MO

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2002, for Philip Morris Companies Inc. (which approved a name change to Altria Group, Inc. in April 2002, pending legal resolution). The company operates primarily in tobacco (Domestic and International), food (North American and International), beer (Miller Brewing Company), and financial services. The financial statements are unaudited.

Key Financial Metrics

Segment Performance (Six Months 2002):

• Domestic Tobacco: Revenues $9,899M; Operating Income $2,704M.
• International Tobacco: Revenues $14,173M; Operating Income $2,967M.
• North American Food: Revenues $10,862M; Operating Income $2,467M.
• International Food: Revenues $3,798M; Operating Income $551M.
• Beer: Revenues $2,641M; Operating Income $276M.
• Financial Services: Revenues $265M; Operating Income $175M.

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 2.2% ($890M) year-over-year, driven primarily by higher tobacco revenues. Excluding unusual items and divestitures, organic revenue growth was 1.9%.
• Profitability: Operating income increased 16.2% ($1.2B). This significant jump is largely attributable to the absence of a $500M litigation-related expense recorded in Q1 2001 (Engle case escrow) and the cessation of goodwill amortization due to new accounting standards (SFAS 142).
• EPS Growth: Diluted EPS rose 25.7% to $2.30. Excluding unusual items, adjusted diluted EPS increased 10.2% to $2.38.
• Debt Reduction: Interest expense decreased $287M due to lower average debt outstanding following the use of Kraft Foods IPO proceeds in 2001 to retire Nabisco acquisition debt.
• Currency Impact: Strong U.S. dollar negatively impacted reported revenues by approximately $1.0B and operating income by $250M compared to 2001.

Guidance, Outlook, and Risks

Management Commentary & Outlook:

• Miller Divestiture: The company announced the merger of Miller Brewing Company with South African Breweries (SAB) on May 30, 2002, closing July 9, 2002. The transaction generated a pre-tax gain of approximately $2.6B (recorded in Q3 2002) and resulted in a 36% economic interest in SABMiller.
• Share Repurchases: The company intends to accelerate share repurchases in the second half of 2002, utilizing approximately $1.7B in cash flow from the Miller debt transfer. Total 2002 repurchases are expected to exceed $6.0B.
• Dividends: Quarterly dividend rate is $0.58 per share (annualized $2.32).

Risks and Contingencies:

• Tobacco Litigation: Significant exposure remains regarding the Engle class action in Florida (approx. $74B punitive damages verdict, stayed pending appeal) and the U.S. Federal Government's RICO lawsuit. The company has placed $1.7B in escrow accounts related to these matters.
• Regulatory Environment: Risks include increasing excise taxes (18 states passed increases in 2002), restrictions on marketing (e.g., "Lights" descriptors), and potential FDA regulation of tobacco products.
• Integration Costs: The company recorded $314M in pre-tax charges related to Kraft/Nabisco integration and facility closures, slightly above the original estimate.
• US Airways Bankruptcy: Philip Morris Capital Corporation (PMCC) has $150M in leveraged lease receivables with US Airways, which filed for Chapter 11 bankruptcy in August 2002. These leases are currently on non-accrual status.

Investor Verification Checklist

• Miller Transaction Gain: Verify the timing and tax treatment of the $2.6B pre-tax gain from the Miller/SAB merger, scheduled for Q3 2002 recognition.
• Engle Case Escrow: Confirm the status of the $1.7B in escrow accounts ($500M non-refundable, $1.2B refundable) and the ongoing appeal process in Florida.
• Goodwill Amortization: Note that 2002 results exclude goodwill amortization charges present in 2001 due to SFAS 142 adoption; compare adjusted EPS for accurate trend analysis.
• US Airways Exposure: Monitor the resolution of the US Airways bankruptcy and the potential impact on PMCC's $150M leveraged lease portfolio.
• Share Repurchase Acceleration: Track the execution of the planned $1.7B additional share buyback in H2 2002.