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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2007, for Altria Group, Inc. (Altria). The company operates primarily through its tobacco subsidiaries, Philip Morris USA Inc. (PM USA) and Philip Morris International Inc. (PMI), and its financial services subsidiary, Philip Morris Capital Corporation (PMCC). A significant corporate event during the period was the tax-free spin-off of Kraft Foods Inc. on March 30, 2007; Kraft is now reported as a discontinued operation. Altria also announced its intention to spin off PMI in early 2008.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 8.9% year-over-year, driven by favorable currency impacts (weakness of the U.S. dollar against the euro, Russian ruble, and Turkish lira), higher pricing, and volume growth in Eastern Europe, Middle East, and Africa.
• Discontinued Operations: Net earnings decreased 16.2% primarily due to the spin-off of Kraft Foods. Earnings from discontinued operations dropped from $2.14 billion in 2006 to $625 million in 2007.
• Asset Impairment and Exit Costs: Pre-tax charges totaled $545 million in 2007 compared to $123 million in 2006. This increase was largely due to a Manufacturing Optimization Program in the U.S. (closing the Cabarrus, NC facility) and streamlining efforts at PMI.
• Financial Services Recovery: PMCC recorded a pre-tax gain of $214 million in 2007 from recoveries on aircraft lease investments, contrasting with a $103 million provision for losses in 2006.
• Tax Rate: The effective tax rate for continuing operations increased to 32.3% in 2007 from a lower rate in 2006, which had benefited from a $631 million non-cash tax reserve reversal.

Guidance, Outlook, and Risks

• 2007 Forecast: On October 17, 2007, Altria raised its full-year 2007 diluted EPS forecast for continuing operations to a range of $4.20 to $4.25 (previously $4.05 to $4.10). This increase reflects a lower tax rate, favorable currency, and improved PMI results.
• Corporate Restructuring: The Board intends to finalize the spin-off of PMI by January 30, 2008. The company plans to close its New York headquarters and sell the building if the spin-off proceeds.
• Acquisitions: Altria announced an agreement to acquire John Middleton, Inc. for $2.9 billion in cash (net cost $2.2 billion) and PMI completed the acquisition of an additional stake in its Mexican tobacco business.
• Key Risks:
  • Litigation: Significant exposure remains from tobacco-related litigation, including the Engle class action in Florida and the Price case in Illinois. Management believes the litigation environment has improved but notes potential for material adverse effects.
  • Regulation: Ongoing risks include excise tax increases, restrictions on marketing and advertising, and the implementation of the WHO Framework Convention on Tobacco Control (FCTC).
  • IRS Challenges: The IRS has disallowed tax benefits for certain PMCC leveraged lease transactions (1996-1999), with approximately $150 million in tax and interest contested.

Investor Verification Checklist

• PMI Spin-off Timing: Verify the finalization of the PMI spin-off decision and the associated tax ruling from the IRS, as this will fundamentally alter the company's structure.
• Manufacturing Optimization Costs: Monitor the execution of the U.S. manufacturing consolidation and the realization of the projected $335 million in annual cost savings by 2011.
• Litigation Escrow: Confirm the status of the $1.2 billion escrow deposit related to the Engle case and the potential for its return or allocation.
• John Middleton Acquisition: Track the regulatory approval process and integration timeline for the $2.9 billion cigar manufacturer acquisition.
• Tax Rate Volatility: Assess the sustainability of the 2007 tax rate, which included $97 million in favorable adjustments from reserve reversals and German tax rate reductions.