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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2005, for Altria Group, Inc. (ALG). The company operates primarily through its tobacco subsidiaries (Philip Morris USA and Philip Morris International) and its majority-owned food subsidiary, Kraft Foods Inc. The reporting period includes the classification of Kraft's sugar confectionery business as discontinued operations, pending its sale for approximately $1.5 billion.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 8.7% year-over-year, driven by higher tobacco revenues and favorable currency translation. Excluding excise taxes, revenue grew 6.9%.
• Profitability: Operating income rose 12.5% to $4.176 billion. This was fueled by higher tobacco segment income, lower asset impairment charges compared to 2004, and gains on the sale of food businesses.
• Asset Impairment: Pre-tax asset impairment and exit costs decreased significantly to $171 million in Q1 2005 from $308 million in Q1 2004, primarily due to reduced restructuring charges at Kraft.
• Cash Flow: Operating cash flow turned negative ($483 million used) compared to positive flow in the prior year. This was primarily due to increased pension plan contributions ($770 million) and cash payments related to Kraft's restructuring program.
• Acquisitions: Investing activities consumed $1.6 billion, largely due to the $1.5 billion initial payment for the acquisition of a 40% stake in PT HM Sampoerna Tbk (Indonesian tobacco company).

Guidance, Outlook, and Risks

• 2005 Forecast: Management forecasts full-year 2005 diluted EPS from continuing operations in the range of $4.95 to $5.05. This assumes current exchange rates and includes approximately $0.12 per share in charges for Kraft's restructuring. It excludes potential tax impacts from the repatriation of foreign earnings under the American Jobs Creation Act.
• Strategic Restructuring: The Board is evaluating alternatives to separate Altria into two or three independent entities, contingent upon improvements in the litigation environment.
• Major Risks:
  • Litigation: Significant exposure remains from tobacco-related litigation, including the U.S. government's RICO lawsuit (trial underway) and the Price Lights/Ultra Lights class action (approx. $10.1 billion verdict on appeal).
  • Regulatory: Ongoing challenges include excise tax increases, the implementation of the WHO Framework Convention on Tobacco Control, and potential FDA regulation of tobacco products.
  • Financial Services: Philip Morris Capital Corporation (PMCC) faces risks from airline lessees (United, US Airways, Delta) in bankruptcy, with $92 million in leveraged lease assets at risk of foreclosure.

Investor Verification Checklist

• Discontinued Operations Tax Impact: Verify the timing and magnitude of the anticipated $270 million tax expense related to the sale of Kraft's sugar confectionery business.
• Sampoerna Acquisition: Monitor the completion of the tender offer for Sampoerna (total cost approx. $5.2 billion) and the associated financing via the Euro 4.5 billion credit facility.
• Litigation Bonding: Review the status of appeal bonds and escrow deposits (e.g., $1.2 billion in Engle case, $1.4 billion in Price case) and potential cash flow impacts if appeals are unsuccessful.
• Kraft Restructuring: Track the progress of Kraft's multi-year restructuring program, specifically the realization of projected cost savings versus ongoing cash outflows.
• Dividend Sustainability: Confirm the company's ability to maintain the current annualized dividend rate of $2.92 per share given the high cash outflows for litigation settlements and pension contributions.