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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2007 for Altria Group, Inc. (ALG). The reporting period is significantly impacted by the spin-off of Kraft Foods Inc. on March 30, 2007. Consequently, Kraft's results are classified as discontinued operations, and the balance sheet reflects a substantial reduction in total assets and equity due to the distribution of Kraft shares to ALG stockholders.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 8.2% year-over-year, driven primarily by a 12.4% increase in International Tobacco revenues due to favorable currency (weak U.S. dollar vs. Euro/Ruble) and price increases. Domestic Tobacco revenues declined 1.8% due to lower volume.
• Earnings Decline: Earnings from continuing operations decreased 18.2% to $2.1 billion. This decline is largely attributable to a $631 million non-cash tax benefit recorded in Q1 2006 following the conclusion of an IRS audit, which is not present in the current period.
• Discontinued Operations: Earnings from discontinued operations (Kraft) decreased 29.0% to $625 million, reflecting lower net earnings from Kraft and the absence of the 2006 tax reserve reversal.
• Unusual Items:
  • Recoveries: A $129 million pre-tax gain was recorded from the sale of leveraged lease investments in aircraft (Financial Services).
  • Charges: $123 million in asset impairment and exit costs were incurred, primarily related to separation programs at Philip Morris International (PMI) and fees associated with the Kraft spin-off.

Guidance, Outlook, and Risks

• 2007 Forecast: On April 19, 2007, ALG raised its full-year 2007 diluted EPS forecast for continuing operations to a range of $4.20 to $4.25, up from the previous $4.15 to $4.20. This reflects an improved outlook at PMI due to favorable currency.
• Dividends: The company intends to adjust its dividend rate so that stockholders retaining both ALG and Kraft shares receive the same aggregate dividend rate as before the distribution. The quarterly dividend declared was $0.86 per share.
• Key Risks:
  • Litigation: Significant exposure remains regarding tobacco-related litigation, including the Engle class action in Florida and the U.S. Government's RICO lawsuit. While the trial court judgment in the RICO case was stayed pending appeal, it imposes significant marketing restrictions.
  • Regulatory Environment: Ongoing risks include potential FDA regulation of tobacco products, excise tax increases globally, and restrictions on brand descriptors (e.g., "Lights," "Ultra Lights").
  • IRS Challenges: The IRS has disallowed tax benefits for certain leveraged lease transactions (1996-1999). ALG is contesting approximately $150 million in assessed taxes and interest.

Investor Verification Checklist

• Kraft Spin-Off Accounting: Verify the treatment of Kraft as discontinued operations and the $27.4 billion reduction in stockholders' equity.
• Tax Rate Volatility: Confirm the impact of the 2006 tax reserve reversal ($631 million) on year-over-year earnings comparability.
• International Currency Impact: Assess the sustainability of the favorable currency translation effects (Euro/Ruble) driving International Tobacco revenue growth.
• Litigation Escrow: Review the status of the $1.2 billion escrow deposit related to the Engle case and the $193 million in security posted for other adverse verdicts.
• Debt Covenants: Confirm compliance with debt covenants, specifically the EBITDA-to-interest ratio for PMI (29.5 to 1.0) and earnings-to-fixed-charges for ALG (17.5 to 1.0).