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

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Discussion and Analysis Financial Review

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Off-Balance Sheet Arrangements and Aggregate Contractual Obligations: Altria Group, Inc. has no off-balance sheet arrangements, including special purpose entities, other than guarantees and contractual obligations that are discussed below.

Guarantees: As discussed in Note 18, at December 31, 2003, Altria Group, Inc. had third-party guarantees, which are primarily derived from acquisition and divestiture activities, approximating $256 million, of which $212 million have no specified expiration dates. The remainder expire through 2023, with $13 million expiring during 2004. Altria Group, Inc. is required to perform under these guarantees in the event that a third party fails to make contractual payments or achieve performance measures. Altria Group, Inc. has a liability of $55 million on its consolidated balance sheet at December 31, 2003, relating to these guarantees. In the ordinary course of business, certain subsidiaries of ALG have agreed to indemnify a limited number of third parties in the event of future litigation. At December 31, 2003, subsidiaries of ALG were also contingently liable for $1.4 billion of guarantees related to their own performance, consisting of the following:

• $1.1 billion of guarantees of excise tax and import duties related primarily to international shipments of tobacco products. In these agreements, a financial institution provides a guarantee of tax payments to the respective governments. PMI then issues a guarantee to the respective financial institution for the payment of the taxes. These are revolving facilities that are integral to the shipment of tobacco products in international markets, and the underlying taxes payable are recorded on Altria Group, Inc.’s consolidated balance sheet.
• $0.3 billion of other guarantees related to the tobacco and food businesses.

Although Altria Group, Inc.’s guarantees of its own performance are frequently short term in nature, the short-term guarantees are expected to be replaced, upon expiration, with similar guarantees of similar amounts. These items have not had, and are not expected to have, a significant impact on Altria Group, Inc.’s liquidity.

Aggregate Contractual Obligations: The following table summarizes Altria Group, Inc.’s contractual obligations at December 31, 2003:

	Payments Due
(in millions)	Total	2004	2005-2006	2007-2008	2009 and Thereafter
Long-term debt(1):
Consumer products	$18,757	$1,661	$  5,029	$4,677	$7,390
Financial services	2,210	184	950	577	499
	20,967	1,845	5,979	5,254	7,889
Operating leases(2)	2,043	552	676	365	450
Purchase obligations(3):
Inventory and
production costs	8,694	3,940	2,909	617	1,228
Other	3,065	1,961	930	165	9
	11,759	5,901	3,839	782	1,237
Other long-term
liabilities(4):	205		171	13	21
	$34,974	$8,298	$10,665	$6,414	$9,597

(1)	Amounts represent the expected cash payments of Altria Group, Inc.’s long-term debt and do not include short-term borrowings reclassified as long-term debt, bond premiums or discounts, or nonrecourse debt issued by PMCC.
(2)	Amounts represent the minimum rental commitments under non-cancelable operating leases. Altria Group, Inc. has no significant capital lease obligations.
(3)	Purchase obligations for inventory and production costs (such as raw materials, indirect materials and supplies, packaging, co-manufacturing arrangements, storage and distribution) are commitments for projected needs to be utilized in the normal course of business. Other purchase obligations include commitments for marketing, advertising, capital expenditures, information technology and professional services. Arrangements are considered purchase obligations if a contract specified all significant terms, including fixed or minimum quantities to be purchased, a pricing structure and approximate timing of the transaction. Most arrangements are cancelable without a significant penalty, and with short notice (usually 30 days). Any amounts reflected on the consolidated balance sheet as accounts payable and accrued liabilities are excluded from the table above.
(4)	Other long-term liabilities primarily consist of tax assessment payments relating to Italian tax matters at PMI (as discussed in Note 18) and specific severance and incentive compensation arrangements. The following long-term liabilities included on the consolidated balance sheet are excluded from the table above: accrued pension, postretirement health care and postemployment costs, income taxes, minority interest, insurance accruals and other accruals. Altria Group, Inc. is unable to estimate the timing of payments for these items. Currently, Altria Group, Inc. anticipates making U.S. pension contributions of approximately $100 million in 2004, based on current tax law (as discussed in Note 15).

The State Settlement Agreements and related legal fee payments, and payments to a tobacco-growers trust fund, as discussed below and in Note 18, are excluded from the table above, as the payments are subject to adjustment for several factors, including inflation, market share and industry volume. Litigation escrow deposits due in 2004 and thereafter, as discussed below and in Note 18, are also excluded from the table above since these deposits will be returned to PM USA should it prevail on appeal.

Tobacco Litigation Settlement Payments: As discussed previously and in Note 18, PM USA, along with other domestic tobacco companies, has entered into State Settlement Agreements that require the domestic tobacco industry to make substantial annual payments in the following amounts (excluding future annual payments contemplated by the agreement with tobacco growers discussed below), subject to adjustment for several factors, including inflation, market share and industry volume: 2004 through 2007, $8.4 billion each year; and thereafter, $9.4 billion each year. In addition, the domestic tobacco industry is required to pay settling plaintiffs’ attorneys’ fees, subject to an annual cap of $500 million. PM USA and the other settling defendants also agreed to make payments to a trust fund to provide aid to tobacco growers and quota-holders. The trust will be funded by four of the major domestic tobacco product manufacturers, including PM USA, over 12 years with payments, prior to application of various adjustments, scheduled to total $5.15 billion. Future industry payments (in 2004 through 2008, $500 million each year; and 2009 and 2010, $295 million each year) are subject to adjustment for several factors, including inflation, industry volume and certain other contingent events, and, in general, are to be allocated based on each manufacturer’s relative market share.

Litigation Escrow Deposits: As discussed in Note 18, in connection with obtaining a stay of execution in May 2001 in the Engle class action, PM USA placed $1.2 billion into an interest-bearing escrow account. The $1.2 billion escrow account and a deposit of $100 million related to the bonding requirement are included in the December 31, 2003 and 2002 consolidated balance sheets as other assets. These amounts will be returned to PM USA should it prevail in its appeal of the case. Interest income on the $1.2 billion escrow account is paid to PM USA quarterly and is being recorded as earned in interest and other debt expense, net, in the consolidated statements of earnings.

In addition, in connection with obtaining a stay of execution in the Price case, PM USA placed a pre-existing 7.0%, $6 billion long-term note from ALG to PM USA into an escrow account with an Illinois financial institution. Since this note is the result of an intercompany financing arrangement, it does not appear on the consolidated balance sheet of Altria Group, Inc. In addition, PM USA agreed to make cash deposits with the clerk of the Madison County Circuit Court in the following amounts: beginning October 1, 2003, an amount equal to the interest earned by PM USA on the ALG note ($210 million every six months), an additional $800 million in four equal quarterly installments between September 2003 and June 2004 and the payments of the principal of the note which are due in April 2008, 2009 and 2010. Through December 31, 2003, PM USA made $610 million of the cash deposits due under the judge’s order. Cash deposits into the account are included in other assets on the consolidated balance sheet. If PM USA prevails on appeal, the escrowed note and all cash deposited with the court will be returned to PM USA, with accrued interest less administrative fees payable to the court.

With respect to certain adverse verdicts currently on appeal, other than the Engle and the Price cases discussed above, as of December 31, 2003, PM USA has posted various forms of security totaling $367 million, the majority of which have been collateralized with cash deposits, to obtain stays of judgments pending appeals. In addition, as discussed in Note 18, PMI placed €51 million in an escrow account pending appeal of an adverse verdict in Italy. These cash deposits are included in other assets on the consolidated balance sheets.

As discussed above under “Tobacco—Business Environment,” the present legislative and litigation environment is substantially uncertain and could result in material adverse consequences for the business, financial condition, cash flows or results of operations of ALG, PM USA and PMI. Assuming there are no material adverse developments in the legislative and litigation environment, Altria Group, Inc. expects its cash flow from operations to provide sufficient liquidity to meet the ongoing needs of the business.

Equity and Dividends: During 2003 and 2002, ALG repurchased 18.7 million and 134.4 million shares, respectively, of its common stock at a cost of $0.7 billion and $6.3 billion, respectively. During 2003, ALG completed its three-year, $10 billion share repurchase program and began a one-year, $3 billion share repurchase program. At December 31, 2003, cumulative repurchases under the $3 billion authority totaled approximately 7.0 million shares at an aggregate cost of $241 million. Following the rating agencies’ actions in the first quarter of 2003, discussed above in “Credit Ratings,” ALG suspended its share repurchase program. During the second half of 2002, ALG accelerated its rate of share repurchases by utilizing approximately $1.7 billion of cash flow to Altria Group, Inc. resulting from the Miller transaction.

During 2003, Kraft completed its $500 million share repurchase program and began a $700 million share repurchase program. During 2003 and 2002, Kraft repurchased 12.5 million and 4.4 million shares of its Class A common stock at a cost of $380 million and $170 million, respectively. As of December 31, 2003, Kraft had repurchased 1.6 million shares of its Class A common stock, under the new $700 million authority, at a cost of $50 million.

Altria Group, Inc. purchased 1.6 million shares of Kraft’s Class A common stock in open market transactions during 2002 in order to completely satisfy a one-time grant of Kraft options to employees of Altria Group, Inc. at the time of the Kraft IPO.

As discussed in Note 11 to the consolidated financial statements, in January 2003 Altria Group, Inc. granted approximately 2.3 million shares of restricted stock to eligible U.S.-based employees and Directors of Altria Group, Inc. and also issued to eligible non-U.S. employees rights to receive approximately 1.5 million equivalent shares. Restrictions on the shares lapse in the first quarter of 2006.

Dividends paid in 2003 and 2002 were $5.3 billion and $5.1 billion, respectively, an increase of 4.3%, reflecting a higher dividend rate in 2003, partially offset by a lower number of shares outstanding as a result of share repurchases. During the third quarter of 2003, Altria Group, Inc.’s Board of Directors approved a 6.3% increase in the quarterly dividend rate to $0.68 per share. As a result, the annualized dividend rate increased to $2.72 from $2.56.