionery businesses in Russia and Poland. The total cost of these and other smaller food acquisitions during 2001 was $194 million.

During 2003, KFI sold a European rice business and a branded fresh cheese business in Italy. The aggregate proceeds received from sales of businesses were $96 million, on which pre-tax gains of $31 million were recorded.

During 2002, Kraft sold several small North American food businesses, most of which were previously classified as businesses held for sale. The net revenues and operating results of the businesses held for sale, which were not significant, were excluded from Altria Group, Inc.’s consolidated statements of earnings, and no gain or loss was recognized on these sales. In addition, KFI sold a Latin American yeast and industrial bakery ingredients business for approximately $110 million and recorded a pre-tax gain of $69 million. The aggregate proceeds received from the sales of these businesses during 2002 were $219 million, on which pre-tax gains of $80 million were recorded.

During 2001, Kraft sold several small food businesses. The aggregate proceeds received in these transactions were $21 million, on which pre-tax gains of $8 million were recorded.

The operating results of businesses acquired and divested were not material to Altria Group, Inc.’s consolidated financial position, results of operations or cash flows in any of the years presented.

In November 2003, Kraft received a “Wells” notice from the staff of the Fort Worth District Office of the Securities and Exchange Commission (“SEC”) advising Kraft that the staff is considering recommending that the SEC bring a civil injunctive action against Kraft charging it with aiding and abetting Fleming Companies (“Fleming”) in violations of the securities laws. District staff alleges that a Kraft employee, who received a similar “Wells” notice, signed documents requested by Fleming, which Fleming used in order to accelerate its revenue recognition. The notice does not contain any allegations or statements regarding Kraft’s accounting for transactions with Fleming. Kraft believes that it has properly recorded the transactions in accordance with U.S. GAAP. Kraft is cooperating fully with the SEC with respect to this matter.