-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BDl0bMMBjrHPD35WK5c1gEWrAs/tFd2Mh4VVMSMq5Z9WfXn25TiRbVGo1+CbIAQL 9gwrAg/d9T7puaMv1xmQwg== 0001193125-08-128830.txt : 20080605 0001193125-08-128830.hdr.sgml : 20080605 20080605164053 ACCESSION NUMBER: 0001193125-08-128830 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20080605 ITEM INFORMATION: Other Events ITEM INFORMATION: Financial Statements and Exhibits FILED AS OF DATE: 20080605 DATE AS OF CHANGE: 20080605 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ALTRIA GROUP, INC. CENTRAL INDEX KEY: 0000764180 STANDARD INDUSTRIAL CLASSIFICATION: TOBACCO PRODUCTS [2100] IRS NUMBER: 133260245 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-08940 FILM NUMBER: 08883527 BUSINESS ADDRESS: STREET 1: 6601 WEST BROAD STREET CITY: RICHMOND STATE: VA ZIP: 23230 BUSINESS PHONE: (804) 274-2200 MAIL ADDRESS: STREET 1: 6601 WEST BROAD STREET CITY: RICHMOND STATE: VA ZIP: 23230 FORMER COMPANY: FORMER CONFORMED NAME: ALTRIA GROUP INC DATE OF NAME CHANGE: 20030127 FORMER COMPANY: FORMER CONFORMED NAME: PHILIP MORRIS COMPANIES INC DATE OF NAME CHANGE: 19920703 8-K 1 d8k.htm FORM 8-K Form 8-K

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

FORM 8-K

 

 

 

 

CURRENT REPORT

Pursuant to Section 13 or 15(d) of

The Securities Exchange Act of 1934

 

Date of Report (Date of earliest event reported): June 5, 2008

 

 

 

 

ALTRIA GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

Virginia   1-8940   13-3260245

(State or other jurisdiction

of incorporation)

  (Commission File Number)  

(I.R.S. Employer

Identification No.)

 

 

6601 West Broad Street, Richmond, Virginia   23230
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (804) 274-2200

 

(Former name or former address, if changed since last report.)

 

 

 

 

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:

 

¨ Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

 

¨ Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

 

¨ Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

 

¨ Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

 

 

 

 


Item  8.01. Other Events.

As previously disclosed, Altria Group, Inc. (“Altria”) completed the spin-off of Philip Morris International Inc. (“PMI”) to Altria stockholders on March 28, 2008 (the “Spin-Off”). Beginning in the first quarter of 2008, as a result of the Spin-Off, Altria classified the operations of PMI as discontinued operations and revised its reportable segments. The revision to Altria’s reportable segments also reflects Altria’s December 2007 acquisition of John Middleton Co. (f/k/a John Middleton, Inc.).

This Current Report on Form 8-K is filed in order to revise, in accordance with accounting principles generally accepted in the United States of America, certain information disclosed in Altria’s Annual Report on Form 10-K for the year ended December 31, 2007 (the “Form 10-K”), namely:

 

   

the Consolidated Financial Statements and Notes thereto;

   

the Financial Statement Schedule – Valuation and Qualifying Accounts;

   

the Ratios of Earnings to Fixed Charges;

   

the Selected Financial Data – Five-Year Review; and

   

certain portions of Management’s Discussion and Analysis of Financial Condition and Results of Operations, in order to reflect PMI as a discontinued operation and the change in reportable segments.

The change in reportable segments does not affect Altria’s:

 

   

Consolidated Balance Sheets, Consolidated Statements of Earnings;

   

Consolidated Statements of Stockholders’ Equity; or

   

Consolidated Statements of Cash Flows.

The revisions to the Form 10-K reported in this Current Report on Form 8-K are limited to the specific items identified above. The information provided herein should be read in conjunction with Altria’s Quarterly Report on Form 10-Q for the period ended March 31, 2008, its Current Reports on Form 8-K filed with the Securities and Exchange Commission, as well as those portions of the Form 10-K not subject to the revisions noted above.

 

Item  9.01. Financial Statements and Exhibits.

 

Exhibit No.

    

Description

    12

    

Computation of ratios of earnings to fixed charges

    23

    

Consent of independent registered public accounting firm

    99.1

    

Selected Financial Data – Five-Year Review

    99.2

    

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

    99.3

    

Consolidated Financial Statements as of December 31, 2007 and 2006, and for Each of the Three Years in the Period Ended December 31, 2007

    99.4

    

Financial Statement Schedule – Valuation and Qualifying Accounts For the Years Ended December 31, 2007, 2006 and 2005

    99.5

    

Report of Independent Registered Public Accounting Firm on Financial Statement Schedule

 


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

 

 

 

ALTRIA GROUP, INC.

By:

  

/s/  LINDA M. WARREN

  

Name:

 

Linda M. Warren

  

Title:

 

Vice President and Controller

DATE: June 5, 2008

 


INDEX TO EXHIBITS

 

 

Exhibit No.

    

Description

    12

    

Computation of ratios of earnings to fixed charges

    23

    

Consent of independent registered public accounting firm

    99.1

    

Selected Financial Data – Five-Year Review

    99.2

    

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

    99.3

    

Consolidated Financial Statements as of December 31, 2007 and 2006, and for Each of the Three Years in the Period Ended December 31, 2007

    99.4

    

Financial Statement Schedule – Valuation and Qualifying Accounts For the Years Ended December 31, 2007, 2006 and 2005

    99.5

    

Report of Independent Registered Public Accounting Firm on Financial Statement Schedule

EX-12 2 dex12.htm COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES Computation of ratios of earnings to fixed charges

Exhibit 12

ALTRIA GROUP, INC. AND SUBSIDIARIES

Computation of Ratios of Earnings to Fixed Charges

(in millions of dollars)

 

 

 

 

         For the Years Ended December 31,
         2007        2006        2005        2004        2003

Earnings from continuing operations before income taxes

     $ 4,678       $ 4,753       $ 4,123       $ 4,083       $ 3,490 

Add (Deduct):

                        

Equity in net earnings of less than 50% owned affiliates

       (516)        (466)        (447)        (524)        (311)

Dividends from less than 50% owned affiliates

       224         193         168         148         112 

Fixed Charges

       514         681         818         783         782 

Interest capitalized, net of amortization

       (5)        -                         
                                            

Earnings available for fixed charges

     $             4,895       $             5,161       $             4,667       $             4,496       $             4,082 
                                            

Fixed Charges:

                        

Interest incurred:

                        

Consumer Products

     $ 438       $ 567       $ 674       $ 648       $ 639 

Financial Services

       54         81         107         94         105 
                                            
       492         648         781         742         744 

Portion of rent expense deemed to represent interest factor

       22         33         37         41         38 
                                            

Fixed Charges

     $ 514       $ 681       $ 818       $ 783       $ 782 
                                            

Ratio of earnings to fixed charges (A)

       9.5         7.6         5.7         5.7         5.2 
                                            

(A) Reflects Philip Morris International Inc. (“PMI”) and Kraft Foods Inc. (“Kraft”) as discontinued operations. Interest incurred and the portion of rent expense deemed to represent the interest factor of PMI and Kraft have been excluded from fixed charges in the computation. Including these amounts in fixed charges, the ratio of earnings to fixed charges would have been 5.9, 3.8, 3.0, 3.1 and 2.9 for the years ended December 31, 2007, 2006, 2005, 2004 and 2003, respectively.

EX-23 3 dex23.htm CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Consent of independent registered public accounting firm

Exhibit 23

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We hereby consent to the incorporation by reference in Post-Effective Amendment No. 13 to the Registration Statement of Altria Group, Inc. on Form S-14 (File No. 2-96149) and in Altria Group, Inc.’s Registration Statements on Form S-3 (File No. 333-35143) and Forms S-8 (File Nos. 333-28631, 33-10218, 33-13210, 33-14561, 33-40110, 33-48781, 33-59109, 333-43478, 333-43484, 333-128494, 333-139523, and 333-148070), of our report dated January 28, 2008, except for Notes 19 and 21 which are as of February 4, 2008, and except for the impact of presenting Philip Morris International Inc. as a discontinued operation as discussed in Notes 1 and 4, the impact of the spin-off of Philip Morris International Inc. as discussed in Note 21, and the change in reportable segments as discussed in Notes 1 and 15, all of which are as of June 5, 2008, relating to the consolidated financial statements and the effectiveness of internal control over financial reporting of Altria Group, Inc., which appears in this Current Report on Form 8-K of Altria Group, Inc. We also consent to the incorporation by reference of our report dated January 28, 2008, except for Notes 19 and 21 which are as of February 4, 2008, and except for the impact of presenting Philip Morris International Inc. as a discontinued operation, as discussed in Notes 1 and 4, the impact of the spin-off of Philip Morris International Inc., as discussed in Note 21 and the change in reportable segments as discussed in Notes 1 and 15, all of which are as of June 5, 2008, relating to the financial statement schedule, which appears in this Current Report on Form 8-K.

 

/s/ PricewaterhouseCoopers LLP

New York, New York

June 5, 2008

EX-99.1 4 dex991.htm SELECTED FINANCIAL DATA - FIVE YEAR REVIEW Selected Financial Data - Five Year Review

Exhibit 99.1

Selected Financial Data—Five-Year Review (in millions of dollars, except per share data)

 

         2007            2006            2005            2004            2003    

Summary of Operations:

              

Net revenues

   $18,664    $18,790    $18,452    $17,901    $17,424

Cost of sales

   7,827    7,387    7,274    6,956    6,649

Excise taxes on products

   3,452    3,617    3,659    3,694    3,698

Operating income

   4,373    4,518    4,104    4,082    3,696

Interest and other debt expense, net

   205    225    427    506    502

Equity earnings in SABMiller

   510    460    446    507    296

Earnings from continuing operations before income taxes

   4,678    4,753    4,123    4,083    3,490

Pre-tax profit margin from continuing operations

   25.1%    25.3%    22.3%    22.8%    20.0%

Provision for income taxes

   1,547    1,571    1,574    1,502    1,199

Earnings from continuing operations

   3,131    3,182    2,549    2,581    2,291

Earnings from discontinued operations, net of income taxes and minority interest

   6,655    8,840    7,886    6,835    6,913

Net earnings

   9,786    12,022    10,435    9,416    9,204

Basic earnings per share - continuing operations

   1.49    1.52    1.23    1.26    1.13

                  - discontinued operations

   3.17    4.24    3.81    3.34    3.41

                  - net earnings

   4.66    5.76    5.04    4.60    4.54

Diluted earnings per share - continuing operations

   1.48    1.51    1.22    1.25    1.12

          - discontinued operations

   3.14    4.20    3.77    3.31    3.40

          - net earnings

   4.62    5.71    4.99    4.56    4.52

Dividends declared per share

   3.05    3.32    3.06    2.82    2.64

Weighted average shares (millions) - Basic

   2,101    2,087    2,070    2,047    2,028

Weighted average shares (millions) - Diluted

   2,116    2,105    2,090    2,063    2,038

Capital expenditures

   386    399    299    243    303

Depreciation

   232    255    269    269    257

Property, plant and equipment, net (consumer products)

   2,422    2,343    2,259    2,278    2,400

Inventories (consumer products)

   1,254    1,605    1,821    1,780    1,924

Total assets

   57,211    104,270    107,949    101,648    96,175

Total long-term debt

   2,385    5,195    6,459    8,960    9,571

Total debt - consumer products

   4,239    4,580    6,462    7,740    9,223

      - financial services

   500    1,119    2,014    2,221    2,210

Stockholders’ equity

   18,554    39,619    35,707    30,714    25,077

Common dividends declared as a % of Basic EPS

   65.5%    57.6%    60.7%    61.3%    58.1%

Common dividends declared as a % of Diluted EPS

   66.0%    58.1%    61.3%    61.8%    58.4%

Book value per common share outstanding

   8.80    18.89    17.13    14.91    12.31

Market price per common share - high/low

   90.50-63.13    86.45-68.36    78.68-60.40    61.88-44.50    55.03-27.70

Closing price of common share at year end

   75.58    85.82    74.72    61.10    54.42

Price/earnings ratio at year end - Basic

   16    15    15    13    12

Price/earnings ratio at year end - Diluted

   16    15    15    13    12

Number of common shares outstanding at year end (millions)

   2,108    2,097    2,084    2,060    2,037

Number of employees

   84,000    175,000    199,000    156,000    165,000
EX-99.2 5 dex992.htm MD&A OF FINANCIAL CONDITION & RESULTS OF OPERATIONS MD&A of Financial Condition & Results of Operations

Exhibit 99.2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Description of the Company

Throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), the term “Altria Group, Inc.” refers to the consolidated financial position, results of operations and cash flows of the Altria family of companies and the term “ALG” refers solely to the parent company. ALG’s wholly-owned subsidiaries are Philip Morris USA Inc. (“PM USA”), which is engaged in the manufacture and sale of cigarettes and other tobacco products in the United States and John Middleton, Inc., which is engaged in the manufacture and sale of machine-made cigars and pipe tobacco. Philip Morris Capital Corporation (“PMCC”), another wholly-owned subsidiary, maintains a portfolio of leveraged and direct finance leases. In addition, ALG held a 28.6% economic and voting interest in SABMiller plc (“SABMiller”) at December 31, 2007. ALG’s wholly owned international tobacco subsidiary as of December 31, 2007, Philip Morris International Inc. (“PMI”), is reflected in the financial statements and throughout MD&A as a discontinued operation as a result of the PMI spin-off discussed below. ALG’s access to the operating cash flows of its subsidiaries consists principally of cash received from the payment of dividends by its subsidiaries.

On March 30, 2007, Altria Group, Inc. distributed all of its remaining interest in Kraft Foods, Inc. (“Kraft”) on a pro-rata basis to Altria Group, Inc. stockholders in a tax-free distribution. For further discussion, please refer to the Kraft Spin-Off discussion below. Altria Group, Inc. has reclassified and reflected the results of Kraft prior to the Kraft Distribution Date as discontinued operations on the consolidated statements of earnings and the consolidated statements of cash flows for all periods presented. The assets and liabilities related to Kraft were reclassified and reflected as discontinued operations on the consolidated balance sheet at December 31, 2006.

PMI Spin-Off:

On January 30, 2008, the Board of Directors announced Altria Group, Inc.’s plans to spin off all of its interest in PMI to Altria Group, Inc. stockholders in a tax-free distribution. The distribution of all the PMI shares owned by Altria Group, Inc. was made on March 28, 2008 (the “PMI Distribution Date”), to Altria Group, Inc. stockholders of record as of the close of business on March 19, 2008 (the “PMI Record Date”). Altria Group, Inc. distributed one share of PMI common stock for every share of Altria Group, Inc. common stock outstanding as of the PMI Record Date.

Holders of Altria Group, Inc. stock options were treated similarly to public stockholders and, accordingly, had their stock awards split into two instruments. Holders of Altria Group, Inc. stock options received the following stock options, which, immediately after the spin-off, had an aggregate intrinsic value equal to the intrinsic value of the pre-spin Altria Group, Inc. options:

 

 

a new PMI option to acquire the same number of shares of PMI common stock as the number of Altria Group, Inc. options held by such person on the PMI Distribution Date; and

 

 

an adjusted Altria Group, Inc. option for the same number of shares of Altria Group, Inc. common stock with a reduced exercise price.

As set forth in the Employee Matters Agreement, the exercise price of each option was developed to reflect the relative market values of PMI and Altria Group, Inc. shares, by allocating the share price of Altria Group, Inc. common stock before the spin-off ($73.83) to PMI shares ($51.44) and Altria Group, Inc. shares ($22.39) and then multiplying each of these allocated values by the Option Conversion Ratio. The Option Conversion Ratio is equal to the exercise price of the Altria Group, Inc. option, prior to any adjustment for the spin-off,


divided by the share price of Altria Group, Inc. common stock before the spin-off ($73.83). As a result, the new PMI option and the adjusted Altria Group, Inc. option have an aggregate intrinsic value equal to the intrinsic value of the pre-spin Altria Group, Inc. option.

Holders of Altria Group, Inc. restricted stock or deferred stock awarded prior to January 30, 2008, retained their existing awards and received the same number of shares of restricted or deferred stock of PMI. The restricted stock and deferred stock will not vest until the completion of the original restriction period (typically, three years from the date of the original grant). Recipients of Altria Group, Inc. deferred stock awarded on January 30, 2008, who were employed by Altria Group, Inc. after the PMI Distribution Date, received additional shares of deferred stock of Altria Group, Inc. to preserve the intrinsic value of the award. Recipients of Altria Group, Inc. deferred stock awarded on January 30, 2008, who were employed by PMI after the PMI Distribution Date, received substitute shares of deferred stock of PMI to preserve the intrinsic value of the award.

To the extent that employees of the remaining Altria Group, Inc. received PMI stock options, Altria Group, Inc. reimbursed PMI in cash for the Black-Scholes fair value of the stock options received. To the extent that PMI employees hold Altria Group, Inc. stock options, PMI reimbursed Altria Group, Inc. in cash for the Black-Scholes fair value of the stock options. To the extent that employees of the remaining Altria Group, Inc. received PMI deferred stock, Altria Group, Inc. paid to PMI the fair value of the PMI deferred stock less the value of projected forfeitures. To the extent that PMI employees hold Altria Group, Inc. restricted stock or deferred stock, PMI reimbursed Altria Group, Inc. in cash for the fair value of the restricted or deferred stock less the value of projected forfeitures and any amounts previously charged to PMI for the restricted or deferred stock. Based upon the number of Altria Group, Inc. stock awards outstanding at the PMI Distribution Date, the net amount of these reimbursements resulted in a payment of $449 million from Altria Group, Inc. to PMI ($427 million of which was paid in March 2008).

In connection with the spin-off, PMI paid to Altria Group, Inc. $4.0 billion in special dividends in addition to its normal dividends to Altria Group, Inc. PMI paid $3.1 billion of these special dividends in 2007 and paid the additional $900 million in the first quarter of 2008.

Prior to the PMI spin-off, PMI was included in the Altria Group, Inc. consolidated federal income tax return, and PMI’s federal income tax contingencies were recorded as liabilities on the balance sheet of ALG. ALG reimbursed PMI in cash for these liabilities, which were $97 million.

Prior to the PMI spin-off, certain employees of PMI participated in the U.S. benefit plans offered by Altria Group, Inc. After the PMI Distribution Date, the benefits previously provided by Altria Group, Inc. will be provided by PMI. As a result, new plans were established by PMI, and the related plan assets (to the extent that the benefit plans were previously funded) and liabilities were transferred to the PMI plans. The transfer of these benefits resulted in Altria Group, Inc. reducing its benefit plan liabilities by $129 million and increasing its prepaid pension assets by $33 million in its consolidated balance sheet, partially offset by the related deferred tax assets ($23 million) and the corresponding Statement of Financial Accounting Standards (“SFAS”) No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” adjustment to stockholders’ equity ($27 million). Altria Group, Inc. paid PMI a corresponding amount of $112 million in cash, which is net of the related tax benefit.

A subsidiary of ALG previously provided PMI with certain corporate services at cost plus a management fee. After the PMI Distribution Date, PMI independently undertook most of these activities. Any remaining limited services provided to PMI by the ALG service subsidiary under the Transition Services Agreement are expected to cease in 2008. The settlement of the intercompany accounts (including the amounts discussed above related to stock awards, tax contingencies and benefit plans) resulted in a net payment from Altria Group, Inc. to PMI of $332 million. In March 2008, Altria Group, Inc. made an estimated payment of $427 million to PMI, thereby resulting in PMI reimbursing $95 million to Altria Group, Inc. in the second quarter of 2008.

Under the terms of the Distribution Agreement between Altria Group, Inc. and PMI, liabilities concerning tobacco products will be allocated based in substantial part on the manufacturer. PMI will indemnify Altria

 

-2-


Group, Inc. and PM USA for liabilities related to tobacco products manufactured by PMI or contract manufactured for PMI by PM USA, and PM USA will indemnify PMI for liabilities related to tobacco products manufactured by PM USA, excluding tobacco products contract manufactured for PMI. Altria Group, Inc. does not have a liability recorded on its condensed consolidated balance sheet at March 31, 2008 as the fair value of this indemnification is insignificant.

Altria Group, Inc. estimates that, if the distribution had occurred on December 31, 2007, it would have resulted in a net decrease to Altria Group, Inc.’s stockholders’ equity of approximately $15 billion.

Dividends and Share Repurchases:

In conjunction with its announcement of the PMI spin-off, the Board of Directors announced its intention to adjust Altria Group, Inc.’s dividend so that Altria Group, Inc. stockholders who retain their PMI shares will initially receive, in the aggregate, the same annual cash dividend rate of $3.00 per common share that existed before the spin-off. Altria Group, Inc. expects to pay a dividend at the initial rate of $0.29 per common share per quarter, or $1.16 per common share on an annualized basis. Altria Group, Inc. has established a dividend policy that anticipates a payout ratio of approximately 75% post-spin. PMI is expected to pay a dividend at the initial rate of $0.46 per common share per quarter, or $1.84 per common share on an annualized basis. PMI has established a dividend policy that anticipates a payout ratio of approximately 65% post-spin. Payment of cash dividends is at the discretion of the Boards of Directors of the respective companies.

In addition, the Board of Directors approved share repurchase programs as follows:

 

 

for Altria Group, Inc. a $7.5 billion two-year share repurchase program that began in April 2008; and

 

 

for PMI, a $13.0 billion two-year share repurchase program that was expected to begin in May 2008.

Tender Offer for Altria Group, Inc. Notes:

In connection with the spin-off of PMI, in the first quarter of 2008, Altria Group, Inc. and its subsidiary, Altria Finance (Cayman Islands) Ltd. completed tender offers to purchase for cash $2.3 billion of notes and debentures denominated in U.S. dollars and €373 million in euro-denominated bonds, equivalent to $568 million in U.S. dollars.

While Altria Group, Inc. believes that the spin-off of PMI was not prohibited by the indentures, it believes that it was desirable to eliminate any uncertainty by amending the indentures with the consent of note holders.

In order to finance the tender offers, Altria Group, Inc. arranged a $4.0 billion, 364-day bridge loan facility with substantially the same terms as its existing credit facilities. The tender offers however, were paid with existing cash and Altria Group, Inc. has not borrowed under this bridge facility. Subsequent to the spin-off of PMI, Altria Group, Inc. intends to issue new public debt for general corporate purposes, including its share repurchase program, if market conditions permit. The tender offers and consent solicitations resulted in pre-tax charges of $393 million in the first quarter of 2008.

Kraft Spin-Off:

On March 30, 2007 (the “Kraft Distribution Date”), Altria Group, Inc. distributed all of its remaining interest in Kraft on a pro-rata basis to Altria Group, Inc. stockholders of record as of the close of business on March 16, 2007 (the “Kraft Record Date”) in a tax-free distribution. The distribution ratio was 0.692024 of a share of Kraft for each share of Altria Group, Inc. common stock outstanding. Altria Group, Inc. stockholders received cash in lieu of fractional shares of Kraft. Following the distribution, Altria Group, Inc. does not own any shares of Kraft. During the second quarter of 2007, Altria Group, Inc. adjusted its quarterly dividend to $0.69 per share, so that its stockholders who retained their Altria Group, Inc. and Kraft shares would receive,

 

-3-


in the aggregate, the same dividend dollars as before the distribution. In August 2007, Altria Group, Inc. increased its quarterly dividend to $0.75 per share.

Holders of Altria Group, Inc. stock options were treated similarly to public stockholders and accordingly, had their stock awards split into two instruments. Holders of Altria Group, Inc. stock options received the following stock options, which, immediately after the spin-off, had an aggregate intrinsic value equal to the intrinsic value of the pre-spin Altria Group, Inc. options:

 

 

a new Kraft option to acquire the number of shares of Kraft Class A common stock equal to the product of (a) the number of Altria Group, Inc. options held by such person on the Kraft Distribution Date and (b) the distribution ratio of 0.692024; and

 

 

an adjusted Altria Group, Inc. option for the same number of shares of Altria Group, Inc. common stock with a reduced exercise price.

The new Kraft option has an exercise price equal to the Kraft market price at the time of the distribution ($31.66) multiplied by the Option Conversion Ratio, which represents the exercise price of the original Altria Group, Inc. option divided by the Altria Group, Inc. market price immediately before the distribution ($87.81). The reduced exercise price of the adjusted Altria Group, Inc. option was determined by multiplying the Altria Group, Inc. market price immediately following the distribution ($65.90) by the Option Conversion Ratio.

Holders of Altria Group, Inc. restricted stock or deferred stock awarded prior to January 31, 2007, retained their existing award and received restricted stock or deferred stock of Kraft Class A common stock. The amount of Kraft restricted stock or deferred stock awarded to such holders was calculated using the same formula set forth above with respect to new Kraft options. All of the restricted stock and deferred stock will vest at the completion of the original restriction period (typically, three years from the date of the original grant). Recipients of Altria Group, Inc. deferred stock awarded on January 31, 2007, did not receive restricted stock or deferred stock of Kraft. Rather, they received additional deferred shares of Altria Group, Inc. to preserve the intrinsic value of the original award.

To the extent that employees of the remaining Altria Group, Inc. received Kraft stock options, Altria Group, Inc. reimbursed Kraft in cash for the Black-Scholes fair value of the stock options received. To the extent that Kraft employees held Altria Group, Inc. stock options, Kraft reimbursed Altria Group, Inc. in cash for the Black-Scholes fair value of the stock options. To the extent that holders of Altria Group, Inc. deferred stock received Kraft deferred stock, Altria Group, Inc. paid to Kraft the fair value of the Kraft deferred stock less the value of projected forfeitures. Based upon the number of Altria Group, Inc. stock awards outstanding at the Kraft Distribution Date, the net amount of these reimbursements resulted in a payment of $179 million from Kraft to Altria Group, Inc. in April 2007. The reimbursement from Kraft is reflected as an increase to the additional paid-in capital of Altria Group, Inc. on the December 31, 2007 consolidated balance sheet.

Kraft was previously included in the Altria Group, Inc. consolidated federal income tax return, and federal income tax contingencies were recorded as liabilities on the balance sheet of ALG. As part of the intercompany account settlement discussed below, ALG reimbursed Kraft in cash for these liabilities, which as of March 30, 2007, were approximately $305 million, plus pre-tax interest of $63 million ($41 million after taxes). ALG also reimbursed Kraft in cash for the federal income tax consequences of the adoption of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”) (approximately $70 million plus pre-tax interest of $14 million, $9 million after taxes). See Note 14. Income Taxes for a discussion of the FIN 48 adoption and the Tax Sharing Agreement between Altria Group, Inc. and Kraft.

A subsidiary of ALG previously provided Kraft with certain services at cost plus a 5% management fee. After the Kraft Distribution Date, Kraft undertook these activities, and any remaining limited services provided to Kraft ceased during 2007. All intercompany accounts were settled in cash within 30 days of the Kraft Distribution Date. The settlement of the intercompany accounts (including the amounts discussed

 

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above related to stock awards and tax contingencies) resulted in a net payment from Kraft to ALG of $85 million in April 2007.

The distribution resulted in a net decrease to Altria Group, Inc.’s stockholders’ equity of $27.4 billion on the Kraft Distribution Date.

Other:

On December 11, 2007, in conjunction with PM USA’s adjacency strategy, Altria Group, Inc. acquired 100% of John Middleton, Inc., a leading manufacturer of machine-made large cigars, for $2.9 billion in cash. The acquisition was financed with existing cash. John Middleton, Inc.’s balance sheet has been consolidated with Altria Group, Inc.’s as of December 31, 2007. Earnings from December 12, 2007 to December 31, 2007, the amounts of which were insignificant, have been included in Altria Group, Inc.’s consolidated operating results.

In March 2008, Altria Group, Inc. sold its headquarters building in New York City for $525 million and recorded a net pre-tax gain on the sale of the building and other assets of $404 million in the first quarter of 2008.

Beginning with the first quarter of 2008, Altria Group, Inc. revised its reportable segments to reflect the change in the way in which Altria Group, Inc.’s management reviews the business as a result of the acquisition of John Middleton, Inc. and the PMI spin-off. Altria Group, Inc.’s revised segments are Cigarettes and other tobacco products; Cigars; and Financial Services. Accordingly, prior year segment results have been revised.

Executive Summary

The following executive summary is intended to provide significant highlights of the Discussion and Analysis that follows.

Consolidated Operating Results – The changes in Altria Group, Inc.’s earnings from continuing operations and diluted earnings per share (“EPS”) from continuing operations for the year ended December 31, 2007, from the year ended December 31, 2006, were due primarily to the following (in millions, except per share data):

 

    

Earnings from
Continuing
Operations

  

Diluted EPS
from
Continuing
Operations

For the year ended December 31, 2006

      $  3,182           $  1.51    

2006 Asset impairment and exit costs

      32           0.02    

2006 Interest on tax reserve transfers to Kraft

      29           0.01    

2006 Tax items

      (170 )         (0.08 )  

2006 Provision for airline industry exposure

      66           0.03    
                       

Subtotal 2006 items

      (43 )         (0.02 )  
                       

2007 Asset impairment, exit and implementation costs

      (300 )         (0.15 )  

2007 Recoveries from airline industry exposure

      137           0.06    

2007 Interest on tax reserve transfers to Kraft

      (50 )         (0.02 )  

2007 Tax items

      168           0.09    
                       

Subtotal 2007 items

      (45 )         (0.02 )  
                       

Higher shares outstanding

              (0.01 )  

Operations

      37           0.02    
                       

For the year ended December 31, 2007

      $  3,131           $  1.48    
                       

 

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See discussion of events affecting the comparability of statement of earnings amounts in the Consolidated Operating Results section of the following Discussion and Analysis.

Asset Impairment, Exit and Implementation Costs – In June 2007, Altria Group, Inc. announced plans by its tobacco subsidiaries to optimize worldwide cigarette production by moving U.S.-based cigarette production for non-U.S. markets to PMI facilities in Europe. Due to declining U.S. cigarette volume, as well as PMI’s decision to re-source its production, PM USA will close its Cabarrus, North Carolina manufacturing facility and consolidate manufacturing for the U.S. market at its Richmond, Virginia manufacturing center. From 2007 through 2011, PM USA expects to incur total pre-tax asset impairment, exit and implementation charges of approximately $670 million for the program, including $371 million ($234 million after taxes) incurred during 2007. During 2006, PM USA recorded pre-tax asset impairment and exit costs of $10 million ($6 million after taxes). In addition, during 2007 and 2006, pre-tax asset impairment and exit costs of $98 million ($66 million after taxes) and $42 million ($26 million after taxes) were recorded in general corporate expense. For further details on asset impairment, exit and implementation costs, see Note 3. Asset Impairment and Exit Costs, to the Consolidated Financial Statements.

Recoveries/Provision from/for Airline Industry Exposure – As discussed in Note 8. Finance Assets, net, (“Note 8”) PMCC recorded a pre-tax gain of $214 million ($137 million after taxes) on the sale of its ownership interests and bankruptcy claims in certain leveraged lease investments in aircraft, which represented a partial recovery, in cash, of amounts that had been previously written down. During 2006, PMCC increased its allowance for losses by $103 million ($66 million after taxes), due to issues within the airline industry.

Interest on Tax Reserve Transfers to Kraft – As further discussed in Note 1. Background and Basis of Presentation and Note 14. Income Taxes, the interest on tax reserves transferred to Kraft is related to the Kraft spin-off, the adoption of FIN 48 in 2007 and the conclusion of an IRS audit in 2006.

Income Taxes – Altria Group, Inc.’s effective tax rate was unchanged at 33.1%. The 2007 effective tax rate includes net tax benefits of $111 million related to the reversal of tax reserves and associated interest resulting from the expiration of statutes of limitations ($55 million in the third quarter and $56 million in the fourth quarter). The tax rate in 2007 also includes the reversal in the fourth quarter of tax accruals of $57 million no longer required. The 2006 effective tax rate includes $146 million of non-cash tax benefits principally representing the reversal of tax reserves after the U.S. Internal Revenue Service (“IRS”) concluded its examination of Altria Group, Inc.’s consolidated tax returns for the years 1996 through 1999 in the first quarter of 2006.

Shares Outstanding – Higher shares outstanding during 2007 primarily reflect exercises of employee stock options (which become outstanding when exercised) and the incremental share impact of stock options outstanding.

Operations – The favorable impact from operations was due primarily to the following:

 

 

Higher U.S. tobacco income, reflecting lower wholesale promotional allowance rates and lower marketing, administration and research costs, partially offset by lower volume and higher ongoing resolution costs; and

 

 

Higher equity earnings in SABMiller;

 

partially offset by:

 

 

Lower financial services income (after excluding the impact of the recoveries/provision from/for airline industry exposure), reflecting lower gains from asset management activity and lower lease revenues.

 

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For further details, see the Consolidated Operating Results and Operating Results by Business Segment sections of the following Discussion and Analysis.

2008 Forecasted Results – In January 2008, Altria Group, Inc. announced that it forecasts 2008 full-year diluted earnings per share from continuing operations to be in the range of $1.63 to $1.67, representing a growth rate of approximately 9% to 11% for the full-year 2008, from a base of $1.50 per share in 2007. This forecast reflects a higher effective tax rate, the contribution of income from recently acquired John Middleton, Inc. and the impact of share repurchases. Earnings per share growth is expected to be stronger in the second half of 2008.

Reconciliation of 2007 Reported Diluted EPS from Continuing Operations to 2007

Adjusted Diluted EPS from Continuing Operations

 

2007 Reported diluted EPS from continuing operations

   $ 1.48  

Tax items

     (0.09 )

PMCC recoveries from airline industry exposure

     (0.06 )

Interest on tax reserve transfers to Kraft

     0.02  

Asset impairment, exit and implementation costs

     0.15  
        

2007 Adjusted diluted EPS from continuing operations

   $ 1.50  
        

The forecast excludes the impact of any potential future acquisitions or divestitures, Altria Group, Inc.’s gain on the sale of its headquarters in New York City, charges related to the tender offer for Altria Group, Inc.’s notes and a number of other factors including the items shown in the table above. The factors described in the Cautionary Factors That May Affect Future Results section of the following Discussion and Analysis represent continuing risks to this forecast.

Discussion and Analysis

Critical Accounting Policies and Estimates

Note 2 to the consolidated financial statements includes a summary of the significant accounting policies and methods used in the preparation of Altria Group, Inc.’s consolidated financial statements. In most instances, Altria Group, Inc. must use an accounting policy or method because it is the only policy or method permitted under accounting principles generally accepted in the United States of America (“U.S. GAAP”).

The preparation of financial statements includes the use of estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities at the dates of the financial statements and the reported amounts of net revenues and expenses during the reporting periods. If actual amounts are ultimately different from previous estimates, the revisions are included in Altria Group, Inc.’s consolidated results of operations for the period in which the actual amounts become known. Historically, the aggregate differences, if any, between Altria Group, Inc.’s estimates and actual amounts in any year, have not had a significant impact on its consolidated financial statements.

The selection and disclosure of Altria Group, Inc.’s critical accounting policies and estimates have been discussed with Altria Group, Inc.’s Audit Committee. The following is a review of the more significant assumptions and estimates, as well as the accounting policies and methods used in the preparation of Altria Group, Inc.’s consolidated financial statements:

 

 

Consolidation – The consolidated financial statements include ALG, as well as its wholly-owned subsidiaries. Investments in which ALG exercises significant influence (20% - 50% ownership interest) are accounted for under the equity method of accounting. All intercompany transactions and balances have been eliminated. The results of PMI have been reclassified and reflected as discontinued operations on the consolidated balance sheets, statements of earnings and statements of cash flows for all periods presented. The results of Kraft prior to the Kraft Distribution Date have been reflected as discontinued operations on the consolidated statements of earnings and statements of cash flows for all periods

 

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presented. The assets and liabilities related to Kraft were reflected as discontinued operations on the consolidated balance sheet at December 31, 2006.

 

 

Revenue Recognition – As required by U.S. GAAP, Altria Group, Inc.’s consumer products businesses recognize revenues, net of sales incentives and including shipping and handling charges billed to customers, upon shipment or delivery of goods when title and risk of loss pass to customers. ALG’s consumer products businesses also include excise taxes billed to customers in revenues. Shipping and handling costs are classified as part of cost of sales.

 

 

Depreciation, Amortization and Intangible Asset Valuation – Altria Group, Inc. depreciates property, plant and equipment and amortizes its definite life intangible assets using the straight-line method over the estimated useful lives of the assets.

Altria Group, Inc. is required to conduct an annual review of goodwill and intangible assets for potential impairment. Goodwill impairment testing requires a comparison between the carrying value and fair value of each reporting unit. If the carrying value exceeds the fair value, goodwill is considered impaired. The amount of impairment loss is measured as the difference between the carrying value and implied fair value of goodwill, which is determined using discounted cash flows. Impairment testing for non-amortizable intangible assets requires a comparison between the fair value and carrying value of the intangible asset. If the carrying value exceeds fair value, the intangible asset is considered impaired and is reduced to fair value. These calculations may be affected by interest rates, general economic conditions and projected growth rates.

During 2007, 2006 and 2005, Altria Group, Inc. completed its annual review of goodwill and intangible assets, and no charges resulted from these reviews.

 

 

Marketing and Advertising Costs – As required by U.S. GAAP, Altria Group, Inc. records marketing costs as an expense in the year to which such costs relate. Altria Group, Inc. does not defer amounts on its year-end consolidated balance sheets with respect to marketing costs. Altria Group, Inc. expenses advertising costs in the year incurred. Consumer incentive and trade promotion activities are recorded as a reduction of revenues based on amounts estimated as being due to customers and consumers at the end of a period, based principally on historical utilization and redemption rates. Such programs include, but are not limited to, discounts, coupons, rebates, in-store display incentives and volume-based incentives. For interim reporting purposes, advertising and certain consumer incentive expenses are charged to operations as a percentage of sales, based on estimated sales and related expenses for the full year.

 

 

Contingencies – As discussed in Note 19. Contingencies (“Note 19”) to the consolidated financial statements, legal proceedings covering a wide range of matters are pending or threatened in various U.S. and foreign jurisdictions against ALG, its subsidiaries and affiliates, including PM USA and its respective indemnitees. In 1998, PM USA and certain other U.S. tobacco product manufacturers entered into the Master Settlement Agreement (the “MSA”) with 46 states and various other governments and jurisdictions to settle asserted and unasserted health care cost recovery and other claims. PM USA and certain other U.S. tobacco product manufacturers had previously settled similar claims brought by Mississippi, Florida, Texas and Minnesota (together with the MSA, the “State Settlement Agreements”). PM USA’s portion of ongoing adjusted payments and legal fees is based on its relative share of the settling manufacturers’ domestic cigarette shipments, including roll-your-own cigarettes, in the year preceding that in which the payment is due. PM USA records its portion of ongoing settlement payments as part of cost of sales as product is shipped. During the years ended December 31, 2007, 2006 and 2005, PM USA recorded expenses of $5.5 billion, $5.0 billion and $5.0 billion, respectively, as part of cost of sales for the payments under the State Settlement Agreements and payments for tobacco growers and quota-holders.

ALG and its subsidiaries record provisions in the consolidated financial statements for pending litigation when they determine that an unfavorable outcome is probable and the amount of the loss can be reasonably estimated. Except as discussed in Note 19: at the present time, while it is reasonably possible that an unfavorable outcome in a case may occur, (i) management has concluded that it is not probable

 

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that a loss has been incurred in any of the pending tobacco-related cases; (ii) management is unable to estimate the possible loss or range of loss that could result from an unfavorable outcome of any of the pending tobacco-related cases; and (iii) accordingly, management has not provided any amounts in the consolidated financial statements for unfavorable outcomes, if any. Legal defense costs are expensed as incurred.

 

 

Employee Benefit Plans – As discussed in Note 16. Benefit Plans (“Note 16”) of the notes to the consolidated financial statements, Altria Group, Inc. provides a range of benefits to its employees and retired employees, including pensions, postretirement health care and postemployment benefits (primarily severance). Altria Group, Inc. records annual amounts relating to these plans based on calculations specified by U.S. GAAP, which include various actuarial assumptions, such as discount rates, assumed rates of return on plan assets, compensation increases, turnover rates and health care cost trend rates. Altria Group, Inc. reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends when it is deemed appropriate to do so. As permitted by U.S. GAAP, any effect of the modifications is generally amortized over future periods. Altria Group, Inc. believes that the assumptions utilized in recording its obligations under its plans, which are presented in Note 16, are reasonable based on advice from its actuaries.

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”). SFAS No. 158 requires that employers recognize the funded status of their defined benefit pension and other postretirement plans on the consolidated balance sheet and record as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that have not been recognized as components of net periodic benefit cost. Altria Group, Inc. adopted SFAS No. 158, prospectively, on December 31, 2006. The adoption of SFAS No. 158 by Altria Group, Inc. resulted in a decrease to total assets of $3,096 million, an increase in total liabilities of $290 million and a decrease to stockholders’ equity of $3,386 million. Included in these amounts were a decrease to Kraft’s total assets of $2,286 million, a decrease to Kraft’s total liabilities of $235 million and a decrease to Kraft’s stockholders’ equity of $2,051 million, as well as a decrease to PMI’s total assets of $162 million, an increase to PMI’s total liabilities of $351 million and a decrease to PMI’s stockholder’s equity of $513 million.

At December 31, 2007, Altria Group, Inc.’s discount rate assumption increased to 6.20%, from 5.90% at December 31, 2006, for its pension and postretirement plans. Altria Group, Inc. presently anticipates that this and other less significant assumption changes, coupled with the amortization of deferred gains and losses, will result in substantially the same 2008 pre-tax pension and postretirement expense, not including amounts in each year related to early retirement programs. A fifty basis point decrease in Altria Group, Inc.’s discount rate would increase Altria Group, Inc.’s pension and postretirement expense by approximately $51 million, whereas, a fifty basis point increase would lower expense by approximately $33 million. Similarly, a fifty basis point decrease (increase) in the expected return on plan assets would increase (decrease) Altria Group, Inc.’s pension expense by approximately $27 million. See Note 16 for a sensitivity discussion of the assumed health care cost trend rates.

 

 

Income Taxes – Altria Group, Inc. accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” Under SFAS No. 109, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Significant judgment is required in determining income tax provisions and in evaluating tax positions.

On January 1, 2007, Altria Group, Inc. adopted the provisions of FIN 48. The Interpretation prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. As a result of the January 1, 2007 adoption of FIN 48, Altria Group, Inc. lowered its liability for unrecognized tax benefits by $1,021 million. This

 

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resulted in an increase to stockholders’ equity of $857 million ($835 million, net of minority interest), a reduction of Kraft’s goodwill of $85 million and a reduction of federal deferred tax benefits of $79 million.

Altria Group, Inc. adopted the provisions of FASB Staff Position No. FAS 13-2, “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction” (“FAS 13-2”) effective January 1, 2007. This Staff Position requires the revenue recognition calculation to be reevaluated if there is a revision to the projected timing of income tax cash flows generated by a leveraged lease. The adoption of this Staff Position by Altria Group, Inc. resulted in a reduction to stockholders’ equity of $124 million as of January 1, 2007.

The tax provision in 2007 includes net tax benefits of $111 million related to the reversal of tax reserves and associated interest resulting from the expiration of statutes of limitations ($55 million in the third quarter and $56 million in the fourth quarter). The 2007 tax provision also includes the reversal in the fourth quarter of tax accruals of $57 million no longer required. The tax provision in 2006 includes $146 million of non-cash tax benefits principally representing the reversal of tax reserves after the U.S. IRS concluded its examination of Altria Group, Inc.’s consolidated tax returns for the years 1996 through 1999 in the first quarter of 2006. The tax provision in 2005 includes the impact of the domestic manufacturers’ deduction under the American Jobs Creation Act.

 

 

Hedging – As discussed below in “Market Risk,” Altria Group, Inc. uses derivative financial instruments principally to reduce exposures to market risks resulting from fluctuations in foreign exchange rates by creating offsetting exposures. Altria Group, Inc. meets the requirements of U.S. GAAP where it has elected to apply hedge accounting to derivatives. As a result, gains and losses on these derivatives are deferred in accumulated other comprehensive earnings (losses) and recognized in the consolidated statement of earnings in the periods when the related hedged transaction is also recognized in operating results. If Altria Group, Inc. had elected not to use and comply with the hedge accounting provisions permitted under U.S. GAAP, gains (losses) deferred in stockholders’ equity as of December 31, 2007, 2006 and 2005, would have been recorded in net earnings.

 

 

Impairment of Long-Lived Assets – Altria Group, Inc. reviews long-lived assets, including amortizable intangible assets, for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. Altria Group, Inc. performs undiscounted operating cash flow analyses to determine if an impairment exists. These analyses are affected by interest rates, general economic conditions and projected growth rates. For purposes of recognition and measurement of an impairment of assets held for use, Altria Group, Inc. groups assets and liabilities at the lowest level for which cash flows are separately identifiable. If an impairment is determined to exist, any related impairment loss is calculated based on fair value. Impairment losses on assets to be disposed of, if any, are based on the estimated proceeds to be received, less costs of disposal.

 

 

Leasing – Approximately 91% of PMCC’s net revenues in 2007 related to leveraged leases. Income relating to leveraged leases is recorded initially as unearned income, which is included in the line item finance assets, net, on Altria Group, Inc.’s consolidated balance sheets, and is subsequently recorded as net revenues over the life of the related leases at a constant after-tax rate of return. The remainder of PMCC’s net revenues consists primarily of amounts related to direct finance leases, with income initially recorded as unearned and subsequently recognized in net revenues over the life of the leases at a constant pre-tax rate of return. As discussed further in Note 8 to the consolidated financial statements, PMCC leases certain assets that were affected by bankruptcy filings.

PMCC’s investment in leases is included in the line item finance assets, net, on the consolidated balance sheets as of December 31, 2007 and 2006. At December 31, 2007, PMCC’s net finance receivable of $5.8 billion in leveraged leases, which is included in the line item on Altria Group, Inc.’s consolidated balance sheet of finance assets, net, consists of rents receivables ($19.4 billion) and the residual value of assets under lease ($1.5 billion), reduced by third-party nonrecourse debt ($12.8 billion) and unearned income ($2.3 billion). The repayment of the nonrecourse debt is collateralized by lease payments receivable and the leased property, and is nonrecourse to the general assets of PMCC. As required by

 

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U.S. GAAP, the third-party nonrecourse debt has been offset against the related rents receivable and has been presented on a net basis within the line item finance assets, net, in Altria Group, Inc.’s consolidated balance sheets. Finance assets, net, at December 31, 2007, also include net finance receivables for direct finance leases ($0.4 billion) and an allowance for losses ($0.2 billion).

Estimated residual values represent PMCC’s estimate at lease inception as to the fair value of assets under lease at the end of the lease term. The estimated residual values are reviewed annually by PMCC’s management based on a number of factors and activity in the relevant industry. If necessary, revisions to reduce the residual values are recorded. Such reviews resulted in decreases of $11 million and $14 million in 2007 and 2006, respectively, to PMCC’s net revenues and results of operations. Such residual reviews resulted in no adjustment in 2005. To the extent that lease receivables due PMCC may be uncollectible, PMCC records an allowance for losses against its finance assets. During 2007, PMCC recorded a pre-tax gain of $214 million on the sale of its ownership interests and bankruptcy claims in certain leveraged lease investments in aircraft, which represented a partial recovery, in cash, of amounts that had been previously written down. During 2006 and 2005, PMCC increased its allowance for losses by $103 million and $200 million, respectively, primarily in recognition of issues within the airline industry. It is possible that additional adverse developments may require PMCC to increase its allowance for losses in future periods.

 

Consolidated Operating Results

See pages 33 - - 36 for a discussion of Cautionary Factors That May Affect Future Results.

 

     Net Revenues  
     (in millions)  
     2007          2006          2005  

Cigarettes and other tobacco products

   $ 18,470        $ 18,474        $ 18,134  

Cigars

     15            

Financial services

     179          316          318  
                              

  Net revenues

   $ 18,664        $ 18,790        $ 18,452  
                              
                 Excise Taxes on Products              
     (in millions)  
     2007          2006          2005  

Cigarettes and other tobacco products

   $ 3,449        $ 3,617        $ 3,659  

Cigars

     3            
                              

  Excise taxes on products

   $ 3,452        $ 3,617        $ 3,659  
                              
                 Operating Income              
     (in millions)  
     2007          2006          2005  

Operating companies income:

            

  Cigarettes and other tobacco products

   $ 4,511        $ 4,812        $ 4,581  

  Cigars

     7            

  Financial services

     380          175          30  

General corporate expenses

     (525 )        (469 )        (507 )
                              

  Operating income

   $ 4,373        $ 4,518        $ 4,104  
                              

As discussed in Note 15. Segment Reporting, management reviews operating companies income, which is defined as operating income before general corporate expenses and amortization of intangibles, to evaluate segment performance and allocate resources. Management believes it is appropriate to disclose this measure to help investors analyze the business performance and trends of the various business segments.

The following events that occurred during 2007, 2006 and 2005 affected the comparability of statement of earnings amounts.

 

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Asset Impairment and Exit Costs – For the years ended December 31, 2007, 2006 and 2005, pre-tax asset impairment and exit costs consisted of the following:

 

            2007      2006      2005
          (in millions)

Separation program

  

Cigarettes and other

  tobacco products

     $ 309      $ 10      $     -

Separation program

  

General corporate

       17        32        49
                             

Total separation programs

          326        42        49
                             

Asset impairment

  

Cigarettes and other

  tobacco products

       35          

Asset impairment

  

General corporate

            10     
                             

Total asset impairment

          35        10        -
                             

Spin-off fees

  

General corporate

       81          
                             

Asset impairment and exit costs

     $ 442      $ 52      $ 49
                             

 

Manufacturing Optimization Program

In June 2007, Altria Group, Inc. announced plans by its tobacco subsidiaries to optimize worldwide cigarette production by moving U.S.-based cigarette production for non-U.S. markets to PMI facilities in Europe. Due to declining U.S. cigarette volume, as well as PMI’s decision to re-source its production, PM USA will close its Cabarrus, North Carolina manufacturing facility and consolidate manufacturing for the U.S. market at its Richmond, Virginia manufacturing center. PMI expects to shift all of its PM USA-sourced cigarette production, which approximates 57 billion cigarettes to PMI facilities in Europe by October 2008 and PM USA will close its Cabarrus manufacturing facility by the end of 2010.

As a result of this program, from 2007 through 2011, PM USA expects to incur total pre-tax charges of approximately $670 million, comprised of accelerated depreciation of $143 million (including the above mentioned asset impairment charge of $35 million recorded in 2007), employee separation costs of $353 million and other charges of $174 million, primarily related to the relocation of employees and equipment, net of estimated gains on sales of land and buildings. Approximately $440 million, or 66% of the total pre-tax charges, will result in cash expenditures. PM USA recorded total pre-tax charges of $371 million in 2007 related to this program. These charges were comprised of pre-tax asset impairment and exit costs of $344 million, and $27 million of pre-tax implementation costs associated with the program. The pre-tax implementation costs primarily related to accelerated depreciation and were included in cost of sales in the consolidated statement of earnings for the year ended December 31, 2007. Pre-tax charges of approximately $140 million are expected during 2008 for the program. The program is expected to generate annual pre-tax cost savings of approximately $156 million by 2011.

Corporate Asset Impairment and Exit Costs

In 2007, 2006 and 2005, general corporate pre-tax charges were $98 million, $42 million and $49 million, respectively. These charges were primarily related to investment banking and legal fees in 2007 associated with the Kraft and contemplated PMI spin-offs, as well as the streamlining of various corporate functions in each year.

 

 

Loss on Tobacco Pool – As further discussed in Note 19 to the consolidated financial statements, in October 2004, the Fair and Equitable Tobacco Reform Act of 2004 (“FETRA”) was signed into law. Under the provisions of FETRA, PM USA was obligated to cover its share of potential losses that the government may incur on the disposition of pool tobacco stock accumulated under the previous

 

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tobacco price support program. In 2005, PM USA recorded a $138 million pre-tax expense for its share of the loss, which is included in the operating companies income of the Cigarettes and other tobacco products segment.

 

 

Tobacco Quota Buy-Out – The provisions of FETRA require PM USA, along with other manufacturers and importers of tobacco products, to make quarterly payments that will be used to compensate tobacco growers and quota holders affected by the legislation. Payments made by PM USA under FETRA offset amounts due under the provisions of the National Tobacco Grower Settlement Trust (“NTGST”), a trust formerly established to compensate tobacco growers and quota holders. Disputes arose as to the applicability of FETRA to 2004 NTGST payments. During the third quarter of 2005, a North Carolina Supreme Court ruling determined that FETRA enactment had not triggered the offset provisions during 2004 and that tobacco companies were required to make full payment to the NTGST for the full year of 2004. The ruling, along with FETRA billings from the United States Department of Agriculture (“USDA”), established that FETRA was effective beginning in 2005. PM USA had accrued for 2004 FETRA charges and after the clarification of the court ruling, PM USA reversed a 2004 accrual for FETRA payments in the amount of $115 million, which is included in the operating companies income of the Cigarettes and other tobacco products segment.

 

 

Recoveries/Provision from/for Airline Industry Exposure – As discussed in Note 8 to the consolidated financial statements, during 2007, PMCC recorded pre-tax gains of $214 million on the sale of its ownership interests and bankruptcy claims in certain leveraged lease investments in aircraft, which represented a partial recovery, in cash, of amounts that had been previously written down. During 2006, PMCC increased its allowance for losses by $103 million, due to issues within the airline industry. During 2005, PMCC increased its allowance for losses by $200 million, reflecting its exposure to the airline industry, particularly Delta Air Lines, Inc. (“Delta”) and Northwest Airlines, Inc. (“Northwest”), both of which filed for bankruptcy protection during 2005.

 

 

Income Tax Benefit – The tax provision in 2007 included net tax benefits of $111 million related to the reversal of tax reserves and associated interest resulting from the expiration of statutes of limitations ($55 million in the third quarter and $56 million in the fourth quarter). The tax provision in 2007 also included the reversal in the fourth quarter of tax accruals of $57 million no longer required. The IRS concluded its examination of Altria Group, Inc.’s consolidated tax returns for the years 1996 through 1999, and issued a final Revenue Agent’s Report (“RAR”) on March 15, 2006. Consequently, in March 2006, Altria Group, Inc. recorded non-cash tax benefits of $1.0 billion, which principally represented the reversal of tax reserves following the issuance of and agreement with the RAR. Altria Group, Inc. reimbursed $337 million and $450 million in cash to Kraft and PMI, respectively, for their portion of the $1.0 billion related to federal tax benefits, as well as pre-tax interest of $46 million to Kraft. The total tax benefits related to Kraft and PMI, which included the above mentioned federal tax benefits, as well as state tax benefits of $74 million, were reclassified to earnings from discontinued operations. The tax reversal resulted in an increase to earnings from continuing operations of approximately $146 million for the year ended December 31, 2006.

 

 

Discontinued Operations – As a result of the Kraft spin-off, which is more fully discussed in Note 1. Background and Basis of Presentation, to the consolidated financial statements, and the PMI spin-off, which is more fully discussed in Note 21. Subsequent Events, to the consolidated financial statements, Altria Group, Inc., has reclassified and reflected the results of Kraft and PMI as discontinued operations on the consolidated statements of earnings and the consolidated statements of cash flows for all periods presented. The assets and liabilities related to PMI were reclassified and reflected as discontinued operations on the consolidated balance sheet for all periods presented. The assets and liabilities related to Kraft were reclassified and reflected as discontinued operations on the consolidated balance sheet at December 31, 2006.

 

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2007 compared with 2006

The following discussion compares consolidated operating results for the year ended December 31, 2007, with the year ended December 31, 2006.

Net revenues, which include excise taxes billed to customers, decreased $126 million (0.7%). Excluding excise taxes, net revenues increased $39 million (0.3%), due primarily to the higher revenues from the Cigarettes and other tobacco products segment and the impact of the John Middleton, Inc. acquisition, partially offset by lower revenues from the Financial services segment.

Excise taxes on products decreased $165 million (4.6%) due to lower volume in the Cigarettes and other tobacco products segment.

Cost of sales increased $440 million (6.0%), due primarily to higher ongoing resolution costs ($484 million).

Marketing, administration and research costs decreased $329 million (10.6%), due primarily to lower marketing expenses and lower general and administrative costs, both decreases reflecting productivity initiatives.

Operating income decreased $145 million (3.2%), due primarily to higher charges for asset impairment, exit and implementation costs, partially offset by higher operating results at PMCC as a result of cash recoveries in 2007 from assets which had previously been written down versus a provision in 2006 for its airline industry exposure, and higher operating results from the Cigarettes and other tobacco products segment.

Interest and other debt expense, net, of $205 million decreased $20 million, due primarily to lower debt levels, partially offset by lower interest income.

Altria Group, Inc.’s effective tax rate was unchanged at 33.1%. The 2007 effective tax rate includes net tax benefits of $111 million related to the reversal of tax reserves and associated interest resulting from the expiration of statutes of limitations ($55 million in the third quarter and $56 million in the fourth quarter). The tax provision in 2007 also includes the reversal in the fourth quarter of tax accruals of $57 million no longer required. The 2006 effective tax rate includes $146 million of non-cash tax benefits principally representing the reversal of tax reserves after the IRS concluded its examination of Altria Group, Inc.’s consolidated tax returns for the years 1996 through 1999 in the first quarter of 2006.

Earnings from continuing operations of $3.1 billion decreased $51 million (1.6%), due primarily to lower operating income, partially offset by higher equity earnings from SABMiller and lower interest and other debt expense, net. Diluted and basic EPS from continuing operations of $1.48 and $1.49, respectively, each decreased by 2.0%.

Earnings from discontinued operations, net of income taxes and minority interest (which represent the results of Kraft prior to the Kraft spin-off, and PMI), decreased $2.2 billion.

Net earnings of $9.8 billion decreased $2.2 billion (18.6%). Diluted and basic EPS from net earnings of $4.62 and $4.66, respectively, each decreased by 19.1%. These decreases reflect the spin-off of Kraft at the end of March 2007.

 

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2006 compared with 2005

The following discussion compares consolidated operating results for the year ended December 31, 2006, with the year ended December 31, 2005.

Net revenues, which include excise taxes billed to customers, increased $338 million (1.8%). Excluding excise taxes, net revenues increased $380 million (2.6%), due primarily to increases from the Cigarettes and other tobacco products segment.

Excise taxes on products decreased $42 million (1.1%), due primarily to lower volume in the Cigarettes and other tobacco products segment.

Cost of sales increased $113 million (1.6%), due primarily to higher leaf costs.

Marketing, administration and research costs decreased $26 million (0.8%), due primarily to lower corporate, and general and administrative expenses, partially offset by higher marketing expenses.

Operating income increased $414 million (10.1%), due primarily to higher operating results from the Cigarettes and other tobacco products segment, the 2005 charge for PM USA’s portion of the losses incurred by the federal government on disposition of its pool tobacco stock, and a lower provision for airline industry exposure at PMCC. These increases were partially offset by an unfavorable comparison with 2005, when PM USA benefited from the reversal of a 2004 accrual related to the tobacco quota buy-out legislation.

Interest and other debt expense, net, of $225 million decreased $202 million (47.3%), due primarily to lower debt levels and higher interest income.

Altria Group, Inc.’s effective tax rate decreased by 5.1 percentage points to 33.1%. The 2006 effective tax rate includes $146 million of non-cash tax benefits principally representing the reversal of tax reserves after the IRS concluded its examination of Altria Group, Inc.’s consolidated tax returns for the years 1996 through 1999 in the first quarter of 2006. The 2006 tax rate also includes benefits related to dividend repatriation.

Earnings from continuing operations of $3.2 billion increased $633 million (24.8%), due primarily to higher operating income, lower interest and other debt expense, net, and a lower effective tax rate. Diluted and basic EPS from continuing operations of $1.51 and $1.52, respectively, increased by 23.8% and 23.6%, respectively.

Earnings from discontinued operations, net of income taxes and minority interest, of $8.8 billion increased $954 million (12.1%), due to higher net earnings at PMI and Kraft.

Net earnings of $12.0 billion increased $1.6 billion (15.2%). Diluted and basic EPS from net earnings of $5.71 and $5.76, respectively, increased by 14.4% and 14.3%, respectively.

Operating Results by Business Segment

Tobacco

Business Environment

Taxes, Legislation, Regulation and Other Matters Regarding Tobacco and Smoking

The United States tobacco industry faces a number of challenges that may adversely affect the business, volume, results of operations, cash flows and financial position of ALG and our tobacco companies. These challenges, which are discussed below and in the Cautionary Factors That May Affect Future Results section, include:

 

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pending and threatened litigation and bonding requirements as discussed in Note 19. Contingencies (“Note 19”);

 

   

competitive disadvantages related to price increases attributable to the settlement of certain tobacco litigation;

 

   

actual and proposed excise tax increases;

 

   

the sale of counterfeit cigarettes by third parties;

 

   

the sale of tobacco products by third parties over the Internet and by other means designed to avoid the collection of applicable taxes;

 

   

price gaps and changes in price gaps between premium and lowest price brands;

 

   

diversion into one market of products intended for sale in another;

 

   

the outcome of proceedings and investigations, and the potential assertion of claims, relating to contraband shipments of cigarettes;

 

   

governmental investigations;

 

   

actual and proposed requirements regarding the use and disclosure of tobacco product ingredients, flavors and other proprietary information;

 

   

actual and proposed restrictions affecting tobacco manufacturing, marketing, advertising and sales;

 

   

governmental and private bans and restrictions on smoking;

 

   

the diminishing prevalence of smoking and increased efforts by tobacco control advocates to further restrict smoking;

 

   

governmental requirements setting ignition propensity standards for cigarettes; and

 

   

actual and proposed tobacco legislation and regulation.

In the ordinary course of business, our tobacco companies are subject to many influences that can impact the timing of sales to customers, including the timing of holidays and other annual or special events, the timing of promotions, customer incentive programs and customer inventory programs, as well as the actual or speculated timing of pricing actions and tax-driven price increases.

Excise Taxes: Tobacco products are subject to substantial excise taxes in the United States. Significant increases in tobacco-related taxes or fees have been proposed or enacted and are likely to continue to be proposed or enacted within the United States. Legislation has been passed by the United States Congress that would increase the federal excise tax on cigarettes by $0.61 a pack. The President has vetoed this legislation. It is not possible to predict whether such legislation will be reintroduced and become law.

Tax increases are expected to continue to have an adverse impact on sales of tobacco products by our tobacco subsidiaries, due to lower consumption levels and to a shift in consumer purchases from the premium to the non-premium or discount segments or to other low-priced or low-taxed tobacco products or to counterfeit and contraband products.

Tar and Nicotine Test Methods and Brand Descriptors: A number of public health organizations have determined that the existing standardized machine-based methods for measuring tar and nicotine yields in cigarettes do not provide useful information about tar and nicotine deliveries and that such results are

 

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misleading to smokers. For example, in the 2001 publication of Monograph 13, the U.S. National Cancer Institute (“NCI”) concluded that measurements based on the Federal Trade Commission (“FTC”) standardized method “do not offer smokers meaningful information on the amount of tar and nicotine they will receive from a cigarette” or “on the relative amounts of tar and nicotine exposure likely to be received from smoking different brands of cigarettes.” Thereafter, the FTC issued a press release indicating that it would be working with the NCI to determine what changes should be made to its testing method to “correct the limitations” identified in Monograph 13. In 2002, PM USA petitioned the FTC to promulgate new rules governing the use of existing standardized machine-based methodologies for measuring tar and nicotine yields and descriptors. That petition remains pending. In addition, the World Health Organization (“WHO”) has concluded that these standardized measurements are “seriously flawed” and that measurements based upon the current standardized methodology “are misleading and should not be displayed.” The International Organization for Standardization (“ISO”) established a working group, chaired by the WHO, to propose a new measurement method that would more accurately reflect human smoking behavior. PM USA has supported the concept of supplementing the ISO test method with a more intensive method, which PM USA believes would better illustrate the wide variability in the delivery of tar, nicotine and carbon monoxide, depending on how an individual smokes a cigarette.

In light of public health concerns about the limitations of current machine measurement methodologies, governments and public health organizations have increasingly challenged the use of descriptors — such as “light,” “mild,” and “low tar” — that are based on measurements produced by those methods. In addition, as discussed in Note 19, in August 2006, a federal trial court entered judgment in favor of the United States government in its lawsuit against various cigarette manufacturers and others, including PM USA and ALG, and enjoined the defendants from using brand descriptors, such as “lights,” “ultra-lights” and “low tar.” In October 2006, the Court of Appeals stayed enforcement of the judgment pending its review of the trial court’s decision.

Food and Drug Administration (“FDA”) Regulations: In February 2007, bipartisan legislation was introduced in the United States Senate and House of Representatives that, if enacted, would grant the FDA broad authority to regulate the design, manufacture and marketing of tobacco products and disclosures of related information. This legislation would also grant the FDA the authority to impose certain recordkeeping and reporting obligations to address counterfeit and contraband tobacco products and would impose fees to pay for the cost of regulation and other matters. ALG and PM USA support this legislation. In August 2007, the Senate Health, Education, Labor and Pensions Committee approved a revised version of this legislation. Whether Congress will grant the FDA broad authority over tobacco products, and the precise nature of that authority if granted, cannot be predicted.

Tobacco Quota Buy-Out: In October 2004, the Fair and Equitable Tobacco Reform Act of 2004 (“FETRA”) was signed into law. FETRA provides for the elimination of the federal tobacco quota and price support program through an industry-funded buy-out of tobacco growers and quota holders. The cost of the buy-out is approximately $9.5 billion and is being paid over 10 years by manufacturers and importers of each kind of tobacco product. The cost is being allocated based on the relative market shares of manufacturers and importers of each kind of tobacco product. The quota buy-out payments will offset already scheduled payments to the National Tobacco Grower Settlement Trust (the “NTGST”), a trust fund established in 1999 by four of the major domestic tobacco product manufacturers to provide aid to tobacco growers and quota holders. Manufacturers and importers of tobacco products are also obligated to cover any losses (up to $500 million) that the government may incur on the disposition of tobacco pool stock accumulated under the previous tobacco price support program. PM USA has paid $138 million for its share of the tobacco pool stock losses. For a discussion of the NTGST, see Note 19. The quota buy-out did not have a material adverse impact on the Altria Group, Inc.’s consolidated results in 2007 and Altria Group, Inc. does not anticipate that the quota buyout will have a material adverse impact on its consolidated results in 2008 and beyond.

The WHO’s Framework Convention on Tobacco Control (“FCTC”): The FCTC entered into force on February 27, 2005. As of January 2008, 152 countries, as well as the European Community, have become parties to the FCTC. The FCTC is the first international public health treaty and its objective is to establish a global agenda for tobacco regulation with the purpose of reducing initiation of tobacco use and

 

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encouraging cessation. The treaty recommends (and in certain instances, requires) signatory nations to enact legislation that would, among other things:

 

   

establish specific actions to prevent youth smoking;

 

   

restrict and/or eliminate all tobacco product advertising, marketing, promotions and sponsorships;

 

   

initiate public education campaigns to inform the public about the health consequences of smoking and the benefits of quitting;

 

   

implement regulations imposing product testing, disclosure and performance standards;

 

   

impose health warning requirements on packaging;

 

   

adopt measures that would eliminate cigarette smuggling and counterfeit cigarettes;

 

   

restrict smoking in public places;

 

   

implement fiscal policies (tax and price increases);

 

   

adopt and implement measures that ensure that descriptive terms do not create the false impression that one brand of cigarettes is safer than another;

 

   

phase out duty-free tobacco sales; and

 

   

encourage litigation against tobacco product manufacturers.

In addition, some of the proposals currently under consideration by the Conference of the Parties, the governing body of the FCTC, could have the potential to substantially restrict the ability of our tobacco subsidiaries to manufacture and market their products. It is not possible to predict the outcome of regulations under consideration.

Ingredient Laws: Some Jurisdictions in the United States have enacted or proposed legislation or regulations that would require tobacco product manufacturers to disclose to the government and, in some instances, publicly the ingredients used in the manufacture of tobacco products and, in certain cases, to provide toxicological information. In some jurisdictions, governments have prohibited the use of certain ingredients, and proposals have been discussed to further prohibit or limit the use of ingredients and flavors.

Laws Addressing Flavor Varieties or Characterizing Flavors: In certain states, legislation has been proposed which would prohibit the sale of certain flavor varieties of tobacco products or tobacco products with characterizing flavors. The proposed legislation varies in terms of the type of tobacco products subject to prohibition, the conditions under which the sale of such products would be prohibited, and exceptions to the prohibitions. To date, Maine is the only state in which such a prohibition has been enacted, but its provisions affecting cigarette and cigar products do not take effect until July 1, 2009, and covered products also may be granted exemptions under that state’s law. Whether other states will enact legislation in this area, and the precise nature of such legislation if enacted, cannot be predicted.

Bans and Restrictions on Advertising, Marketing, Promotions and Sponsorships: For many years, some legislators and public health groups have called for bans of product displays and for generic packaging. PM USA opposes complete bans on advertising, but supports limitations on marketing, provided that the limitations are within constitutional constraints and manufacturers are able to communicate appropriately with adult smokers.

Health Warning Requirements: Health warnings on tobacco product packs are required in the United States. PM USA supports and complies with health warning requirements. PM USA does not support warning

 

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sizes that deprive it of the ability to use their distinctive trademarks and pack designs which differentiate its products from those of its competitors.

Health Effects of Smoking and Exposure to Environmental Tobacco Smoke (“ETS”): Reports with respect to the health effects of cigarette smoking have been publicized for many years, including in a June 2006 United States Surgeon General report on ETS entitled “The Health Consequences of Involuntary Exposure to Tobacco Smoke.” Many countries have restricted smoking in public places. The pace and scope of public smoking bans has increased significantly. Some public health groups have called for, and some jurisdictions have adopted or proposed, bans on smoking in outdoor places, and some tobacco control groups have advocated banning smoking in cars with minors in them.

It is not possible to predict the results of ongoing scientific research or the types of future scientific research into the health risks of tobacco exposure. Although most regulation of ETS exposure to date has been done at the local level through bans in public establishments, the State of California is in the process of regulating ETS exposure in the ambient air at the state level. In January 2006, the California Air Resources Board (“CARB”) listed ETS as a toxic air contaminant under state law. CARB is now required to consider the adoption of appropriate control measures utilizing “best available control technology” in order to reduce public exposure to ETS in outdoor air to the “lowest level achievable.” In addition, in June 2006, the California Office of Environmental Health Hazard Assessment (“OEHHA”) listed ETS as a contaminant known to the State of California to cause reproductive toxicity. Consequently, under California Proposition 65, businesses employing 10 or more persons must post warning signs in certain areas stating that ETS is known to the State of California to be a reproductive toxicant.

It is the policy of PM USA to support a single, consistent public health message on the health effects of cigarette smoking in the development of diseases in smokers, smoking and addiction, and on exposure to ETS. It is also PM USA’s policy to defer to the judgment of public health authorities as to the content of warnings in advertisements and on product packaging regarding the health effects of smoking, addiction and exposure to ETS.

PM USA has established a website that includes, among other things, the views of public health authorities on smoking, disease causation in smokers, addiction and ETS. The site reflects PM USA’s agreement with the medical and scientific consensus that cigarette smoking is addictive, and causes lung cancer, heart disease, emphysema and other serious diseases in smokers. The website advises smokers, and those considering smoking, to rely on the messages of public health authorities in making all smoking-related decisions. The website address is www.philipmorrisusa.com. The information on PM USA’s website is not, and shall not be deemed to be, a part of this document or incorporated into any filings ALG makes with the Securities and Exchange Commission.

Testing and Reporting of Other Smoke Constituents: In addition to tar, nicotine and carbon monoxide, public health authorities have classified between 45 and 70 other smoke constituents as potential causes of tobacco-related diseases. PM USA measures most of these constituents for its product research and development purposes. However, the capacity to conduct by-brand testing on a national basis does not exist today, and the cost of by-brand annual testing would be significant.

Reduced Cigarette Ignition Propensity Legislation: Legislation or regulation requiring cigarettes to meet reduced ignition propensity standards is being considered in many states, at the federal and local levels. New York State implemented ignition propensity standards in June 2004. To date, the same standards have been enacted by twenty-one other states, effective as follows: Vermont (May 2006), California (January 2007), Oregon (April 2007), New Hampshire (October 2007), Illinois (January 2008), Maine (January 2008), Massachusetts (January 2008), Kentucky (April 2008), Montana (May 2008), Alaska (August 2008), New Jersey (June 2008), Maryland (July 2008), Utah (July 2008), Connecticut (July 2008), Rhode Island (August 2008), Delaware (January 2009), Iowa (January 2009), Minnesota (January 2009), Texas (January 2009), Louisiana (August 2009) and North Carolina (January 2010). PM USA supports the enactment of federal legislation mandating a uniform and technically feasible national standard for reduced ignition propensity cigarettes that would preempt state standards and apply to all cigarettes sold in the United States. Although PM USA believes that a national standard is the most appropriate way to address the issue, it has

 

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been actively supporting the adoption of laws at the state level that require all manufacturers to comply with the standard first adopted in New York.

Illicit Trade: Regulatory measures and related governmental actions to prevent the illicit manufacture and trade of tobacco products are being considered by a number of jurisdictions. PM USA supports strict regulations and enforcement measures to prevent all forms of illicit trade in tobacco products. PM USA agrees that manufacturers should implement monitoring systems of their sales and distribution practices, and that where appropriately confirmed, manufacturers should stop supplying vendors who have knowingly engaged in illicit trade. For example, PM USA is engaged in a number of initiatives to help prevent contraband trade in cigarettes, including: enforcement of PM USA wholesale and retail trade policies on trade in contraband cigarettes and Internet/remote sales; engagement with and support of law enforcement and regulatory agencies; litigation to protect the Company’s trademarks; and support for federal and state legislation. PM USA’s legislative initiatives to address contraband trade in cigarettes are designed to better control and protect the legitimate channels of distribution, impose more stringent penalties for the violation of laws and provide additional tools for law enforcement.

State Settlement Agreements: As discussed in Note 19, during 1997 and 1998, PM USA and other major domestic tobacco product manufacturers entered into agreements with states and various United States jurisdictions settling asserted and unasserted health care cost recovery and other claims. These settlements require PM USA to make substantial annual payments. The settlements also place numerous restrictions on PM USA’s business operations, including prohibitions and restrictions on the advertising and marketing of cigarettes. Among these are prohibitions of outdoor and transit brand advertising; payments for product placement; and free sampling (except in adult-only facilities). Restrictions are also placed on the use of brand name sponsorships and brand name non-tobacco products. The State Settlement Agreements also place prohibitions on targeting youth and the use of cartoon characters. In addition, the State Settlement Agreements require companies to affirm corporate principles directed at reducing underage use of cigarettes; impose requirements regarding lobbying activities; mandate public disclosure of certain industry documents; limit the industry’s ability to challenge certain tobacco control and underage use laws; and provide for the dissolution of certain tobacco-related organizations and place restrictions on the establishment of any replacement organizations.

Other Legislation or Governmental Initiatives: Legislative and regulatory initiatives affecting the tobacco industry have been adopted or are being considered in a number of jurisdictions. In recent years, various members of federal and state governments have introduced legislation that would subject cigarettes and other tobacco products to various regulations; restrict or eliminate the use of descriptors for cigarettes such as “lights” or “ultra lights;” establish educational campaigns relating to tobacco consumption or tobacco control programs, or provide additional funding for governmental tobacco control activities; further restrict the advertising of cigarettes and other tobacco products; require additional warnings, including graphic warnings, on packages and in advertising of cigarettes and other tobacco products; eliminate or reduce the tax deductibility of tobacco product advertising; provide that the Federal Cigarette Labeling and Advertising Act and the Smoking Education Act not be used as a defense against liability under state statutory or common law; allow state and local governments to restrict the use of flavors in tobacco products; and allow state and local governments to restrict the sale and distribution of tobacco products.

It is not possible to predict what, if any, additional legislation, regulation or other governmental action will be enacted or implemented relating to the manufacturing, advertising, sale or use of tobacco products, or the tobacco industry generally. It is possible, however, that legislation, regulation or other governmental action could be enacted or implemented in the United States that might materially affect the business, volume, results of operations and cash flows of our tobacco subsidiaries, and ultimately their parent, ALG.

 

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Governmental Investigations: From time to time, ALG and its subsidiaries are subject to governmental investigations on a range of matters. In this regard, ALG believes that Canadian authorities are contemplating a legal proceeding based on an investigation of ALG entities relating to allegations of contraband shipments of cigarettes into Canada in the early to mid-1990s. ALG and its subsidiaries cannot predict the outcome of this investigation or whether additional investigations may be commenced.

Manufacturing Optimization Program:

In June 2007, Altria Group, Inc. announced plans by its tobacco subsidiaries to optimize worldwide cigarette production by moving U.S.-based cigarette production for non-U.S. markets to PMI facilities in Europe. Due to declining U.S. cigarette volume, as well as PMI’s decision to re-source its production, PM USA will close its Cabarrus, North Carolina manufacturing facility and consolidate manufacturing for the U.S. market at its Richmond, Virginia manufacturing center. PMI expects to shift all of its PM USA-sourced cigarette production, which approximates 57 billion cigarettes, to PMI facilities in Europe by October 2008, and PM USA will close its Cabarrus manufacturing facility by the end of 2010.

As a result of this program, from 2007 through 2011, PM USA expects to incur total pre-tax charges of approximately $670 million, comprised of accelerated depreciation of $143 million, employee separation costs of $353 million and other charges of $174 million, primarily related to the relocation of employees and equipment, net of estimated gains on sales of land and buildings. Approximately $440 million, or 66% of the total pre-tax charges, will result in cash expenditures. PM USA recorded total pre-tax charges of $371 million in 2007 related to this program. These charges were comprised of pre-tax asset impairment and exit costs of $344 million, and $27 million of pre-tax implementation costs associated with the program. The pre-tax implementation costs primarily related to accelerated depreciation and were included in cost of sales in the consolidated statement of earnings for the year ended December 31, 2007. Pre-tax charges of approximately $140 million are expected during 2008 for the program. In addition, the program will entail capital expenditures of approximately $230 million.

The program is expected to generate annual pre-tax cost savings of approximately $156 million by 2011.

Acquisition

As discussed in Note 5. Acquisition, to the consolidated financial statements, the following acquisition occurred during 2007.

On December 11, 2007, in conjunction with PM USA’s adjacency strategy, Altria Group, Inc. acquired 100% of John Middleton, Inc., a leading manufacturer of machine-made large cigars, for $2.9 billion in cash. The acquisition was financed with existing cash. John Middleton, Inc.’s balance sheet has been consolidated with Altria Group, Inc.’s as of December 31, 2007. Earnings from December 12, 2007 to December 31, 2007 have been included in Altria Group, Inc.’s consolidated operating results.

 

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Operating Results

 

       Net Revenues      Operating
        Companies Income        
                     (in millions)              
       2007      2006      2005      2007      2006      2005

Cigarettes and other tobacco products

     $ 18,470      $ 18,474      $ 18,134      $ 4,511      $ 4,812      $ 4,581

Cigars

       15                  7          
                                                     

   Total tobacco

     $ 18,485      $ 18,474      $ 18,134      $ 4,518      $ 4,812      $ 4,581
                                                     

2007 compared with 2006

The following discussion compares tobacco operating results for 2007 with 2006.

Cigarettes and other tobacco products.    Net revenues, which include excise taxes billed to customers, decreased $4 million. Excluding excise taxes, net revenues increased $164 million (1.1%) to $15.0 billion, due primarily to lower wholesale promotional allowance rates ($1.1 billion), partially offset by lower volume ($906 million).

Operating companies income decreased $301 million (6.3%), due primarily to lower volume ($608 million) and higher pre-tax charges in 2007 for asset impairment, exit and implementation costs related to the announced closing of the Cabarrus, North Carolina cigarette manufacturing facility ($361 million), partially offset by lower wholesale promotional allowance rates, net of higher ongoing resolution costs ($329 million) and lower marketing, administration and research costs ($311 million, net of a $26 million provision for the Scott case in Louisiana in 2007). Lower marketing, administration and research costs primarily reflect productivity savings in marketing, and general and administrative expenses.

Marketing, administration and research costs include PM USA’s cost of administering and litigating product liability claims. Litigation defense costs are influenced by a number of factors, as more fully discussed in Note 19. Principal among these factors are the number and types of cases filed, the number of cases tried annually, the results of trials and appeals, the development of the law controlling relevant legal issues, and litigation strategy and tactics. For the years ended December 31, 2007, 2006 and 2005, product liability defense costs were $200 million, $195 million and $258 million, respectively. The factors that have influenced past product liability defense costs are expected to continue to influence future costs. PM USA does not expect that product liability defense costs will increase significantly in the future.

PM USA’s shipment volume was 175.1 billion units, a decrease of 4.6% or 8.3 billion units, but was estimated to be down approximately 3.6% when adjusted for changes in trade inventories and calendar differences. For the full year 2007, PM USA estimates a decline of about 4% in total cigarette industry volume. In the premium segment, PM USA’s shipment volume decreased 4.3%. Marlboro shipment volume decreased 5.9 billion units (3.9%) to 144.4 billion units. In the discount segment, PM USA’s shipment volume also decreased, with Basic shipment volume down 8.8% to 13.2 billion units. PM USA estimates that cigarette consumption in 2008 may decline by 2.5% to 3.0%.

 

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The following table summarizes PM USA’s cigarette volume performance by brand for 2007 and 2006:

 

   

For the Years Ended

December 31,

         2007      2006    
             (in billion units)    

Marlboro

     144.4      150.3  

Parliament

     6.0      6.0  

Virginia Slims

     7.0      7.5  

Basic

     13.2      14.5  
               

Focus on Four Brands

     170.6      178.3  

Other

     4.5      5.1  
               

Total PM USA

     175.1      183.4  
               

The following table summarizes PM USA’s retail share performance, based on data from the IRI/Capstone Total Retail Panel, which is a tracking service that uses a sample of stores to project market share performance in retail stores selling cigarettes. This panel was not designed to capture sales through other channels, including Internet and direct mail:

 

   

For the Years Ended

December 31,

         2007        2006      

Marlboro

     41.0 %      40.5 %  

Parliament

     1.9        1.8    

Virginia Slims

     2.2        2.3    

Basic

     4.1        4.2    
                   

Focus on Four Brands

     49.2        48.8    

Other

     1.4        1.5    
                   

Total PM USA

     50.6 %      50.3 %  
                   

Effective September 10, 2007, PM USA reduced its wholesale promotional allowances on Marlboro, Parliament and Basic by $0.50 per carton, from $4.00 to $3.50, and Virginia Slims by $2.00 per carton, from $4.00 to $2.00. In addition, PM USA raised the price on its other brands by $2.50 per thousand cigarettes or $0.50 per carton effective September 10, 2007 and by $9.95 per thousand cigarettes or $1.99 per carton effective February 12, 2007.

Effective December 18, 2006, PM USA reduced its wholesale promotional allowance on its Focus on Four brands by $1.00 per carton, from $5.00 to $4.00, and increased the price of its other brands by $1.00 per carton.

Effective December 19, 2005, PM USA reduced its wholesale promotional allowance on its Focus on Four brands by $0.50 per carton, from $5.50 to $5.00. In addition, effective December 27, 2005, PM USA increased the price of its other brands by $2.50 per thousand cigarettes or $0.50 per carton.

PM USA anticipates that U.S. industry volume will decline by approximately 2.5% to 3.0% annually over the next few years. PM USA cannot predict the relative sizes of the premium and discount segments or its shipment or retail market share. PM USA believes that its results may be materially adversely affected by the items discussed under the caption Tobacco—Business Environment.

Cigars. On December 11, 2007, in conjunction with ALG’s and PM USA’s adjacency strategy, Altria Group, Inc. acquired 100% of John Middleton, Inc., a leading manufacturer of machine-made large cigars, for $2.9 billion in cash. The acquisition was financed with existing cash. John Middleton, Inc.’s balance sheet has been consolidated with Altria Group, Inc.’s as of December 31, 2007. Earnings from December 12, 2007 to December 31, 2007 have been included in Altria Group, Inc.’s consolidated operating results.

 

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2006 compared with 2005

The following discussion compares tobacco operating results for 2006 with 2005.

Cigarettes and other tobacco products.    Net revenues, which include excise taxes billed to customers, increased $340 million (1.9%). Excluding excise taxes, net revenues increased $382 million (2.6%) to $14.9 billion, due primarily to lower wholesale promotional allowance rates ($604 million), partially offset by lower volume ($239 million).

Operating companies income increased $231 million (5.0%), due primarily to lower wholesale promotional allowance rates, net of higher ongoing resolution costs ($424 million) and several other items (aggregating $79 million), partially offset by lower volume ($170 million), higher fixed manufacturing costs ($47 million) and higher marketing, administration and research costs (including spending in 2006 for various excise tax ballot initiatives). The other items reflect a pre-tax provision in 2005 for the Boeken individual smoking case ($56 million) and the previously mentioned 2005 net charges related to tobacco quota buy-out legislation ($23 million).

PM USA’s shipment volume was 183.4 billion units, a decrease of 1.1%, but was estimated to be down approximately 1.5% when adjusted for trade inventory changes and the timing of promotional shipments. In the premium segment, PM USA’s shipment volume decreased 0.7%. Marlboro shipment volume decreased 0.2 billion units (0.2%) to 150.3 billion units. In the discount segment, PM USA’s shipment volume decreased 6.2%, while Basic shipment volume was down 5.0% to 14.5 billion units.

The following table summarizes PM USA’s cigarette volume performance by brand for 2006 and 2005:

 

        For the Years Ended    
December 31,
     2006    2005   
     (in billion units)   

Marlboro

     150.3    150.5   

Parliament

     6.0    5.8   

Virginia Slims

     7.5    7.9   

Basic

     14.5    15.2   
              

Focus on Four Brands

     178.3    179.4   

Other

     5.1    6.1   
              

Total PM USA

     183.4    185.5   
              

The following table summarizes PM USA’s retail share performance, based on data from the IRI/Capstone Total Retail Panel, which is a tracking service that uses a sample of stores to project market share performance in retail stores selling cigarettes. The panel was not designed to capture sales through other channels, including Internet or direct mail:

 

        For the Years Ended    
December 31,
     2006     2005    

Marlboro

     40.5 %   40.0 %  

Parliament

     1.8     1.7    

Virginia Slims

     2.3     2.3    

Basic

     4.2     4.3    
                

Focus on Four Brands

     48.8     48.3    

Other

     1.5     1.7    
                

Total PM USA

     50.3 %   50.0 %  
                

 

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Financial Services

Business Environment

In 2003, PMCC shifted its strategic focus and is no longer making new investments but is instead focused on managing its existing portfolio of finance assets in order to maximize gains and generate cash flow from asset sales and related activities. Accordingly, PMCC’s operating companies income will fluctuate over time as investments mature or are sold. During 2007, 2006 and 2005, proceeds from asset sales, maturities and bankruptcy recoveries totaled $486 million, $357 million and $476 million, respectively, and gains totaled $274 million, $132 million and $72 million, respectively, in operating companies income.

Included in the proceeds for 2007 were partial recoveries of amounts previously charged to earnings in the allowance for losses related to PMCC’s airline exposure. The operating companies income associated with these recoveries, which is included in the gains shown above, was $214 million for the year ended December 31, 2007.

PMCC leases one 750 megawatt (“MW”) natural gas-fired power plant (located in Pasadena, Texas) to an indirect subsidiary of Calpine Corporation (“Calpine”). Calpine, which has guaranteed the lease, was operating under bankruptcy protection at December 31, 2007. The subsidiary was not included as part of the bankruptcy filing of Calpine. PMCC does not record income on leases when the lessee or its guarantor is in bankruptcy. At December 31, 2007, PMCC’s finance asset balance for this lessee was $60 million. Based on PMCC’s assessment of the prospect for recovery on the Pasadena plant, a portion of the outstanding finance asset balance has been provided for in the allowance for losses. In July 2007, PMCC’s interest in two 265 MW natural gas-fired power plants (located in Tiverton, Rhode Island, and Rumford, Maine), which were part of the bankruptcy filing, were foreclosed upon. These leases were rejected and written off during 2006.

None of PMCC’s aircraft lessees are operating under bankruptcy protection at December 31, 2007. One of PMCC’s aircraft lessees, Northwest Airlines, Inc. (“Northwest”), exited bankruptcy on May 31, 2007 and assumed PMCC’s leveraged leases for three Airbus A-320 aircraft. PMCC’s leases for 19 aircraft with Delta Air Lines, Inc. (“Delta”) were sold in early 2007.

The activity in the allowance for losses on finance assets for the years ended December 31, 2007, 2006 and 2005 was as follows (in millions):

 

     2007     2006     2005  

Balance at beginning of the year

   $480     $596     $497  

Amounts (recovered)/charged to earnings

   (129 )   103     200  

Amounts written-off

   (147 )   (219 )   (101 )
                  

Balance at end of the year

   $204     $480     $596  
                  

The net impact to the allowance for losses in 2007, 2006 and 2005 related primarily to various airline leases. Amounts recovered of $129 million in 2007 related to partial recoveries of amounts charged to earnings in the allowance for losses in prior years. In addition, PMCC recovered $85 million related to amounts previously charged to earnings and written-off in prior years. In total, these recoveries resulted in additional operating companies income of $214 million for the year ended December 31, 2007. As a result of the $200 million charge in 2005, PMCC’s fixed charges coverage ratio did not meet its 1.25:1 requirement under a support agreement with ALG. Accordingly, as required by the support agreement, a support payment of $150 million was made by ALG to PMCC in September 2005. It is possible that additional adverse developments may require PMCC to increase its allowance for losses. Acceleration of taxes on the foreclosures of leveraged leases written-off amounted to approximately $50 million and $80 million in 2007 and 2006, respectively. There were no foreclosures in 2005.

As discussed further in Note 14. Income Taxes, the IRS has disallowed benefits pertaining to several PMCC leverage lease transactions for the years 1996 through 1999.

 

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Operating Results

 

           Net Revenues            Operating
    Companies Income    
     (in millions)
   2007      2006      2005      2007      2006      2005

Financial Services

   $179      $316      $318      $380      $175      $30
                                       

PMCC’s net revenues for 2007 decreased $137 million (43.4%) from 2006, due primarily to lower lease revenues due to lower investment balances, and to lower gains from asset management activity. PMCC’s operating companies income for 2007 of $380 million increased $205 million (100.0+%) from 2006, due primarily to cash recoveries in 2007 on aircraft leases previously written down versus an increase to the loss provision in 2006, partially offset by lower revenues.

PMCC’s net revenues for 2006 decreased $2 million (0.6%) from 2005, due primarily to lower lease revenues as a result of lower investment balances, partially offset by higher gains from asset sales. PMCC’s operating companies income for 2006 of $175 million increased $145 million (100.0+%) from 2005. Operating companies income for 2006 includes a $103 million increase to the provision for airline industry exposure as discussed above, a decrease of $97 million from the 2005 provision, and higher gains from asset sales.

Financial Review

Net Cash Provided by Operating Activities, Continuing Operations

During 2007, net cash provided by operating activities on a continuing operations basis was $4.6 billion, compared with $3.6 billion during 2006. The increase in cash provided by operating activities was due primarily to the 2006 reimbursements of PMI’s and Kraft’s portions of federal income tax benefits related to the RAR, higher accrued settlement charges and lower pension plan contributions, partially offset by lower returns of escrow bond deposits.

During 2006, net cash provided by operating activities on a continuing operations basis was $3.6 billion, compared with $2.4 billion during 2005. The increase in cash provided by operating activities was due primarily to the return of the escrow bond deposit related to the Price tobacco case and lower pension plan contributions, partially offset by the 2006 reimbursements of PMI’s and Kraft’s portions of federal income tax benefits related to the RAR.

Net Cash (Used in) Provided by Investing Activities, Continuing Operations

ALG and PM USA from time to time consider acquisitions as part of their adjacency strategy. On December 11, 2007, in conjunction with this adjacency strategy, Altria Group, Inc. acquired 100% of John Middleton, Inc., a leading manufacturer of machine-made large cigars, for $2.9 billion in cash. The acquisition was financed with existing cash.

During 2007 and 2006, net cash used in investing activities on a continuing operations basis was $2.7 billion and $63 million, respectively. During 2005, net cash of $212 million was provided by investing activities on a continuing operations basis. In 2007, the net cash used primarily reflects the purchase of John Middleton, Inc. The net cash provided in 2005 reflects higher proceeds from finance assets.

Capital expenditures for 2007 decreased 3.3% to $386 million. The expenditures were primarily for modernization and consolidation of manufacturing facilities, expansion of research and development, and expansion of certain production capacity. Capital expenditures for 2008 are expected to be slightly below 2007 expenditures, and are expected to be funded by operating cash flows.

 

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Net Cash (Used in) Provided by Financing Activities, Continuing Operations

During 2007 and 2006, net cash used in financing activities on a continuing operations basis was $148 million and $5.2 billion, respectively. During 2005 net cash of $1.8 billion was provided by financing activities on a continuing operations basis. The decrease of $5.1 billion from 2006 was due primarily to higher dividends received from PMI in 2007 and to lower repayments of debt in 2007. The increase in cash used of $7.0 billion from 2005 to 2006 was due primarily to lower dividends received from PMI in 2006 and higher repayments of debt in 2006. ALG received a final dividend payment from PMI in the first quarter of 2008.

Debt and Liquidity

Credit Ratings – At December 31, 2007, ALG’s debt ratings by major credit rating agencies were as follows:

 

     Short-term    Long-term    Outlook

Moody’s

   P-2    Baa1    Stable

Standard & Poor’s

   A-2    BBB    Stable

Fitch

   F-2      BBB+    Stable

On January 30, 2008, the major credit rating agencies listed in the table above affirmed ALG's debt ratings following the announcement of the PMI spin-off, and Fitch upgraded ALG’s outlook to positive.

Credit Lines – ALG maintains revolving credit facilities. ALG intends to use its revolving credit facilities to support the issuance of commercial paper.

ALG has a 364-day revolving credit facility in the amount of $1.0 billion, which expires on March 27, 2008. In addition, ALG maintains a multi-year credit facility in the amount of $4.0 billion, which expires April 15, 2010. The ALG facilities require the maintenance of an earnings to fixed charges ratio, as defined by the agreements, of not less than 2.5 to 1.0. At December 31, 2007, the ratio calculated in accordance with the agreements was 19.6 to 1.0. After the effectiveness of the spin-off of PMI, ALG’s multi-year credit facility was reduced from $4.0 billion to $3.5 billion and the earnings to fixed charges ratio was replaced with a ratio of EBITDA to interest expense of not less than 4.0 to 1.0. In addition, the facility now requires the maintenance of a ratio of debt to EBITDA of not more than 2.5 to 1.0. If the PMI spin-off had occurred as of December 31, 2007, the ratio of EBITDA to interest expense would have been 15.6 to 1.0, and the ratio of debt to EBITDA would have been 0.9 to 1.0. On January 28, 2008, Altria Group, Inc. entered into a $4.0 billion, 364-day bridge loan facility to finance the tender offers and consent solicitation expenses related to its outstanding consumer products debt. The tender offers, however, were financed with existing cash and Altria Group, Inc. has not borrowed under this bridge loan agreement. The agreement contains the same covenants mentioned above, and is required to be prepaid or reduced by the net proceeds of any capital markets transactions.

ALG expects to continue to meet its covenants. These facilities do not include any credit rating triggers or any provisions that could require the posting of collateral.

At December 31, 2007, credit lines for ALG, and the related activity, were as follows (in billions of dollars):

 

ALG    December 31, 2007
Type   

Credit

Lines

  

Amount

Drawn

  

Commercial

Paper

Outstanding

  

Lines

Available

364-day revolving credit, expiring 3/27/08

   $ 1.0    $ -    $ -    $ 1.0

Multi-year revolving credit, expiring 4/15/10

     4.0            4.0
                           
   $ 5.0    $ -    $ -    $ 5.0
                           

 

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Debt – Altria Group, Inc.’s total debt (consumer products and financial services) was $4.7 billion and $5.7 billion at December 31, 2007 and 2006, respectively. Total consumer products debt was $4.2 billion and $4.6 billion at December 31, 2007 and 2006, respectively. Fixed-rate debt constituted approximately 97% of total consumer products debt at December 31, 2007 and 2006. The weighted average interest rate on total consumer products debt, including the impact of swap agreements, was approximately 6.1% and 6.2% at December 31, 2007 and 2006, respectively.

During the first quarter of 2008, Altria Group, Inc. and its subsidiary, Altria Finance (Cayman Islands) Ltd. completed tender offers to purchase for cash $2.3 billion of notes and debentures denominated in U.S. dollars and €373 million in euro-denominated bonds, equivalent to $568 million in U.S. dollars. The tender offers and consent solicitations resulted in charges of $393 million in the first quarter of 2008. In order to finance the tender offers, Altria Group, Inc. arranged a $4.0 billion, 364-day bridge loan facility. The tender offers, however, were paid with existing cash. Subsequent to the spin-off, Altria Group, Inc. intends to issue new public debt for general corporate purposes, including its share repurchase program, if market conditions permit.

Taxes – The IRS concluded its examination of Altria Group, Inc.’s consolidated tax returns for the years 1996 through 1999, and issued a final RAR on March 15, 2006. Altria Group, Inc. agreed with the RAR, with the exception of certain leasing matters discussed below. Consequently, in March 2006, Altria Group, Inc. recorded non-cash tax benefits of $1.0 billion, which principally represented the reversal of tax reserves following the issuance of and agreement with the RAR. Altria Group, Inc. reimbursed $337 million and $450 million in cash to Kraft and PMI, respectively, for their portion of the $1.0 billion related to federal tax benefits, as well as pre-tax interest of $46 million to Kraft. The total tax benefits related to Kraft and PMI, which included the above mentioned federal tax benefits, as well as state tax benefits of $74 million, were reclassified to earnings from discontinued operations. The tax reversal resulted in an increase to earnings from continuing operations of $146 million for the year ended December 31, 2006.

Altria Group, Inc. has agreed with all conclusions of the RAR, with the exception of the disallowance of benefits pertaining to several PMCC leveraged lease transactions for the years 1996 through 1999. PMCC will continue to assert its position regarding these leveraged lease transactions and contest approximately $150 million of tax and net interest assessed and paid with regard to them. The IRS may in the future challenge and disallow more of PMCC’s leveraged leases based on Revenue Rulings, an IRS Notice and subsequent case law addressing specific types of leveraged leases (lease-in/lease-out (“LILO”) and sale-in/lease-out (“SILO”) transactions). PMCC believes that the position and supporting case law described in the RAR, Revenue Rulings and the IRS Notice are incorrectly applied to PMCC’s transactions and that its leveraged leases are factually and legally distinguishable in material respects from the IRS’s position. PMCC and ALG intend to vigorously defend against any challenges based on that position through litigation. In this regard, on October 16, 2006, PMCC filed a complaint in the U.S. District Court for the Southern District of New York to claim refunds for a portion of these tax payments and associated interest. However, should PMCC’s position not be upheld, PMCC may have to accelerate the payment of significant amounts of federal income tax and significantly lower its earnings to reflect the recalculation of the income from the affected leveraged leases, which could have a material effect on the earnings and cash flows of Altria Group, Inc. in a particular fiscal quarter or fiscal year. PMCC considered this matter in its adoption of FIN 48 and FASB Staff Position No. FAS 13-2.

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 19, at December 31, 2007, Altria Group, Inc.’s third-party guarantees, which are primarily related to divestiture activities, were $22 million. These guarantees have no specified expiration dates. Altria Group, Inc. is required to perform under these guarantees in the event that a third party fails to make contractual payments. Altria Group, Inc. has a liability of $22 million on its consolidated

 

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balance sheet at December 31, 2007, 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, 2007, subsidiaries of ALG were also contingently liable for $27 million of guarantees related to their own performance, consisting primarily of surety bonds. 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 from continuing operations at December 31, 2007:

 

     Payments Due
     Total    2008    2009-2010    2011-2012   

2013 and

Thereafter

     (in millions)

Long-term debt (1):

              

Consumer products

   $ 4,239    $ 2,354    $ 135    $ -    $ 1,750

Financial services

     500         500      
                                  
     4,739      2,354      635      -      1,750

Interest on borrowings (2)

     1,758      292      297      256      913

Operating leases (3)

     286      59      92      42      93

Purchase obligations (4):

              

Inventory and production costs

     827      469      256      52      50

Other

     1,492      736      604      152      -
                                  
     2,319      1,205      860      204      50

Other long-term liabilities (5)

     1,443      117      264      290      772
                                  
   $ 10,545    $ 4,027    $ 2,148    $ 792    $ 3,578
                                  

 

  (1)

Amounts represent the expected cash payments of Altria Group, Inc.’s long-term debt, excluding the impact of the previously discussed tender offers.

 

  (2)

Amounts represent the expected cash payments of Altria Group, Inc.’s interest expense on its long-term debt, including the current portion of long-term debt. Interest on Altria Group, Inc.’s fixed-rate debt is presented using the stated interest rate. Interest on Altria Group, Inc.’s variable rate debt is estimated using the rate in effect at December 31, 2007. Amounts exclude the amortization of debt discounts, the amortization of loan fees and fees for lines of credit that would be included in interest expense in the consolidated statements of earnings.

 

  (3)

Amounts represent the minimum rental commitments under non-cancelable operating leases.

 

  (4)

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 specifies 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.

 

  (5)

Other long-term liabilities primarily consist of postretirement health care costs. The following long-term liabilities included on the consolidated balance sheet are excluded from the table above: accrued pension and postemployment costs, income taxes and tax contingencies, insurance accruals and other

 

-29-


 

accruals. Altria Group, Inc. is unable to estimate the timing of payments (or contributions in the case of accrued pension costs) for these items. Currently, Altria Group, Inc. anticipates making pension contributions of approximately $16 million in 2008, based on current tax law (as discussed in Note 16. Benefit Plans).

The State Settlement Agreements and related legal fee payments, and payments for tobacco growers, as discussed below and in Note 19, 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, as discussed below and in Note 19, are also excluded from the table above since these deposits will be returned to PM USA should it prevail on appeal.

Payments Under State Settlement and Other Tobacco Agreements – As discussed previously and in Note 19, PM USA has entered into State Settlement Agreements with the states and territories of the United States and also entered into a trust agreement to provide certain aid to U.S. tobacco growers and quota holders, but PM USA’s obligations under this trust have now been eliminated by the obligations imposed on PM USA by FETRA. Each of these agreements calls for payments that are based on variable factors, such as cigarette volume, market shares and inflation. PM USA accounts for the cost of these agreements as a component of cost of sales as product is shipped.

As a result of these agreements and the enactment of FETRA, PM USA recorded the following amounts in cost of sales for the years ended December 31, 2007, 2006 and 2005 (in billions):

 

         PM USA
 

2007

   $5.5
 

2006

     5.0
 

2005

     5.0

Based on current agreements and current estimates of volume and market share, the estimated amounts that PM USA and John Middleton, Inc. (FETRA) may charge to cost of sales under these agreements will be approximately as follows:

 

PM USA

      

John Middleton, Inc.

(in billions)        (in millions)

2008

           $5.6      2008    $4

2009

             5.5      2009      4

2010

             5.6      2010      5

2011

             5.6      2011      5

2012

             5.6      2012      5

2013 to 2017

             5.6 annually      2013      5

Thereafter

             5.7 annually      2014      5

The estimated amounts charged to cost of sales in each of the years above would generally be paid in the following year. As previously stated, the payments due under the terms of these agreements are subject to adjustment for several factors, including volume, inflation and certain contingent events and, in general, are allocated based on each manufacturer’s market share. The amounts shown in the table above are estimates, and actual amounts will differ as underlying assumptions differ from actual future results. See Note 19 for a discussion of proceedings that may result in a downward adjustment of amounts paid under State Settlement Agreements for the years 2003 and 2004.

Litigation Escrow Deposits – As discussed in Note 19, in December 2007, $1.2 billion of funds held in an interest-bearing escrow account in connection with obtaining a stay of execution in the Engle class action was returned to PM USA. In addition, the $100 million relating to the bonding requirement in the same case has been discharged. The $1.2 billion escrow account and the deposit of $100 million related to the bonding requirement were included in the December 31, 2006 consolidated balance sheet as other assets. Interest income on the $1.2 billion escrow account, prior to its return to PM USA, was paid to PM USA quarterly and

 

-30-


was being recorded as earned in interest and other debt expense, net, in the consolidated statements of earnings.

Also, in June 2006 under the order of the Illinois Supreme Court, the cash deposits of approximately $2.2 billion related to the Price case were returned to PM USA, and PM USA’s obligations to deposit further cash payments were terminated.

With respect to certain adverse verdicts currently on appeal, as of December 31, 2007, PM USA has posted various forms of security totaling approximately $193 million, the majority of which have been collateralized with cash deposits, to obtain stays of judgments pending appeals. These cash deposits are included in other assets on the consolidated balance sheets.

Although litigation is subject to uncertainty and could result in material adverse consequences for the financial condition, cash flows or results of operations of PM USA or Altria Group, Inc. in a particular fiscal quarter or fiscal year, management believes the litigation environment has substantially improved and expects cash flow from operations, together with existing credit facilities, to provide sufficient liquidity to meet the ongoing needs of the business.

Equity and Dividends

As discussed in Note 1. Background and Basis of Presentation, on March 30, 2007, Altria Group, Inc. distributed all of its remaining interest in Kraft on a pro rata basis to Altria Group, Inc. stockholders of record as of the close of business on March 16, 2007 in a tax-free distribution. The distribution resulted in a net decrease to Altria Group, Inc.’s stockholders’ equity of $27.4 billion on March 30, 2007.

As discussed in Note 12. Stock Plans, in January 2007, Altria Group, Inc. issued 1.7 million shares of deferred stock to eligible U.S.-based and non-U.S. employees. Restrictions on these shares lapse in the first quarter of 2010. The market value per share was $87.36 on the date of grant. Recipients of these Altria Group, Inc. deferred shares did not receive restricted stock or deferred stock of Kraft upon the Kraft spin-off. Rather, they received 0.6 million additional deferred shares of Altria Group, Inc. to preserve the intrinsic value of the original award.

At December 31, 2007, the number of shares to be issued upon exercise of outstanding stock options and vesting of deferred stock was 33.2 million, or 1.6% of shares outstanding.

Dividends paid in 2007 and 2006 were $6.7 billion and $6.8 billion, respectively, a decrease of 2.4%, primarily reflecting a lower dividend rate in 2007 due to the Kraft spin-off, partially offset by a greater number of shares outstanding in 2007. During the second quarter of 2007, Altria Group, Inc. adjusted its quarterly dividend to $0.69 per share so that its stockholders who retained their Altria Group, Inc. and Kraft shares would receive in the aggregate the same dividend dollars as before the distribution. During the third quarter of 2007, Altria Group, Inc.’s Board of Directors approved an 8.7% increase in the quarterly dividend rate to $0.75 per share. As a result, the present annualized dividend rate is $3.00 per share.

Altria Group, Inc. has announced its intention to adjust its current dividend so that its stockholders who retain their PMI shares will initially receive, in the aggregate, the same dividend dollars as before the PMI Distribution. In that regard, PMI’s annualized dividend rate will be $1.84 per common share and Altria Group, Inc.’s annualized dividend rate will be $1.16 per common share.

On January 30, 2008, the Altria Group, Inc. Board of Directors approved a $7.5 billion two-year share repurchase program which began in April 2008.

 

Market Risk

Derivative financial instruments are used by ALG and its subsidiaries, principally to reduce exposures to market risks resulting from fluctuations in foreign exchange rates, by creating offsetting exposures. Altria

 

-31-


Group, Inc. is not a party to leveraged derivatives and, by policy, does not use derivative financial instruments for speculative purposes.

Hedging activity affected accumulated other comprehensive earnings (losses), net of income taxes, during the years ended December 31, 2007, 2006 and 2005, as follows (in millions):

 

     2007     2006     2005  

Gain (loss) as of January 1

   $ 13     $ 24     $ (14 )

Derivative gains transferred to earnings

     (45 )     (35 )     (95 )

Change in fair value

     25       24       133  

Kraft spin-off

     2      
                        

(Loss) gain as of December 31

   $ (5 )   $ 13     $ 24  
                        

The fair value of all derivative financial instruments has been calculated based on market quotes.

Foreign exchange rates.     Altria Group, Inc. (primarily PMI) uses forward foreign exchange contracts, foreign currency swaps and foreign currency options to mitigate its exposure to changes in exchange rates from third-party and intercompany actual and forecasted transactions. The primary currencies to which Altria Group, Inc. (primarily PMI) is exposed include the Japanese yen, Swiss franc, euro, Turkish lira, Russian ruble and Indonesian rupiah. At December 31, 2007 and 2006, Altria Group, Inc. had contracts with aggregate notional amounts of $6.9 billion and $3.2 billion, respectively, of which $6.9 billion and $3.1 billion, respectively, were at PMI. A portion of Altria Group, Inc.’s foreign currency swaps, while effective as economic hedges, do not qualify for hedge accounting and therefore the unrealized gain (loss) relating to these contracts are reported in Altria Group, Inc.’s consolidated statements of earnings. For the years ended December 31, 2007, 2006 and 2005, the unrealized gain (loss) with regard to the contracts that do not qualify for hedge accounting was insignificant.

In addition, Altria Group, Inc. uses foreign currency swaps to mitigate its exposure to changes in exchange rates related to foreign currency denominated debt. These swaps typically convert fixed-rate foreign currency denominated debt to fixed-rate debt denominated in the functional currency of the borrowing entity, and are accounted for as cash flow hedges. At December 31, 2007 and 2006, the notional amounts of foreign currency swap agreements aggregated $1.5 billion and $1.4 billion, respectively.

Altria Group, Inc. also designates certain foreign currency denominated debt and forwards as net investment hedges of foreign operations. During the years ended December 31, 2007 and 2006, these hedges of net investments resulted in losses, net of income taxes, of $45 million and $164 million, respectively, and during the year ended December 31, 2005, resulted in a gain, net of income taxes, of $369 million. These gains and losses were reported as a component of accumulated other comprehensive earnings (losses) within currency translation adjustments.

Value at Risk.     Altria Group, Inc. uses a value at risk (“VAR”) computation to estimate the potential one-day loss in the fair value of its interest rate-sensitive financial instruments and to estimate the potential one-day loss in pre-tax earnings of its foreign currency derivative financial instruments. The VAR computation includes Altria Group, Inc.’s debt; short-term investments; and foreign currency forwards and swaps. Anticipated transactions and net investments in foreign subsidiaries, which the foregoing instruments are intended to hedge, were excluded from the computation.

The VAR estimates were made assuming normal market conditions, using a 95% confidence interval. Altria Group, Inc. used a “variance/co-variance” model to determine the observed interrelationships between movements in interest rates and various currencies. These interrelationships were determined by observing interest rate and forward currency rate movements over the preceding quarter for the calculation of VAR amounts at December 31, 2007 and 2006, and over each of the four preceding quarters for the calculation of average VAR amounts during each year.

The estimated potential one-day loss in fair value of Altria Group, Inc.’s (excluding PMI) interest rate-sensitive instruments, primarily debt, under normal market conditions and the estimated potential one-day

 

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loss in pre-tax earnings from foreign currency instruments under normal market conditions, as calculated in the VAR model, were as follows (in millions):

 

     Pre-Tax Earnings Impact    Fair Value Impact
    

At

12/31/07

   Average    High    Low   

At

12/31/07

   Average    High    Low

Instruments sensitive to:

                       

Foreign currency rates

   $ -    $1    $1    $ -            

Interest rates

               $15    $11    $15    $8
     Pre-Tax Earnings Impact    Fair Value Impact
     At
12/31/06
   Average    High    Low    At
12/31/06
   Average    High    Low

Instruments sensitive to:

                       

Foreign currency rates

   $1    $3    $4    $1            

Interest rates

               $13    $16    $17    $13

The VAR computation is a risk analysis tool designed to statistically estimate the maximum probable daily loss from adverse movements in interest rates and foreign currency rates under normal market conditions. The computation does not purport to represent actual losses in fair value or earnings to be incurred by Altria Group, Inc., nor does it consider the effect of favorable changes in market rates. Altria Group, Inc. cannot predict actual future movements in such market rates and does not present these VAR results to be indicative of future movements in such market rates or to be representative of any actual impact that future changes in market rates may have on its future results of operations or financial position.

New Accounting Standards

See Note 2, Note 16 and Note 18 to the consolidated financial statements for a discussion of new accounting standards.

Contingencies

See Note 19 to the consolidated financial statements for a discussion of contingencies.

Cautionary Factors That May Affect Future Results

Forward-Looking and Cautionary Statements

We* may from time to time make written or oral forward-looking statements, including statements contained in filings with the SEC, in reports to stockholders and in press releases and investor webcasts. You can identify these forward-looking statements by use of words such as “strategy,” “expects,” “continues,” “plans,” “anticipates,” “believes,” “will,” “estimates,” “intends,” “projects,” “goals,” “targets” and other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts.

We cannot guarantee that any forward-looking statement will be realized, although we believe we have been prudent in our plans and assumptions. Achievement of future results is subject to risks, uncertainties and inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from those anticipated, estimated or projected. Investors should bear this in mind as they consider forward-looking statements and whether to invest in or remain invested in Altria Group, Inc.’s securities. In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, we are identifying important factors that, individually

 

 

*

This section uses the terms “we,” “our” and “us” when it is not necessary to distinguish among ALG and its various operating subsidiaries or when any distinction is clear from the context.

 

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or in the aggregate, could cause actual results and outcomes to differ materially from those contained in any forward-looking statements made by us; any such statement is qualified by reference to the following cautionary statements. We elaborate on these and other risks we face throughout this document, particularly in the “Business Environment” sections preceding our discussion of operating results of our subsidiaries’ businesses. You should understand that it is not possible to predict or identify all risk factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties. We do not undertake to update any forward-looking statement that we may make from time to time.

Tobacco-Related Litigation.    There is substantial litigation related to tobacco products in the United States. Damages claimed in some of the tobacco-related litigation are significant, and in certain cases, range into the billions of dollars. We anticipate that new cases will continue to be filed. It is possible that there could be adverse developments in pending cases. An unfavorable outcome or settlement of pending tobacco-related litigation could encourage the commencement of additional litigation. Although PM USA has historically been able to obtain required bonds or relief from bonding requirements in order to prevent plaintiffs from seeking to collect judgments while adverse verdicts have been appealed, there remains a risk that such relief may not be obtainable in all cases. This risk has been substantially reduced given that 42 states now limit the dollar amount of bonds or require no bond at all.

It is possible that the consolidated results of operations, cash flows or financial position of PM USA or Altria Group, Inc. could be materially affected in a particular fiscal quarter or fiscal year by an unfavorable outcome or settlement of certain pending litigation. Nevertheless, although litigation is subject to uncertainty, management believes the litigation environment has substantially improved. ALG and each of its subsidiaries named as a defendant believe, and each has been so advised by counsel handling the respective cases, that it has a number of valid defenses to the litigation pending against it, as well as valid bases for appeal of adverse verdicts against it. All such cases are, and will continue to be, vigorously defended. However, ALG and its subsidiaries may enter into settlement discussions in particular cases if they believe it is in the best interests of ALG’s stockholders to do so. Please see Note 19 for a discussion of pending tobacco-related litigation.

Tobacco Control Action in the Public and Private Sectors.    Our tobacco subsidiaries face significant governmental action, including efforts aimed at reducing the incidence of smoking, restricting marketing and advertising, imposing regulations on warnings and disclosure of ingredients and flavors, and seeking to hold us responsible for the adverse health effects associated with both smoking and exposure to environmental tobacco smoke. Governmental actions, combined with the diminishing social acceptance of smoking and private actions to restrict smoking, have resulted in reduced industry volume, and we expect that such actions will continue to reduce consumption levels.

Excise Taxes.    Tobacco products are subject to substantial excise taxes and significant increases in tobacco product-related taxes or fees have been proposed or enacted and are likely to continue to be proposed or enacted within the United States. For example, legislation was passed by the United States Congress in 2007 that would increase the federal excise tax on cigarettes by $0.61 a pack. The President vetoed this legislation. It is not possible to predict whether such legislation will be reintroduced and become law. Tax increases are expected to continue to have an adverse impact on sales of our tobacco products due to lower consumption levels and to a shift in consumer purchases from the premium to the non-premium or discount segments or to other low-priced or low-taxed tobacco products or to counterfeit and contraband products.

Increased Competition in the United States Tobacco Market.    Settlements of certain tobacco litigation in the United States have resulted in substantial cigarette price increases. PM USA faces competition from lowest priced brands sold by certain United States and foreign manufacturers that have cost advantages because they are not parties to these settlements. These manufacturers may fail to comply with related state escrow legislation or may avoid escrow deposit obligations on the majority of their sales by concentrating on certain states where escrow deposits are not required or are required on fewer than all such manufacturers’ cigarettes sold in such states. Additional competition has resulted from diversion into the United States market of cigarettes intended for sale outside the United States, the sale of counterfeit cigarettes by third parties, the sale of cigarettes by third parties over the Internet and by other means designed to avoid collection of applicable taxes, and increased imports of foreign lowest priced brands.

 

-34-


Governmental Investigations.    From time to time, ALG and its tobacco subsidiaries are subject to governmental investigations on a range of matters, including allegations of contraband shipments of cigarettes. We cannot predict the outcome of those investigations or whether additional investigations may be commenced, and it is possible that our tobacco subsidiaries’ businesses could be materially affected by an unfavorable outcome of pending or future investigations.

New Tobacco Product Technologies.    Our tobacco subsidiaries continue to seek ways to develop and to commercialize new product technologies that may reduce the risk of tobacco use while continuing to offer adult consumers products that meet their taste expectations. Potential solutions being researched include attempting to reduce constituents in tobacco smoke identified by public health authorities as harmful and seeking to produce products that reduce or eliminate exposure to tobacco smoke. Our tobacco subsidiaries may not succeed in these efforts. If they do not succeed, but one or more of their competitors do, our tobacco subsidiaries may be at a competitive disadvantage. Further, we cannot predict whether regulators will permit the marketing of products with claims of reduced risk to consumers, which could significantly undermine the commercial viability of any products that might be developed.

Adjacency Strategy.    ALG and PM USA have adjacency growth strategies involving moves and potential moves into complementary tobacco or tobacco-related products or processes. We cannot guarantee that these strategies, or any products introduced in connection with these strategies, will be successful.

Tobacco Availability and Quality.    Government mandated prices, production control programs, shifts in crops driven by economic conditions and adverse weather patterns may increase or decrease the cost or reduce the quality of tobacco and other agricultural products used to manufacture our products. As with other agriculture commodities, the price of tobacco leaf can be influenced by imbalances in supply and demand and crop quality can be influenced by variations in weather patterns. Tobacco production in certain countries is subject to a variety of controls, including governmental mandated prices and production control programs. Changes in the patterns of demand for agricultural products could cause farmers to plant less tobacco. Any significant change in the price of tobacco leaf, quality and quantity could affect our tobacco subsidiaries' profitability and business.

Attracting and Retaining Talent.    Our ability to implement our strategy of attracting and retaining the best global talent may be impaired by the decreasing social acceptance of cigarette smoking. The tobacco industry competes for talent with the consumer products industry and other companies that enjoy greater societal acceptance. As a result, our tobacco subsidiaries may be unable to attract and retain the best global talent.

Competition and Economic Downturns.    Each of our tobacco subsidiaries is subject to intense competition, changes in consumer preferences and local economic conditions. To be successful, they must continue to:

 

   

promote brand equity successfully;

 

   

anticipate and respond to new consumer trends;

 

   

develop new products and markets and to broaden brand portfolios in order to compete effectively with lower priced products;

 

   

improve productivity; and

 

   

be able to protect or enhance margins through price increases.

The willingness of consumers to purchase premium cigarette brands depends in part on local economic conditions. In periods of economic uncertainty, consumers tend to purchase more private label and other economy brands, and the volume of our consumer products subsidiaries could suffer accordingly.

Our finance subsidiary, PMCC, holds investments in finance leases, principally in transportation (including aircraft), power generation and manufacturing equipment and facilities. Its lessees are also subject to intense competition and economic conditions. If counterparties to PMCC’s leases fail to manage through difficult

 

-35-


economic and competitive conditions, PMCC may have to increase its allowance for losses, which would adversely affect our profitability.

Acquisitions.    ALG and PM USA from time to time consider acquisitions as part of their adjacency strategy, as evidenced by ALG’s 2007 acquisition of John Middleton, Inc. Acquisition opportunities are limited, and acquisitions present risks of failing to achieve efficient and effective integration, strategic objectives and anticipated revenue improvements and cost savings. There can be no assurance that we will be able to continue to acquire attractive businesses on favorable terms or that all future acquisitions will be quickly accretive to earnings.

Asset Impairment.    We periodically calculate the fair value of our goodwill and intangible assets to test for impairment. This calculation may be affected by the market conditions noted above, as well as interest rates and general economic conditions. If an impairment is determined to exist, we will incur impairment losses, which will reduce our earnings.

IRS Challenges to PMCC Leases.    The IRS concluded its examination of Altria Group, Inc.’s consolidated tax returns for the years 1996 through 1999 and issued a final Revenue Agent’s Report (“RAR”) on March 15, 2006. The RAR disallowed benefits pertaining to certain PMCC leveraged lease transactions for the years 1996 through 1999. Altria Group, Inc. has agreed with all conclusions of the RAR, with the exception of the disallowance of benefits pertaining to several PMCC leveraged lease transactions for the years 1996 through 1999. PMCC will continue to assert its position regarding these leveraged lease transactions and contest approximately $150 million of tax and net interest assessed and paid with regard to them. The IRS may in the future challenge and disallow more of PMCC’s leveraged leases based on Revenue Rulings, an IRS Notice and subsequent case law addressing specific types of leveraged leases (lease-in/lease-out (“LILO”) and sale-in/lease-out (“SILO”) transactions). PMCC believes that the position and supporting case law described in the RAR, Revenue Rulings and the IRS Notice are incorrectly applied to PMCC’s transactions and that its leveraged leases are factually and legally distinguishable in material respects from the IRS’s position. PMCC and ALG intend to vigorously defend against any challenges based on that position through litigation. In this regard, on October 16, 2006, PMCC filed a complaint in the U.S. District Court for the Southern District of New York to claim refunds for a portion of these tax payments and associated interest. However, should PMCC’s position not be upheld, PMCC may have to accelerate the payment of significant amounts of federal income tax and significantly lower its earnings to reflect the recalculation of the income from the affected leveraged leases, which could have a material effect on the earnings and cash flows of Altria Group, Inc. in a particular fiscal quarter or fiscal year. PMCC considered this matter in its adoption of FIN 48 and FASB Staff Position No. FAS 13-2.

 

-36-

EX-99.3 6 dex993.htm CONSOLIDATED FINANCIAL STATEMENTS Consolidated Financial Statements

Exhibit 99.3

 

 

 

 

 

ALTRIA GROUP, INC.

and SUBSIDIARIES

PMI ON DISCONTINUED OPERATIONS BASIS AND NEW SEGMENTS

Consolidated Financial Statements as of

December 31, 2007 and 2006, and for Each of the

Three Years in the Period Ended December 31, 2007


REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of Altria Group, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Altria Group, Inc.’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes those written policies and procedures that:

 

   

pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of Altria Group, Inc.;

 

   

provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America;

 

   

provide reasonable assurance that receipts and expenditures of Altria Group, Inc. are being made only in accordance with authorization of management and directors of Altria Group, Inc.; and

 

   

provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the consolidated financial statements.

Internal control over financial reporting includes the controls themselves, monitoring and internal auditing practices and actions taken to correct deficiencies as identified.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of Altria Group, Inc.’s internal control over financial reporting as of December 31, 2007. Management based this assessment on criteria for effective internal control over financial reporting described in “Internal Control – Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included an evaluation of the design of Altria Group, Inc.’s internal control over financial reporting and testing of the operational effectiveness of its internal control over financial reporting. Management reviewed the results of its assessment with the Audit Committee of our Board of Directors.

Based on this assessment, management determined that, as of December 31, 2007, Altria Group, Inc. maintained effective internal control over financial reporting.

PricewaterhouseCoopers LLP, independent registered public accounting firm, who audited and reported on the consolidated financial statements of Altria Group, Inc. included in this report, has audited the effectiveness of Altria Group, Inc.’s internal control over financial reporting as of December 31, 2007, as stated in their report herein.

 

 

January 28, 2008


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Altria Group, Inc.:

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of earnings, stockholders’ equity, and cash flows, present fairly, in all material respects, the financial position of Altria Group, Inc. and its subsidiaries at December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Altria Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Altria Group, Inc.’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements and on Altria Group, Inc.’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

As discussed in Notes 16 and 14 to the consolidated financial statements, Altria Group, Inc. changed the manner in which it accounts for pension, postretirement and postemployment plans in fiscal 2006 and the manner in which it accounts for uncertain tax positions in fiscal 2007, respectively.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.


Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

/s/ PricewaterhouseCoopers LLP

New York, New York

January 28, 2008, except for Notes 19 and 21 which are as of February 4, 2008, and except for the impact of presenting Philip Morris International Inc. as a discontinued operation as discussed in Notes 1 and 4, the impact of the spin-off of Philip Morris International Inc. as discussed in Note 21, and the change in reportable segments as discussed in Notes 1 and 15, all of which are as of June 5, 2008


ALTRIA GROUP, INC. and SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS, at December 31,

(in millions of dollars, except share and per share data)

 

 

 

     2007      2006

ASSETS

     

Consumer products

     

Cash and cash equivalents

   $ 4,842    $ 3,105

Receivables (less allowances of $3 in 2007 and $6 in 2006)

     83      61

Receivable from Kraft Foods Inc.

        607

Inventories:

     

Leaf tobacco

     861      1,215

Other raw materials

     160      163

Finished product

     233      227
             
     1,254      1,605

Current assets of discontinued operations

     14,767      18,964

Other current assets

     1,944      1,810
             

Total current assets

     22,890      26,152

Property, plant and equipment, at cost:

     

Land and land improvements

     171      167

Buildings and building equipment

     1,787      1,567

Machinery and equipment

     3,305      3,286

Construction in progress

     363      400
             
     5,626      5,420

Less accumulated depreciation

     3,204      3,077
             
     2,422      2,343

Goodwill

     76   

Other intangible assets, net

     3,049      283

Prepaid pension assets

     912      658

Investment in SABMiller

     3,960      3,674

Long-term assets of discontinued operations

     16,969      62,922

Other assets

     870      1,705
             

Total consumer products assets

     51,148      97,737

Financial services

     

Finance assets, net

     6,029      6,503

Other assets

     34      30
             

Total financial services assets

     6,063      6,533
             

TOTAL ASSETS

   $ 57,211    $ 104,270
             
     2007       2006  

LIABILITIES

    

Consumer products

    

Short-term borrowings

   $ -     $ 1  

Current portion of long-term debt

     2,354       503  

Accounts payable

     611       742  

Payable to Philip Morris International Inc.

     257       588  

Accrued liabilities:

    

Marketing

     327       418  

Taxes, except income taxes

     70       79  

Employment costs

     283       405  

Settlement charges

     3,986       3,552  

Other

     849       953  

Income taxes

     184       207  

Dividends payable

     1,588       1,811  

Current liabilities of discontinued operations

     8,273       16,168  
                

Total current liabilities

     18,782       25,427  

Long-term debt

     1,885       4,076  

Deferred income taxes

     968       460  

Accrued pension costs

     198       193  

Accrued postretirement health care costs

     1,916       2,009  

Long-term liabilities of discontinued operations

     8,065       24,487  

Other liabilities

     1,240       1,530  
                

Total consumer products liabilities

     33,054       58,182  

Financial services

    

Long-term debt

     500       1,119  

Deferred income taxes

     4,911       5,301  

Other liabilities

     192       49  
                

Total financial services liabilities

     5,603       6,469  
                

Total liabilities

     38,657       64,651  
                

Contingencies (Note 19)

    

STOCKHOLDERS’ EQUITY

    

Common stock, par value $0.33 1/3 per share
(2,805,961,317 shares issued)

     935       935  

Additional paid-in capital

     6,884       6,356  

Earnings reinvested in the business

     34,426       59,879  

Accumulated other comprehensive losses

     (237 )     (3,808 )

Cost of repurchased stock
(698,284,555 shares in 2007 and 708,880,389 shares in 2006)

     (23,454 )     (23,743 )
                

Total stockholders’ equity

     18,554       39,619  
                

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 57,211     $ 104,270  
                

 

See notes to consolidated financial statements.

 

5


ALTRIA GROUP, INC. and SUBSIDIARIES

CONSOLIDATED STATEMENTS of EARNINGS

for the years ended December 31,

(in millions of dollars, except per share data)

 

 

 

     2007       2006       2005  

Net revenues

   $ 18,664     $ 18,790     $ 18,452  

Cost of sales

     7,827       7,387       7,274  

Excise taxes on products

     3,452       3,617       3,659  
                        

Gross profit

     7,385       7,786       7,519  

Marketing, administration and research costs

     2,784       3,113       3,139  

Tobacco headquarters relocation charges

         4  

Loss on tobacco pool

         138  

Tobacco quota buy-out

         (115 )

Asset impairment and exit costs

     442       52       49  

(Recoveries) provision (from) for airline industry exposure

     (214 )     103       200  
                        

Operating income

     4,373       4,518       4,104  

Interest and other debt expense, net

     205       225       427  

Equity earnings in SABMiller

     (510 )     (460 )     (446 )
                        

Earnings from continuing operations before income taxes

     4,678       4,753       4,123  

Provision for income taxes

     1,547       1,571       1,574  
                        

Earnings from continuing operations

     3,131       3,182       2,549  

Earnings from discontinued operations, net of income taxes and minority interest

     6,655       8,840       7,886  
                        

  Net earnings

   $ 9,786     $ 12,022     $ 10,435  
                        

Per share data:

      

Basic earnings per share:

      

Continuing operations

   $ 1.49     $ 1.52     $ 1.23  

Discontinued operations

     3.17       4.24       3.81  
                        

Net earnings

   $ 4.66     $ 5.76     $ 5.04  
                        

Diluted earnings per share:

      

Continuing operations

   $ 1.48     $ 1.51     $ 1.22  

Discontinued operations

     3.14       4.20       3.77  
                        

Net earnings

   $ 4.62     $ 5.71     $ 4.99  
                        

See notes to consolidated financial statements.

 

6


ALTRIA GROUP, INC. and SUBSIDIARIES

CONSOLIDATED STATEMENTS of STOCKHOLDERS’ EQUITY

(in millions of dollars, except per share data)

 

 

 

            
 
Accumulated Other
            Comprehensive Earnings (Losses)            
 
 
   
    

 

Common

    Stock    

    

 

 

Additional

Paid-in

  Capital  

    

 

 

Earnings

Reinvested in

  the Business  

 

 

 

   

 

 

Currency

Translation

Adjustments

 

 

 

    Other         Total        

 

 

Cost of

Repurchased

  Stock  

 

 

 

   

 

 

Total

Stockholders’

  Equity  

 

 

 

Balances, January 1, 2005

   $ 935    $ 5,176    $ 50,595     $ (610 )   $ (531 )   $ (1,141 )   $ (24,851 )   $ 30,714  

Comprehensive earnings:

                  

Net earnings

           10,435               10,435  

Other comprehensive earnings (losses), net of income taxes:

                  

Currency translation adjustments

             (707 )       (707 )       (707 )

Additional minimum pension liability

               (54 )     (54 )       (54 )

Change in fair value of derivatives accounted for as hedges

               38       38         38  

Other

               11       11         11  
                        

Total other comprehensive losses

                     (712 )
                        

Total comprehensive earnings

                     9,723  
                        

Exercise of stock options and issuance of other stock awards

        519      (6 )           749       1,262  

Cash dividends declared ($3.06 per share)

           (6,358 )             (6,358 )

Other

        366                366  
                                                              

Balances, December 31, 2005

     935      6,061      54,666       (1,317 )     (536 )     (1,853 )     (24,102 )     35,707  

Comprehensive earnings:

                  

Net earnings

           12,022               12,022  

Other comprehensive earnings (losses), net of income taxes:

                  

Currency translation adjustments

             1,220         1,220         1,220  

Additional minimum pension liability

               233       233         233  

Change in fair value of derivatives accounted for as hedges

               (11 )     (11 )       (11 )

Other

               (11 )     (11 )       (11 )
                        

Total other comprehensive earnings

                     1,431  
                        

Total comprehensive earnings

                     13,453  
                        

Initial adoption of FASB Statement No. 158, net of income taxes (Note 16)

               (3,386 )     (3,386 )       (3,386 )

Exercise of stock options and issuance of other stock awards

        295      145             359       799  

Cash dividends declared ($3.32 per share)

           (6,954 )             (6,954 )
                                                              

Balances, December 31, 2006

     935      6,356      59,879       (97 )     (3,711 )     (3,808 )     (23,743 )     39,619  

Comprehensive earnings:

                  

Net earnings

           9,786               9,786  

Other comprehensive earnings (losses), net of income taxes:

                  

Currency translation adjustments

             736         736         736  

Change in net loss and prior service cost

               744       744         744  

Change in fair value of derivatives accounted for as hedges

               (18 )     (18 )       (18 )
                        

Total other comprehensive earnings

                     1,462  
                        

Total comprehensive earnings

                     11,248  
                        

Adoption of FIN 48 and FAS 13-2

           711               711  

Exercise of stock options and issuance of other stock awards (1)

        528              289       817  

Cash dividends declared ($3.05 per share)

           (6,430 )             (6,430 )

Spin-off of Kraft Foods Inc.

           (29,520 )     89       2,020       2,109         (27,411 )
                                                              

Balances, December 31, 2007

   $ 935    $ 6,884    $ 34,426     $ 728     $ (965 )   $ (237 )   $ (23,454 )   $ 18,554  
                                                              

    (1) Includes $179 million increase to additional paid-in-capital for the reimbursement from Kraft for Altria stock awards. See Note 1.

See notes to consolidated financial statements.

 

7


ALTRIA GROUP, INC. and SUBSIDIARIES

CONSOLIDATED STATEMENTS of CASH FLOWS

for the years ended December 31,

(in millions of dollars)

 

 

 

     2007       2006       2005  

CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES

      

Earnings from continuing operations – Consumer products

   $ 2,910     $ 3,059     $ 2,533  

                               – Financial services

     221       123       16  

Earnings from discontinued operations, net of income taxes and minority interest

     6,655       8,840       7,886  
                        

Net earnings

     9,786       12,022       10,435  

Impact of earnings from discontinued operations, net of income taxes and minority interest

     (6,655 )     (8,840 )     (7,886 )

Adjustments to reconcile net earnings to operating cash flows:

      

Consumer products

      

Depreciation

     232       255       269  

Deferred income tax provision (benefit)

     101       (332 )     292  

Equity earnings in SABMiller

     (510 )     (460 )     (446 )

Tobacco quota buy-out

         (115 )

Escrow bond for the Engle tobacco case

     1,300      

Escrow bond for the Price tobacco case

       1,850       (420 )

Asset impairment and exit costs, net of cash paid

     333       7       17  

Income tax reserve reversal

       (1,006 )  

Cash effects of changes, net of the effects from acquired and divested companies:

      

Receivables, net

     162       150       (284 )

Inventories

     375       216       (41 )

Accounts payable

     (82 )     (105 )     (161 )

Income taxes

     (900 )     (398 )     263  

Accrued liabilities and other current assets

     (247 )     (45 )     194  

Accrued settlement charges

     434       50       (30 )

Pension plan contributions

     (37 )     (288 )     (507 )

Pension provisions and postretirement, net

     165       318       293  

Other

     526       492       468  

Financial services

      

Deferred income tax benefit

     (320 )     (238 )     (137 )

Provision for airline industry exposure

       103       200  

Other

     (83 )     (102 )     29  
                        

Net cash provided by operating activities, continuing operations

     4,580       3,649       2,433  

Net cash provided by operating activities, discontinued operations

     5,736       9,937       8,627  
                        

Net cash provided by operating activities

     10,316       13,586       11,060  
                        

See notes to consolidated financial statements.

Continued

 

8


ALTRIA GROUP, INC. and SUBSIDIARIES

CONSOLIDATED STATEMENTS of CASH FLOWS (Continued)

for the years ended December 31,

(in millions of dollars)

 

 

 

     2007       2006       2005  

CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES

      

Consumer products

      

Capital expenditures

   $ (386 )   $ (399 )   $ (299 )

Purchase of businesses, net of acquired cash

     (2,898 )    

Other

     108       (6 )     38  

Financial services

      

Investments in finance assets

     (5 )     (15 )     (3 )

Proceeds from finance assets

     486       357       476  
                        

Net cash (used in) provided by investing activities, continuing operations

     (2,695 )     (63 )     212  

Net cash used in investing activities, discontinued operations

     (2,560 )     (555 )     (5,097 )
                        

Net cash used in investing activities

     (5,255 )     (618 )     (4,885 )
                        

CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES

      

Consumer products

      

Net issuance (repayment) of short-term borrowings

     2       1       (2 )

Long-term debt repaid

     (500 )     (2,052 )     (1,002 )

Financial services

      

Long-term debt repaid

     (617 )     (1,015 )  

Dividends paid on Altria Group, Inc. common stock

     (6,652 )     (6,815 )     (6,191 )

Issuance of Altria Group, Inc. common stock

     423       486       985  

Kraft Foods Inc. dividends paid to Altria Group, Inc.

     728       1,369       1,232  

Philip Morris International Inc. dividends paid to Altria Group, Inc.

     6,560       2,780       7,682  

Changes in amounts due to/from discontinued operations

     (370 )     (166 )     (870 )

Other

     278       164       (48 )
                        

Net cash (used in) provided by financing activities, continuing operations

     (148 )     (5,248 )     1,786  

Net cash used in financing activities, discontinued operations

     (3,531 )     (9,118 )     (6,920 )
                        

Net cash used in financing activities

     (3,679 )     (14,366 )     (5,134 )
                        

Effect of exchange rate changes on cash and cash equivalents

      

Continuing operations

       34       (164 )

Discontinued operations

     347       126       (363 )
                        
     347       160       (527 )
                        

Cash and cash equivalents, continuing operations:

      

Increase (Decrease)

     1,737       (1,628 )     4,267  

Balance at beginning of year

     3,105       4,733       466  
                        

Balance at end of year

   $ 4,842     $ 3,105     $ 4,733  
                        

Cash paid, continuing operations:         Interest – Consumer products

   $ 348     $ 377     $ 720  
                        

                                       – Financial services

   $ 62     $ 108     $ 106  
                        

                         Income taxes

   $ 2,241     $ 3,074     $ 1,773  
                        

See notes to consolidated financial statements.

 

9


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Note 1.   Background and Basis of Presentation:

Background:

Throughout these financial statements, the term “Altria Group, Inc.” refers to the consolidated financial position, results of operations and cash flows of the Altria family of companies, and the term “ALG” refers solely to the parent company. ALG’s wholly-owned subsidiaries include Philip Morris USA Inc. (“PM USA”), which is engaged in the manufacture and sale of cigarettes and other tobacco products in the United States and John Middleton, Inc., which is engaged in the manufacture and sale of machine-made cigars and pipe tobacco. Philip Morris Capital Corporation (“PMCC”), another wholly-owned subsidiary, maintains a portfolio of leveraged and direct finance leases. In addition, ALG held a 28.6% economic and voting interest in SABMiller plc (“SABMiller”) at December 31, 2007. ALG’s access to the operating cash flows of its subsidiaries consists principally of cash received from the payment of dividends from its subsidiaries.

ALG’s wholly-owned international tobacco subsidiary as of December 31, 2007, Philip Morris International Inc. (“PMI”) is reflected in these revised financial statements as a discontinued operation as a result of the PMI spin-off discussed in Note 21. Subsequent Events.

On March 30, 2007, Altria Group, Inc. distributed all of its remaining interest in Kraft Foods Inc. (“Kraft”) on a pro-rata basis to Altria Group, Inc. stockholders in a tax-free distribution. For further discussion, please refer to the Kraft Spin-Off discussion below. Altria Group, Inc. has reclassified and reflected the results of Kraft prior to the Kraft distribution date as discontinued operations on the consolidated statements of earnings and the consolidated statements of cash flows for all periods presented. The assets and liabilities related to Kraft were reclassified and reflected as discontinued operations on the consolidated balance sheet at December 31, 2006.

In November 2007, Altria Group, Inc. announced that it had signed an agreement to sell its headquarters building in New York City for approximately $525 million and will record a pre-tax gain of approximately $400 million upon closing the transaction. Under the terms of the agreement, Altria Group, Inc. plans to close the sale no later than April 1, 2008.

Kraft Spin-Off:

On March 30, 2007 (the “Kraft Distribution Date”), Altria Group, Inc. distributed all of its remaining interest in Kraft on a pro-rata basis to Altria Group, Inc. stockholders of record as of the close of business on March 16, 2007 (the “Kraft Record Date”) in a tax-free distribution. The distribution ratio was 0.692024 of a share of Kraft for each share of Altria Group, Inc. common stock outstanding. Altria Group, Inc. stockholders received cash in lieu of fractional shares of Kraft. Following the distribution, Altria Group, Inc. does not own any shares of Kraft. During the second quarter of 2007, Altria Group, Inc. adjusted its quarterly dividend to $0.69 per share, so that its stockholders who retained their Altria Group, Inc. and Kraft shares would receive, in the aggregate, the same dividend dollars as before the distribution. In August 2007, Altria Group, Inc. increased its quarterly dividend to $0.75 per share.

Holders of Altria Group, Inc. stock options were treated similarly to public stockholders and accordingly, had their stock awards split into two instruments. Holders of Altria Group, Inc. stock options received the following stock options, which, immediately after the spin-off, had an aggregate intrinsic value equal to the intrinsic value of the pre-spin Altria Group, Inc. options:

 

10


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

   

a new Kraft option to acquire the number of shares of Kraft Class A common stock equal to the product of (a) the number of Altria Group, Inc. options held by such person on the Kraft Distribution Date and (b) the distribution ratio of 0.692024 mentioned above; and

 

   

an adjusted Altria Group, Inc. option for the same number of shares of Altria Group, Inc. common stock with a reduced exercise price.

The new Kraft option has an exercise price equal to the Kraft market price at the time of the distribution ($31.66) multiplied by the Option Conversion Ratio, which represents the exercise price of the original Altria Group, Inc. option divided by the Altria Group, Inc. market price immediately before the distribution ($87.81). The reduced exercise price of the adjusted Altria Group, Inc. option was determined by multiplying the Altria Group, Inc. market price immediately following the distribution ($65.90) by the Option Conversion Ratio.

Holders of Altria Group, Inc. restricted stock or deferred stock awarded prior to January 31, 2007, retained their existing award and received restricted stock or deferred stock of Kraft Class A common stock. The amount of Kraft restricted stock or deferred stock awarded to such holders was calculated using the same formula set forth above with respect to new Kraft options. All of the restricted stock and deferred stock will vest at the completion of the original restriction period (typically, three years from the date of the original grant). Recipients of Altria Group, Inc. deferred stock awarded on January 31, 2007, did not receive restricted stock or deferred stock of Kraft. Rather, they received additional deferred shares of Altria Group, Inc. to preserve the intrinsic value of the original award.

To the extent that employees of the remaining Altria Group, Inc. received Kraft stock options, Altria Group, Inc. reimbursed Kraft in cash for the Black-Scholes fair value of the stock options received. To the extent that Kraft employees held Altria Group, Inc. stock options, Kraft reimbursed Altria Group, Inc. in cash for the Black-Scholes fair value of the stock options. To the extent that holders of Altria Group, Inc. deferred stock received Kraft deferred stock, Altria Group, Inc. paid to Kraft the fair value of the Kraft deferred stock less the value of projected forfeitures. Based upon the number of Altria Group, Inc. stock awards outstanding at the Kraft Distribution Date, the net amount of these reimbursements resulted in a payment of $179 million from Kraft to Altria Group, Inc. in April 2007. The reimbursement from Kraft is reflected as an increase to the additional paid-in capital of Altria Group, Inc. on the December 31, 2007 consolidated balance sheet.

Kraft was previously included in the Altria Group, Inc. consolidated federal income tax return, and federal income tax contingencies were recorded as liabilities on the balance sheet of ALG. As part of the intercompany account settlement discussed below, ALG reimbursed Kraft in cash for these liabilities, which as of March 30, 2007, were approximately $305 million, plus pre-tax interest of $63 million ($41 million after taxes). ALG also reimbursed Kraft in cash for the federal income tax consequences of the adoption of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”) (approximately $70 million plus pre-tax interest of $14 million, $9 million after taxes). See Note 14. Income Taxes for a discussion of the FIN 48 adoption and the Tax Sharing Agreement between Altria Group, Inc. and Kraft.

A subsidiary of ALG previously provided Kraft with certain services at cost plus a 5% management fee. After the Kraft Distribution Date, Kraft undertook these activities, and any remaining limited services provided to Kraft ceased during 2007. All intercompany accounts were settled

 

11


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

in cash within 30 days of the Kraft Distribution Date. The settlement of the intercompany accounts (including the amounts discussed above related to stock awards and tax contingencies) resulted in a net payment from Kraft to ALG of $85 million in April 2007.

The distribution resulted in a net decrease to Altria Group, Inc.’s stockholders’ equity of $27.4 billion on the Kraft Distribution Date.

Basis of presentation:

The consolidated financial statements include ALG, as well as its wholly-owned subsidiaries. Investments in which ALG exercises significant influence (20%-50% ownership interest), are accounted for under the equity method of accounting. All intercompany transactions and balances have been eliminated. The results of Kraft prior to the Kraft Distribution Date have been reclassified and reflected as discontinued operations on the consolidated statements of earnings and statements of cash flows for all periods presented. The assets and liabilities related to Kraft were reclassified and reflected as discontinued operations on the consolidated balance sheet at December 31, 2006.

The results of PMI have been reclassified and reflected as discontinued operations on the consolidated balance sheets, statements of earnings and statements of cash flows for all periods presented.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities at the dates of the financial statements and the reported amounts of net revenues and expenses during the reporting periods. Significant estimates and assumptions include, among other things, pension and benefit plan assumptions, lives and valuation assumptions of goodwill and other intangible assets, marketing programs, income taxes, and the allowance for loan losses and estimated residual values of finance leases. Actual results could differ from those estimates.

Balance sheet accounts are segregated by two broad types of business. Consumer products assets and liabilities are classified as either current or non-current, whereas financial services assets and liabilities are unclassified, in accordance with respective industry practices.

Certain subsidiaries of PMI report their results up to ten days before the end of December, rather than on December 31.

Beginning with the first quarter of 2008, Altria Group, Inc. revised its reportable segments to reflect the change in the way in which Altria Group, Inc.’s management reviews the business as a result of the acquisition of John Middleton, Inc. and the PMI spin-off. Altria Group, Inc.’s revised segments, which are reflected in these financial statements, are Cigarettes and other tobacco products; Cigars; and Financial services. Prior year segment results have also been revised.

 

12


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Note 2.   Summary of Significant Accounting Policies:

Cash and cash equivalents:

Cash equivalents include demand deposits with banks and all highly liquid investments with original maturities of three months or less.

Depreciation, amortization and goodwill valuation:

Property, plant and equipment are stated at historical cost and depreciated by the straight-line method over the estimated useful lives of the assets. Machinery and equipment are depreciated over periods up to 15 years, and buildings and building improvements over periods up to 50 years.

Definite life intangible assets are amortized over their estimated useful lives. Altria Group, Inc. is required to conduct an annual review of goodwill and intangible assets for potential impairment. Goodwill impairment testing requires a comparison between the carrying value and fair value of each reporting unit. If the carrying value exceeds the fair value, goodwill is considered impaired. The amount of impairment loss is measured as the difference between the carrying value and implied fair value of goodwill, which is determined using discounted cash flows. Impairment testing for non-amortizable intangible assets requires a comparison between the fair value and carrying value of the intangible asset. If the carrying value exceeds fair value, the intangible asset is considered impaired and is reduced to fair value. During 2007 and 2006, Altria Group, Inc. completed its annual review of goodwill and intangible assets, and no charges resulted from these reviews.

Goodwill and other intangible assets, net, by segment were as follows (in millions):

 

     Goodwill    Other Intangible Assets, net
     December 31,
2007
   December 31,
2006
   December 31,
2007
   December 31,
2006

Cigarettes and other tobacco products

   $ -      $ -      $ 283    $ 283

Cigars

     76         2,766   
                           

Total

   $ 76    $ -    $ 3,049    $ 283
                           

Intangible assets were as follows (in millions):

     December 31, 2007    December 31, 2006
     Gross
Carrying
Amount
   Accumulated
Amortization
   Gross
Carrying
Amount
   Accumulated
Amortization

Non-amortizable intangible assets

   $ 2,894       $ 283   

Amortizable intangible assets

     155    $ -       $ -
                           

Total intangible assets

   $ 3,049    $ -    $ 283    $ -
                           

 

13


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Non-amortizable intangible assets substantially consist of trademarks from Altria Group, Inc.’s December 2007 acquisition of John Middleton, Inc., as well as other acquired trademarks. Amortizable intangible assets consist primarily of customer relationships from the December 2007 acquisition of John Middleton, Inc. There was no pre-tax amortization expense for intangible assets during the years ended December 31, 2007, 2006 and 2005. Amortization expense for each of the next five years is estimated to be $10 million or less, assuming no additional transactions occur that require the amortization of intangible assets.

Goodwill relates to the December 2007 acquisition of John Middleton, Inc. The movement in goodwill and gross carrying amount of intangible assets is as follows (in millions):

 

     2007    2006
     Goodwill    Intangible
Assets
   Goodwill    Intangible
Assets

Balance at January 1

   $ -    $ 283    $ -    $ 283

Changes due to:

           

Acquisition of John Middleton, Inc.

     76      2,766      
                           

Balance at December 31

   $ 76    $ 3,049    $ -    $ 283
                           

The increase in goodwill and intangible assets during 2007 was due to Altria Group, Inc.’s acquisition of John Middleton, Inc. The allocation of purchase price is based upon preliminary estimates and assumptions and is subject to revision when appraisals are finalized in 2008. See Note 5. Acquisitions for a further discussion of the John Middleton, Inc. acquisition.

Environmental costs:

Altria Group, Inc. is subject to laws and regulations relating to the protection of the environment. Altria Group, Inc. provides for expenses associated with environmental remediation obligations on an undiscounted basis when such amounts are probable and can be reasonably estimated. Such accruals are adjusted as new information develops or circumstances change.

While it is not possible to quantify with certainty the potential impact of actions regarding environmental remediation and compliance efforts that Altria Group, Inc. may undertake in the future, in the opinion of management, environmental remediation and compliance costs, before taking into account any recoveries from third parties, will not have a material adverse effect on Altria Group, Inc.’s consolidated financial position, results of operations or cash flows.

Finance leases:

Income attributable to leveraged leases is initially recorded as unearned income and subsequently recognized as revenue over the terms of the respective leases at constant after-tax rates of return on the positive net investment balances. Investments in leveraged leases are stated net of related nonrecourse debt obligations.

Income attributable to direct finance leases is initially recorded as unearned income and subsequently recognized as revenue over the terms of the respective leases at constant pre-tax rates of return on the net investment balances.

Finance leases include unguaranteed residual values that represent PMCC’s estimates at lease inception as to the fair values of assets under lease at the end of the non-cancelable lease terms.

 

14


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

The estimated residual values are reviewed annually by PMCC’s management based on a number of factors and activity in the relevant industry. If necessary, revisions are recorded to reduce the residual values. Such reviews resulted in decreases of $11 million and $14 million in 2007 and 2006, respectively, to PMCC’s net revenues and results of operations. Residual reviews in 2005 resulted in no adjustments.

Foreign currency translation:

Altria Group, Inc. translates the results of operations of its foreign subsidiaries using average exchange rates during each period, whereas balance sheet accounts are translated using exchange rates at the end of each period. Currency translation adjustments are recorded as a component of stockholders’ equity. Transaction gains and losses are recorded in the consolidated statements of earnings and were not significant for any of the periods presented.

Guarantees:

Altria Group, Inc. accounts for guarantees in accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” Interpretation No. 45 requires the disclosure of certain guarantees and requires the recognition of a liability for the fair value of the obligation of qualifying guarantee activities. See Note 19. Contingencies for a further discussion of guarantees.

Hedging instruments:

Derivative financial instruments are recorded at fair value on the consolidated balance sheets as either assets or liabilities. Changes in the fair value of derivatives are recorded each period either in accumulated other comprehensive earnings (losses) or in earnings, depending on whether a derivative is designated and effective as part of a hedge transaction and, if it is, the type of hedge transaction. Gains and losses on derivative instruments reported in accumulated other comprehensive earnings (losses) are reclassified to the consolidated statements of earnings in the periods in which operating results are affected by the hedged item. Cash flows from hedging instruments are classified in the same manner as the affected hedged item in the consolidated statements of cash flows.

Impairment of long-lived assets:

Altria Group, Inc. reviews long-lived assets, including amortizable intangible assets, for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. Altria Group, Inc. performs undiscounted operating cash flow analyses to determine if an impairment exists. For purposes of recognition and measurement of an impairment for assets held for use, Altria Group, Inc. groups assets and liabilities at the lowest level for which cash flows are separately identifiable. If an impairment is determined to exist, any related impairment loss is calculated based on fair value. Impairment losses on assets to be disposed of, if any, are based on the estimated proceeds to be received, less costs of disposal.

Income taxes:

Altria Group, Inc. accounts for income taxes in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes.” Under SFAS No. 109, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Significant judgment is required in determining income tax provisions and in evaluating tax positions.

 

15


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

On January 1, 2007, Altria Group, Inc. adopted the provisions of FIN 48. The Interpretation prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. As a result of the January 1, 2007 adoption of FIN 48, Altria Group, Inc. lowered its liability for unrecognized tax benefits by $1,021 million. This resulted in an increase to stockholders’ equity of $857 million ($835 million, net of minority interest), a reduction of Kraft’s goodwill of $85 million and a reduction of federal deferred tax benefits of $79 million.

Altria Group, Inc. adopted the provisions of FASB Staff Position No. FAS 13-2, “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction” (“FAS 13-2”) effective January 1, 2007. This Staff Position requires the revenue recognition calculation to be reevaluated if there is a revision to the projected timing of income tax cash flows generated by a leveraged lease. The adoption of this Staff Position by Altria Group, Inc. resulted in a reduction to stockholders’ equity of $124 million as of January 1, 2007.

Inventories:

Inventories are stated at the lower of cost or market. The last-in, first-out (“LIFO”) method is used to cost substantially all tobacco inventories. It is a generally recognized industry practice to classify leaf tobacco inventory as a current asset although part of such inventory, because of the duration of the aging process, ordinarily would not be utilized within one year.

Altria Group, Inc. adopted the provisions of SFAS No. 151, “Inventory Costs” prospectively as of January 1, 2006. SFAS No. 151 requires that abnormal idle facility expense, spoilage, freight and handling costs be recognized as current-period charges. In addition, SFAS No. 151 requires that allocation of fixed production overhead costs to inventories be based on the normal capacity of the production facility. The effect of adoption did not have a material impact on Altria Group, Inc.’s consolidated results of operations, financial position or cash flows.

Marketing costs:

ALG’s subsidiaries promote their products with advertising, consumer incentives and trade promotions. Such programs include, but are not limited to, discounts, coupons, rebates, in-store display incentives and volume-based incentives. Advertising costs are expensed as incurred. Consumer incentive and trade promotion activities are recorded as a reduction of revenues based on amounts estimated as being due to customers and consumers at the end of a period, based principally on historical utilization and redemption rates. For interim reporting purposes, advertising and certain consumer incentive expenses are charged to operations as a percentage of sales, based on estimated sales and related expenses for the full year.

Revenue recognition:

The consumer products businesses recognize revenues, net of sales incentives and including shipping and handling charges billed to customers, upon shipment or delivery of goods when title and risk of loss pass to customers. ALG’s consumer products businesses also include excise taxes billed to customers in revenues. Shipping and handling costs are classified as part of cost of sales.

 

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ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Software costs:

Altria Group, Inc. capitalizes certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use. Capitalized software costs are included in property, plant and equipment on the consolidated balance sheets and are amortized on a straight-line basis over the estimated useful lives of the software, which do not exceed five years.

Stock-based compensation:

Effective January 1, 2006, Altria Group, Inc. adopted the provisions of SFAS No. 123 (Revised 2004) “Share-Based Payment” (“SFAS No. 123(R)”) using the modified prospective method, which requires measurement of compensation cost for all stock-based awards at fair value on date of grant and recognition of compensation over the service periods for awards expected to vest. The fair value of restricted stock and deferred stock is determined based on the number of shares granted and the market value at date of grant. The fair value of stock options is determined using a modified Black-Scholes methodology. The impact of adoption was not material.

The adoption of SFAS No. 123(R) resulted in a cumulative effect gain of $3 million, which is net of $2 million in taxes, in the consolidated statement of earnings for the year ended December 31, 2006. This gain resulted from the impact of estimating future forfeitures on restricted stock and deferred stock in the determination of periodic expense for unvested awards, rather than recording forfeitures only when they occur. The gross cumulative effect was recorded in marketing, administration and research costs for the year ended December 31, 2006.

Altria Group, Inc. previously applied the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”) and provided the pro forma disclosures required by SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). No compensation expense for employee stock options was reflected in net earnings in 2005, as all stock options granted under those plans had an exercise price not less than the fair market value of the common stock on the date of the grant. Historical consolidated statements of earnings already include the compensation expense for restricted stock and deferred stock. The following table illustrates the effect on net earnings and earnings per share (“EPS”) if Altria Group, Inc. had applied the fair value recognition provisions of SFAS No. 123 to measure compensation expense for stock option awards for the year ended December 31, 2005 (in millions, except per share data):

 

17


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

     2005

Net earnings, as reported

   $ 10,435

Deduct:

  

Total stock-based employee compensation expense determined under fair value method for all stock option awards, net of related tax effects

     15
      

Pro forma net earnings

   $ 10,420
      

Earnings per share:

  

Basic - as reported

   $ 5.04
      

Basic - pro forma

   $ 5.03
      

Diluted - as reported

   $ 4.99
      

Diluted - pro forma

   $ 4.98
      

Altria Group, Inc. has not granted stock options to employees since 2002. The amount shown above as stock-based compensation expense relates to Executive Ownership Stock Options (“EOSOs”). Under certain circumstances, senior executives who exercised outstanding stock options, using shares to pay the option exercise price and taxes, received EOSOs equal to the number of shares tendered. This feature ceased during 2007. During the years ended December 31, 2007, 2006 and 2005, Altria Group, Inc. granted 0.5 million, 0.7 million and 2.0 million EOSOs, respectively.

Altria Group, Inc. elected to calculate the initial pool of tax benefits resulting from tax deductions in excess of the stock-based employee compensation expense recognized in the statement of earnings (“excess tax benefits”) under the FASB Staff Position 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.” Excess tax benefits occur when the tax deduction claimed at vesting exceeds the fair value compensation expense accrued under SFAS No. 123(R). Excess tax benefits of $141 million and $195 million were recognized for the years ended December 31, 2007 and 2006, respectively, and were presented as financing cash flows. Previously, excess tax benefits were included in operating cash flows. Under SFAS No. 123(R), tax shortfalls occur when actual tax deductible compensation expense is less than cumulative stock-based compensation expense recognized in the financial statements. Tax shortfalls of $8 million at Kraft were recognized for the year ended December 31, 2006, and were recorded in additional paid-in capital.

New Accounting Standards:

In December 2007, the FASB issued SFAS No. 141 (Revised 2007) “Business Combinations” (“SFAS 141(R)”). SFAS 141(R) is effective for business combinations that close on or after January 1, 2009, the first day of Altria Group, Inc.’s annual reporting period beginning after December 15, 2008. SFAS 141(R) requires the recognition of assets acquired, liabilities assumed and any noncontrolling interest in the acquiree to be measured at fair value as of the acquisition date. Additionally, costs incurred to effect the acquisition are to be recognized separately from the acquisition and expensed as incurred.

Additionally, in December 2007, the FASB issued SFAS No. 160 “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”). SFAS 160 changes the reporting for

 

18


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

minority interests by reporting these as noncontrolling interests within equity. Moreover, SFAS 160 requires that any transactions between an entity and a noncontrolling interest are to be accounted for as equity transactions. SFAS 160 is effective for financial statements issued for fiscal years beginning after December 15, 2008. SFAS 160 is to be applied prospectively, except for the presentation and disclosure requirements, which shall be applied retrospectively for all periods presented.

Altria Group, Inc. is currently in the process of evaluating the impact of these pronouncements.

Note 3.   Asset Impairment and Exit Costs:

For the years ended December 31, 2007, 2006 and 2005, pre-tax asset impairment and exit costs consisted of the following:

 

            2007        2006        2005  
        (in millions)

Separation program

  

Cigarettes and other tobacco products

   $ 309    $ 10    $ -

Separation program

  

General corporate

     17      32      49
                       

Total separation programs

        326      42      49
                       

Asset impairment

  

Cigarettes and other tobacco products

     35      

Asset impairment

  

General corporate

        10   
                       

Total asset impairment

        35      10      -
                       

Spin-off fees

  

General corporate

     81      
                       

Asset impairment and exit costs

      $ 442    $ 52    $ 49
                       

The movement in the asset impairment and exit cost liabilities for Altria Group, Inc. for the years ended December 31, 2007 and 2006 was as follows:

 

     Severance     Asset
write-downs
    Other     Total  
     (in millions)  

Liability balance, January 1, 2006

   $ 24     $ -     $ -     $ 24  

Charges

     21       10       21       52  

Cash spent

     (24 )       (21 )     (45 )

Charges against assets

       (10 )       (10 )
                                

Liability balance, December 31, 2006

     21       -       -       21  

Charges

     281       35       126       442  

Cash spent

     (20 )       (89 )     (109 )

Charges against assets

       (35 )       (35 )

Other

     (3 )       (34 )     (37 )
                                

Liability balance, December 31, 2007

   $ 279     $ -     $ 3     $ 282  
                                

 

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ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Manufacturing Optimization Program:

In June 2007, Altria Group, Inc. announced plans by its tobacco subsidiaries to optimize worldwide cigarette production by moving U.S.-based cigarette production for non-U.S. markets to PMI facilities in Europe. Due to declining U.S. cigarette volume, as well as PMI’s decision to re-source its production, PM USA will close its Cabarrus, North Carolina manufacturing facility and consolidate manufacturing for the U.S. market at its Richmond, Virginia manufacturing center. PMI expects to shift all of its PM USA-sourced production, which approximates 57 billion cigarettes, to PMI facilities in Europe by the third quarter of 2008 and PM USA will close its Cabarrus manufacturing facility by the end of 2010.

As a result of this program, from 2007 through 2011, PM USA expects to incur total pre-tax charges of approximately $670 million, comprised of accelerated depreciation of $143 million (including the above mentioned asset impairment charge of $35 million recorded in 2007), employee separation costs of $353 million and other charges of $174 million, primarily related to the relocation of employees and equipment, net of estimated gains on sales of land and buildings. Approximately $440 million, or 66% of the total pre-tax charges, will result in cash expenditures. PM USA recorded total pre-tax charges of $371 million in 2007 related to this program. These charges were comprised of pre-tax asset impairment and exit costs of $344 million, and $27 million of pre-tax implementation costs associated with the program. The pre-tax implementation costs primarily related to accelerated depreciation and were included in cost of sales in the consolidated statement of earnings for the year ended December 31, 2007. Pre-tax charges of approximately $140 million are expected during 2008 for the program.

Corporate Asset Impairment and Exit Costs:

In 2007, 2006 and 2005, general corporate pre-tax charges were $98 million, $42 million and $49 million, respectively. These charges primarily related to investment banking and legal fees in 2007 associated with the Kraft and PMI spin-offs, as well as the streamlining of various corporate functions in each year.

 

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ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Note 4.  Divestitures:

Discontinued Operations:

As further discussed in Note 21. Subsequent Events, on March 28, 2008, Altria Group, Inc. completed the spin-off of PMI to Altria Group, Inc. stockholders in a tax-free distribution. Altria Group, Inc. distributed one share of PMI common stock for every share of Altria Group, Inc. common stock outstanding. Altria Group, Inc. has reflected PMI as discontinued operations in the consolidated balance sheets, statements of earnings and statements of cash flows for all periods presented.

As further discussed in Note 1. Background and Basis of Presentation, on March 30, 2007, Altria Group, Inc. distributed all of its remaining interest in Kraft on a pro-rata basis to Altria Group, Inc. stockholders in a tax-free distribution. Altria Group, Inc. stockholders received 0.692024 of a share of Kraft for each share of Altria Group, Inc. common stock outstanding. Altria Group, Inc. stockholders received cash in lieu of fractional shares of Kraft. The distribution was accounted for as a dividend and as such resulted in a net decrease of $27.4 billion to Altria Group, Inc.’s stockholders’ equity on March 30, 2007.

Altria Group, Inc. has reflected the results of Kraft prior to the distribution date as discontinued operations on the consolidated statements of earnings and the consolidated statements of cash flows for all periods presented. The assets and liabilities related to Kraft were reclassified and reflected as discontinued operations on the consolidated balance sheet at December 31, 2006.

Summarized financial information for PMI for the years ended December 31, 2007, 2006 and 2005 were as follows (in millions):

 

     2007     2006     2005  

Net revenues

   $ 55,137     $ 48,261     $ 45,289  
                        

Earnings before income taxes

   $ 8,852     $ 8,227     $ 7,642  

Provision for income taxes

     (2,549 )     (1,829 )     (1,835 )

Minority interest in earnings from discontinued operations

     (273 )     (251 )     (186 )
                        

Earnings from discontinued operations, net of income taxes and minority interest

   $ 6,030     $ 6,147     $ 5,621  
                        

 

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ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Summarized assets and liabilities of PMI as of December 31, 2007 and 2006 were as follows (in millions):

 

     2007    2006

Assets:

     

Cash and cash equivalents

   $ 1,656    $ 1,676

Receivables, net

     3,240      2,140

Inventories

     9,317      7,075

Other current assets

     554      426
             

Current assets of discontinued operations

     14,767      11,317
             

Property, plant and equipment, net

     6,435      5,238

Goodwill

     7,925      6,197

Other intangible assets, net

     1,904      1,625

Prepaid pension assets

     408      103

Other assets

     297      697

Financial services assets

        257
             

Long-term assets of discontinued operations

     16,969      14,117
             

Liabilities:

     

Short-term borrowings

     638      419

Current portion of long-term debt

     91      145

Accounts payable

     595      84

Accrued liabilities

     6,479      5,079

Income taxes

     470      575
             

Current liabilities of discontinued operations

     8,273      6,302
             

Long-term debt

     5,578      2,222

Deferred income taxes

     1,214      931

Accrued pension costs

     190      348

Other liabilities

     1,083      1,128

Financial services liabilities

        229
             

Long-term liabilities of discontinued operations

     8,065      4,858
             

Net Assets

   $ 15,398    $ 14,274
             

Summarized financial information for Kraft for the years ended December 31, 2007, 2006 and 2005 were as follows (in millions):

 

     2007     2006     2005  

Net revenues

   $ 8,586     $ 34,356     $ 34,341  
                        

Earnings before income taxes and minority interest

   $ 1,059     $ 4,016     $ 4,157  

Provision for income taxes

     (356 )     (951 )     (1,225 )

Loss on sale of discontinued operations

         (297 )

Minority interest in earnings from discontinued operations

     (78 )     (372 )     (370 )
                        

Earnings from discontinued operations, net of income taxes and minority interest

   $ 625     $ 2,693     $ 2,265  
                        

 

22


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Summarized assets and liabilities of Kraft as of December 31, 2006 were as follows (in millions):

 

     2006

Assets:

  

Cash and cash equivalents

   $ 239

Receivables, net

     3,262

Inventories

     3,506

Other current assets

     640
      

Current assets of discontinued operations

     7,647
      

Property, plant and equipment, net

     9,693

Goodwill

     27,038

Other intangible assets, net

     10,177

Prepaid pension assets

     1,168

Other assets

     729
      

Long-term assets of discontinued operations

     48,805
      

Liabilities:

  

Short-term borrowings

     1,715

Current portion of long-term debt

     1,418

Accounts payable

     2,602

Accrued liabilities

     3,980

Income taxes

     151
      

Current liabilities of discontinued operations

     9,866
      

Long-term debt

     7,081

Deferred income taxes

     3,930

Accrued pension costs

     1,022

Accrued postretirement health care costs

     3,014

Minority interest

     3,109

Other liabilities

     1,473
      

Long-term liabilities of discontinued operations

     19,629
      

Net Assets

   $ 26,957
      

Note 5.  Acquisition:

On December 11, 2007, in conjunction with PM USA’s adjacency strategy, Altria Group, Inc. acquired 100% of John Middleton, Inc., a leading manufacturer of machine-made large cigars, for $2.9 billion in cash. The acquisition was financed with existing cash. John Middleton, Inc.’s balance sheet has been consolidated with Altria Group, Inc.’s as of December 31, 2007. Earnings from December 12, 2007 to December 31, 2007, the amounts of which were insignificant, have been included in Altria Group, Inc.’s consolidated operating results.

Assets purchased consist primarily of non-amortizable intangible assets related to acquired brands of $2.6 billion, amortizable intangible assets of $0.1 billion, goodwill of $0.1 billion and other assets of $0.1 billion, partially offset by accrued liabilities assumed in the acquisition. These

 

23


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

amounts represent the preliminary allocation of purchase price and are subject to revision when appraisals are finalized in 2008.

Note 6.  Inventories:

The cost of approximately 94% and 95% of inventories in 2007 and 2006, respectively, was determined using the LIFO method. The stated LIFO amounts of inventories were approximately $0.7 billion lower than the current cost of inventories at December 31, 2007 and 2006.

Note 7.  Investment in SABMiller:

At December 31, 2007, ALG had a 28.6% economic and voting interest in SABMiller. ALG’s investment in SABMiller is being accounted for under the equity method and was $4.0 billion and $3.7 billion at December 31, 2007 and 2006, respectively. ALG had deferred tax liabilities of $1.3 billion and $1.2 billion related to its investment in SABMiller at December 31, 2007 and 2006, respectively.

Summary financial data of SABMiller is as follows:

 

         At December 31,
         2007    2006
         (in millions)

Current assets

     $ 4,225    $ 3,325
               

Long-term assets

     $ 29,803    $ 27,007
               

Current liabilities

     $ 5,718    $ 4,845
               

Long-term liabilities

     $ 10,773    $ 10,179
               
    For the Years Ended December 31,
    2007    2006    2005
    (in millions)

Net revenues

  $ 20,825    $ 18,103    $ 14,302
                   

Operating profit

  $ 3,230    $ 2,990    $ 2,543
                   

Net earnings

  $ 1,865    $ 1,588    $ 1,408
                   

The market value of ALG’s investment in SABMiller was $12.1 billion and $9.9 billion at December 31, 2007 and 2006, respectively.

In October 2005, SABMiller purchased a 71.8% interest in Bavaria SA, the second-largest brewer in South America, in exchange for the issuance of 225 million SABMiller ordinary shares of common stock. The ordinary shares had a value of approximately $3.5 billion. The remaining shares of Bavaria SA were acquired through a cash tender offer. Following the completion of the share issuance, ALG’s economic ownership interest in SABMiller was reduced from 33.9% to 28.7%. In addition, ALG elected to convert all of its non-voting shares to voting shares, and as a result increased its voting interest from 24.9% to 28.7%. The issuance of SABMiller ordinary common shares in exchange for controlling interest in Bavaria SA resulted in a change

 

24


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

of ownership gain for ALG of $402 million, net of income taxes, that was recorded in stockholders’ equity in the fourth quarter of 2005.

Note 8.   Finance Assets, net:

In 2003, PMCC shifted its strategic focus and is no longer making new investments but is instead focused on managing its existing portfolio of finance assets in order to maximize gains and generate cash flow from asset sales and related activities. Accordingly, PMCC’s operating companies income will fluctuate over time as investments mature or are sold. During 2007, 2006 and 2005, proceeds from asset sales, maturities and bankruptcy recoveries totaled $486 million, $357 million and $476 million, respectively, and gains totaled $274 million, $132 million and $72 million, respectively, in operating companies income.

Included in the proceeds for 2007 were partial recoveries of amounts previously charged to earnings in the allowance for losses related to PMCC’s airline exposure. The operating companies income associated with these recoveries, which is included in the gains shown above, was $214 million for the year ended December 31, 2007.

At December 31, 2007, finance assets, net, of $6,029 million were comprised of investments in finance leases of $6,221 million and other receivables of $12 million, reduced by the allowance for losses of $204 million. At December 31, 2006, finance assets, net, of $6,503 million were comprised of investments in finance leases of $6,970 million and other receivables of $13 million, reduced by the allowance for losses of $480 million.

A summary of the net investment in finance leases at December 31, before allowance for losses, was as follows (in millions):

 

     Leveraged Leases     Direct
Finance Leases
    Total  
     2007     2006     2007     2006     2007     2006  

Rentals receivable, net

   $6,628     $7,255     $371     $426     $6,999     $7,681  

Unguaranteed residual values

   1,499     1,752     89     98     1,588     1,850  

Unearned income

   (2,327 )   (2,495 )   (30 )   (37 )   (2,357 )   (2,532 )

Deferred investment tax credits

   (9 )   (29 )       (9 )   (29 )
                                    

Investments in finance leases

   5,791     6,483     430     487     6,221     6,970  

Deferred income taxes

   (4,739 )   (5,214 )   (273 )   (293 )   (5,012 )   (5,507 )
                                    

Net investments in finance leases

   $1,052     $1,269     $157     $194     $1,209     $1,463  
                                    

For leveraged leases, rentals receivable, net, represent unpaid rentals, net of principal and interest payments on third-party nonrecourse debt. PMCC’s rights to rentals receivable are subordinate to the third-party nonrecourse debtholders, and the leased equipment is pledged as collateral to the debtholders. The payment of the nonrecourse debt is collateralized by lease payments receivable and the leased property, and is nonrecourse to the general assets of PMCC. As required by U.S. GAAP, the third-party nonrecourse debt of $12.8 billion and $14.5 billion at December 31, 2007 and 2006, respectively, has been offset against the related rentals receivable. There were no leases with contingent rentals in 2007, 2006 and 2005.

 

25


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

At December 31, 2007, PMCC’s investment in finance leases was principally comprised of the following investment categories: electric power (30%), aircraft (23%), rail and surface transport (22%), manufacturing (14%), and real estate (11%). Investments located outside the United States, which are all dollar-denominated, represent 21% and 19% of PMCC’s investments in finance leases in 2007 and 2006, respectively.

PMCC leases one 750 megawatt (“MW”) natural gas-fired power plant (located in Pasadena, Texas) to an indirect subsidiary of Calpine Corporation (“Calpine”). Calpine, which has guaranteed the lease, is currently operating under bankruptcy protection. The subsidiary was not included as part of the bankruptcy filing of Calpine. PMCC does not record income on leases when the lessee or its guarantor is in bankruptcy. At December 31, 2007, PMCC’s finance asset balance for this lessee was $60 million. Based on PMCC’s assessment of the prospect for recovery on the Pasadena plant, a portion of the outstanding finance asset balance has been provided for in the allowance for losses. In July 2007, PMCC’s interest in two 265 MW natural gas-fired power plants (located in Tiverton, Rhode Island, and Rumford, Maine), which were part of the bankruptcy filing, were foreclosed upon. These leases were rejected and written off during 2006.

None of PMCC’s aircraft lessees are operating under bankruptcy protection at December 31, 2007. One of PMCC’s aircraft lessees, Northwest Airlines, Inc. (“Northwest”), exited bankruptcy on May 31, 2007 and assumed PMCC’s leveraged leases for three Airbus A-320 aircraft. PMCC’s leases for 19 aircraft with Delta Air Lines, Inc. (“Delta”) were sold in early 2007.

The activity in the allowance for losses on finance assets for the years ended December 31, 2007, 2006 and 2005 was as follows (in millions):

 

       2007      2006      2005  

Balance at beginning of year

     $480      $596      $497  

Amounts (recovered)/charged to earnings

     (129 )    103      200  

Amounts written-off

     (147 )    (219 )    (101 )
                      

Balance at end of year

     $204      $480      $596  
                      

The net impact to the allowance for losses in 2007, 2006 and 2005 related primarily to various airline leases. Amounts recovered of $129 million in 2007 related to partial recoveries of amounts previously charged to earnings in the allowance for losses in prior years. In addition, PMCC recovered $85 million related to amounts previously charged to earnings and written-off in the allowance for losses in prior years. In total, these recoveries resulted in additional operating companies income of $214 million for the year ended December 31, 2007. As a result of the $200 million charge in 2005, PMCC’s fixed charges coverage ratio did not meet its 1.25:1 requirement under a support agreement with ALG. Accordingly, as required by the support agreement, a support payment of $150 million was made by ALG to PMCC in September 2005. It is possible that additional adverse developments may require PMCC to increase its allowance for losses. Acceleration of taxes on the foreclosures of leveraged leases written-off amounted to approximately $50 million and $80 million in 2007 and 2006, respectively. There were no foreclosures in 2005.

 

26


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Rentals receivable in excess of debt service requirements on third-party nonrecourse debt related to leveraged leases and rentals receivable from direct finance leases at December 31, 2007, were as follows (in millions):

 

     Leveraged
Leases
   Direct
Finance
Leases
   Total

2008

   $ 297    $ 48    $ 345

2009

     218      48      266

2010

     204      45      249

2011

     110      45      155

2012

     195      50      245

2013 and thereafter

     5,604      135      5,739
                    

Total

   $ 6,628    $ 371    $ 6,999
                    

Included in net revenues for the years ended December 31, 2007, 2006 and 2005, were leveraged lease revenues of $163 million, $301 million and $302 million, respectively, and direct finance lease revenues of $15 million, $8 million and $11 million, respectively. Income tax expense on leveraged lease revenues for the years ended December 31, 2007, 2006 and 2005, was $57 million, $107 million and $108 million, respectively.

Income from investment tax credits on leveraged leases and initial direct costs and executory costs on direct finance leases were not significant during the years ended December 31, 2007, 2006 and 2005.

As discussed further in Note 14. Income Taxes, the Internal Revenue Service has disallowed benefits pertaining to several PMCC leveraged lease transactions for the years 1996 through 1999.

Note 9.   Short-Term Borrowings and Borrowing Arrangements:

At December 31, 2007, Altria Group, Inc. had no short-term borrowings. At December 31, 2006, Altria Group, Inc. had short-term borrowings of $1 million at an average year-end interest rate of 6.0%.

The fair value of Altria Group, Inc.’s short-term borrowings at December 31, 2006, based upon current market interest rates, approximate the amount disclosed above.

At December 31, 2007, ALG’s debt ratings by major credit rating agencies were as follows:

 

     Short-term    Long-term    Outlook     

Moody’s

   P-2    Baa1    Stable   

Standard & Poor’s

   A-2     BBB    Stable   

Fitch

   F-2       BBB+    Stable   

ALG has a 364-day revolving credit facility in the amount of $1.0 billion, which expires on March 27, 2008. In addition, ALG maintains a multi-year credit facility in the amount of $4.0 billion, which expires April 15, 2010. The ALG facilities require the maintenance of an earnings to fixed charges ratio, as defined by the agreements, of not less than 2.5 to 1.0. At December 31,

 

27


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

2007, the ratio calculated in accordance with the agreements was 19.6 to 1.0. After the effectiveness of the spin-off of PMI, ALG’s multi-year credit facility will be reduced from $4.0 billion to $3.5 billion and the earnings to fixed charges ratio will be replaced with a ratio of EBITDA to interest expense of not less than 4.0 to 1.0. In addition, the facility will then require the maintenance of a ratio of debt to EBITDA of not more than 2.5 to 1.0. If the PMI spin-off had occurred as of December 31, 2007, the ratio of EBITDA to interest expense would have been 15.6 to 1.0, and the ratio of debt to EBITDA would have been 0.9 to 1.0.

ALG expects to continue to meet its covenants. These facilities do not include any credit rating triggers or any provisions that could require the posting of collateral. The multi-year facilities enable ALG to reclassify short-term debt on a long-term basis.

At December 31, 2007, credit lines for ALG and the related activity, were as follows (in billions of dollars):

 

ALG

   December 31, 2007
Type    Credit
Lines
  

Amount

Drawn

  

Commercial

Paper

Outstanding

  

Lines

Available

364-day revolving credit, expiring 3/27/08

   $ 1.0    $ -      $ -      $ 1.0

Multi-year revolving credit, expiring, 4/15/10

     4.0            4.0
                           
   $ 5.0    $ -      $ -      $ 5.0
                           

 

 

Note 10.   Long-Term Debt:

At December 31, 2007 and 2006, Altria Group, Inc.’s long-term debt consisted of the following:

 

     2007        2006  
     (in millions)  

Consumer products:

       

Notes, 5.63% to 7.65% (average interest rate 6.75%), due through 2013

   $ 1,850        $ 2,350  

7.75% Debenture, due 2027

     750          750  

Foreign currency obligation:

       

Euro, 5.63% due 2008

     1,503          1,340  

Other

     136          139  
                   
     4,239          4,579  

Less current portion of long-term debt

     (2,354 )        (503 )
                   
   $ 1,885        $ 4,076  
                   

 

Financial services:

       

Eurodollar bonds, 7.50%, due 2009

   $ 500        $ 499  

Swiss franc, 4.00%, due 2007

          620  
                   
   $ 500        $ 1,119  
                   

 

28


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Aggregate maturities of Altria Group, Inc.’s long-term debt, are as follows (in millions):

 

           Consumer Products            Financial Services

2008

   $2,354     

2009

        135      $500

2013

     1,000     

2027

       750     

Based on market quotes, where available, or interest rates currently available to Altria Group, Inc. for issuance of debt with similar terms and remaining maturities, the aggregate fair value of consumer products and financial services long-term debt, including the current portion of long-term debt, at December 31, 2007 and 2006 was $5.0 billion and $6.0 billion, respectively.

 

Note 11.   Capital Stock:

Shares of authorized common stock are 12 billion; issued, repurchased and outstanding shares were as follows:

 

       Shares
Issued
     Shares
Repurchased
     Shares
Outstanding

Balances, January 1, 2005

     2,805,961,317      (746,433,841 )    2,059,527,476

Exercise of stock options and issuance of other stock awards

          24,736,923      24,736,923
                    

Balances, December 31, 2005

     2,805,961,317      (721,696,918 )    2,084,264,399

Exercise of stock options and issuance of other stock awards

          12,816,529      12,816,529
                    

Balances, December 31, 2006

     2,805,961,317      (708,880,389 )    2,097,080,928

Exercise of stock options and issuance of other stock awards

          10,595,834      10,595,834
                    

Balances, December 31, 2007

     2,805,961,317      (698,284,555 )    2,107,676,762
                    

At December 31, 2007, 77,491,184 shares of common stock were reserved for stock options and other stock awards under Altria Group, Inc.’s stock plans, and 10 million shares of Serial Preferred Stock, $1.00 par value, were authorized, none of which have been issued.

Note 12.   Stock Plans:

Under the Altria Group, Inc. 2005 Performance Incentive Plan (the “2005 Plan”), Altria Group, Inc. may grant to eligible employees stock options, stock appreciation rights, restricted stock, deferred stock, and other stock-based awards, as well as cash-based annual and long-term incentive awards. Up to 50 million shares of common stock may be issued under the 2005 Plan. In addition, Altria Group, Inc. may grant up to one million shares of common stock to members of the Board of Directors who are not employees of Altria Group, Inc. under the 2005

 

29


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Stock Compensation Plan for Non-Employee Directors (the “2005 Directors Plan”). At December 31, 2007, options to purchase 29,536,591 shares of Altria Group, Inc.’s common stock were outstanding. Shares available to be granted under the 2005 Plan and the 2005 Directors Plan at December 31, 2007 were 43,360,958 and 945,798, respectively.

As more fully described in Note 1. Background and Basis of Presentation, certain modifications were made to stock options, restricted stock and deferred stock as a result of the Kraft spin-off.

Altria Group, Inc. has not granted stock options to employees since 2002. Under certain circumstances, senior executives who exercised outstanding stock options using shares to pay the option exercise price and taxes received EOSOs equal to the number of shares tendered. EOSOs were granted at an exercise price of not less than fair market value on the date of the grant, and became exercisable six months after the grant date. This feature ceased during 2007.

 

Stock Option Plan

In connection with the Kraft spin-off, Altria Group, Inc. employee stock options were modified through the issuance of Kraft employee stock options and the adjustment of the stock option exercise prices for the Altria Group, Inc. awards. For each employee stock option outstanding the aggregate intrinsic value of the option immediately after the spin-off was not greater than the aggregate intrinsic value of the option immediately before the spin-off. Due to the fact that the Black-Scholes fair values of the awards immediately before and immediately after the spin-off were equivalent, as measured in accordance with the provisions of SFAS No. 123(R), no incremental compensation expense was recorded as a result of the modification of the Altria Group, Inc. awards.

Pre-tax compensation cost and the related tax benefit for stock option awards totaled $9 million and $3 million, respectively, for the year ended December 31, 2007. Pre-tax compensation cost and the related tax benefit for stock option awards totaled $17 million and $6 million, respectively, for the year ended December 31, 2006. Pre-tax compensation cost for stock option awards included $1 million in 2007 and $4 million in 2006 related to employees of discontinued operations. The fair value of the awards was determined using a modified Black-Scholes methodology using the following weighted average assumptions:

 

     Risk-Free
Interest Rate
  Expected
Life
   Expected
Volatility
  Expected
Dividend
Yield

2007 Altria Group, Inc.

   4.56%   4 years    25.98%   3.99%

2006 Altria Group, Inc.

   4.83      4    28.30      4.29   

2005 Altria Group, Inc.

   3.97      4    32.66      4.39   

 

30


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Altria Group, Inc. stock option activity was as follows for the year ended December 31, 2007:

 

     Shares Subject
to Option
    Weighted
Average
Exercise Price
   Average
Remaining
Contractual
Term
   Aggregate
Intrinsic
Value

Balance at January 1, 2007

   40,093,392     $33.84      

Options granted (EOSOs)

   507,555       64.69      

Options exercised

   (11,049,904 )     38.25      

Options canceled

   (14,452 )     42.01      
              

Balance/Exercisable at December 31, 2007

   29,536,591       32.71    2 years    $1.3 billion
              

As more fully described in Note 1. Background and Basis of Presentation, the weighted average exercise prices shown in the table above were reduced as a result of the Kraft spin-off.

The aggregate intrinsic value shown in the table above was based on the December 31, 2007 closing price for Altria Group, Inc.’s common stock of $75.58. The weighted-average grant date fair value of options granted during the years ended December 31, 2007, 2006 and 2005 was $15.55, $14.53 and $14.41, respectively. The total intrinsic value of options exercised during the years ended December 31, 2007, 2006 and 2005 was $454 million, $456 million and $756 million, respectively.

Restricted Stock Plans

Altria Group, Inc. may grant shares of restricted stock and deferred stock to eligible employees, giving them in most instances all of the rights of stockholders, except that they may not sell, assign, pledge or otherwise encumber such shares. Such shares are subject to forfeiture if certain employment conditions are not met. Restricted and deferred stock generally vests on the third anniversary of the grant date.

The fair value of the restricted shares and deferred shares at the date of grant is amortized to expense ratably over the restriction period, which is generally three years. Altria Group, Inc. recorded pre-tax compensation expense related to restricted stock and deferred stock granted to employees of its continuing operations for the years ended December 31, 2007, 2006 and 2005 of $80 million, $59 million and $70 million, respectively. The deferred tax benefit recorded related to this compensation expense was $29 million, $22 million and $26 million for the years ended December 31, 2007, 2006 and 2005, respectively. The pre-tax compensation expense for the year ended December 31, 2006 includes the pre-tax cumulative effect gain of $5 million from the adoption of SFAS No. 123(R). The unamortized compensation expense related to Altria Group, Inc. restricted stock and deferred stock was $90 million at December 31, 2007 and is expected to be recognized over a weighted average period of 2 years.

 

31


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Altria Group, Inc. restricted stock and deferred stock activity was as follows for the year ended December 31, 2007:

 

   Number of

Shares

 

 

  Weighted-Average

Grant Date Fair Value

            Per Share            

Balance at January 1, 2007

   6,396,710     $61.80

Granted

   2,282,486       65.62

Vested

   (2,137,294 )     55.51

Forfeited

   (394,395 )     66.29
        

Balance at December 31, 2007

   6,147,507       65.11
        

In January 2007, Altria Group, Inc. issued 1.7 million shares of deferred stock to eligible U.S.-based and non-U.S. employees. Restrictions on these shares lapse in the first quarter of 2010. The market value per share was $87.36 on the date of grant. Recipients of these Altria Group, Inc. deferred shares did not receive restricted stock or deferred stock of Kraft upon the Kraft spin-off. Rather, they received 0.6 million additional deferred shares of Altria Group, Inc. to preserve the intrinsic value of the original award, and accordingly, the grant date fair value per share, in the table above, related to this grant was reduced.

The grant price information for restricted stock and deferred stock awarded prior to January 31, 2007 reflects historical market prices which are not adjusted to reflect the Kraft spin-off. As discussed more fully in Note 1. Background and Basis of Presentation, as a result of the Kraft spin-off, holders of restricted stock and deferred stock awarded prior to January 31, 2007 retained their existing award and received restricted stock or deferred stock of Kraft Class A common stock.

The weighted–average grant date fair value of Altria Group, Inc. restricted stock and deferred stock granted during the years ended December 31, 2007, 2006 and 2005 was $150 million, $146 million and $137 million, respectively, or $65.62, $74.21 and $62.05 per restricted or deferred share, respectively. The total fair value of Altria Group, Inc. restricted stock and deferred stock vested during the years ended December 31, 2007, 2006 and 2005 was $184 million, $215 million and $4 million, respectively.

 

32


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Note 13.   Earnings per Share:

Basic and diluted EPS from continuing and discontinued operations were calculated using the following:

 

     For the Years Ended December 31,
     2007    2006    2005
     (in millions)

Earnings from continuing operations

   $ 3,131    $ 3,182    $ 2,549

Earnings from discontinued operations

     6,655      8,840      7,886
                    

Net earnings

   $ 9,786    $ 12,022    $ 10,435
                    

Weighted average shares for basic EPS

     2,101      2,087      2,070

Plus incremental shares from assumed conversions:

        

Restricted stock and deferred stock

     3      4      6

Stock options

     12      14      14
                    

Weighted average shares for diluted EPS

     2,116      2,105      2,090
                    

For the 2007 computation, there were no antidilutive stock options. For the 2006 and 2005 computations, the number of stock options excluded from the calculation of weighted average shares for diluted EPS because their effects were antidilutive was immaterial.

 

33


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Note 14.   Income Taxes:

Earnings from continuing operations before income taxes, and provision for income taxes consisted of the following for the years ended December 31, 2007, 2006 and 2005:

 

       2007         2006         2005
     (in millions)

Earnings from continuing operations before income taxes:

      

United States

   $ 4,674     $ 4,732     $ 4,102

Outside United States

     4       21       21
                      

Total

   $ 4,678     $ 4,753     $ 4,123
                      

Provision for income taxes:

      

United States federal:

      

Current

   $ 1,659     $ 1,825     $ 1,136

Deferred

     (219 )     (570 )     158
                      
     1,440       1,255       1,294

State and local

     98       303       260
                      

Total United States

     1,538       1,558       1,554
                      

Outside United States:

      

Current

     9       13       20

Deferred

      
                      

Total outside United States

     9       13       20
                      

Total provision for income taxes

   $ 1,547     $ 1,571     $ 1,574
                      

The Internal Revenue Service (“IRS”) concluded its examination of Altria Group, Inc.’s consolidated tax returns for the years 1996 through 1999, and issued a final Revenue Agent’s Report (“RAR”) on March 15, 2006. Altria Group, Inc. agreed with the RAR, with the exception of certain leasing matters discussed below. Consequently, in March 2006, Altria Group, Inc. recorded non-cash tax benefits of $1.0 billion, which principally represented the reversal of tax reserves following the issuance of and agreement with the RAR. Altria Group, Inc. reimbursed $337 million and $450 million in cash to Kraft and PMI, respectively, for their portion of the $1.0 billion related to federal tax benefits, as well as pre-tax interest of $46 million to Kraft. The total tax benefits related to Kraft and PMI, which included the above mentioned federal tax benefits, as well as state tax benefits of $74 million, were reclassified to earnings from discontinued operations. The tax reversal resulted in an increase to earnings from continuing operations of $146 million for the year ended December 31, 2006.

Altria Group, Inc. has agreed with all conclusions of the RAR, with the exception of the disallowance of benefits pertaining to several PMCC leveraged lease transactions for the years 1996 through 1999. PMCC will continue to assert its position regarding these leveraged lease transactions and contest approximately $150 million of tax and net interest assessed and paid with regard to them. The IRS may in the future challenge and disallow more of PMCC’s leveraged leases based on Revenue Rulings, an IRS Notice and subsequent case law addressing specific types of leveraged leases (lease-in/lease-out (“LILO”) and sale-in/lease-out (“SILO”) transactions). PMCC believes that the position and supporting case law described in the RAR, Revenue Rulings and the IRS Notice are incorrectly applied to PMCC’s transactions and that its

 

34


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

leveraged leases are factually and legally distinguishable in material respects from the IRS’s position. PMCC and ALG intend to vigorously defend against any challenges based on that position through litigation. In this regard, on October 16, 2006, PMCC filed a complaint in the U.S. District Court for the Southern District of New York to claim refunds for a portion of these tax payments and associated interest. However, should PMCC’s position not be upheld, PMCC may have to accelerate the payment of significant amounts of federal income tax and significantly lower its earnings to reflect the recalculation of the income from the affected leveraged leases, which could have a material effect on the earnings and cash flows of Altria Group, Inc. in a particular fiscal quarter or fiscal year. PMCC considered this matter in its adoption of FIN 48 and FASB Staff Position No. FAS 13-2.

Altria Group, Inc.’s U.S. subsidiaries join in the filing of a U.S. federal consolidated income tax return. The U.S. federal statute of limitations remains open for the year 2000 and onward with years 2000 to 2003 currently under examination by the IRS. State jurisdictions have statutes of limitations generally ranging from 3 to 5 years. Altria Group, Inc. is currently under examination in various states.

As previously discussed in Note 2. Summary of Significant Accounting Policies, on January 1, 2007, Altria Group, Inc. adopted the provisions of FIN 48. As a result of the January 1, 2007 adoption of FIN 48, Altria Group, Inc. lowered its liability for unrecognized tax benefits by $1,021 million. This resulted in an increase to stockholders’ equity of $857 million ($835 million, net of minority interest), a reduction of Kraft’s goodwill of $85 million and a reduction of federal deferred tax benefits of $79 million.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

 

    (in millions)

Balance at January 1, 2007

     $1,053    

    Additions based on tax positions related to the current year

     70    

    Additions for tax positions of prior years

     22    

    Reductions for tax positions of prior years

     (28 )  

    Reductions for tax positions due to lapse of statutes of limitations

     (116 )  

    Settlements

     (21 )  

    Reduction of state and foreign unrecognized tax benefits due to Kraft spin-off

     (365 )  
          

Balance at December 31, 2007

     $615    
          

 

35


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Unrecognized tax benefits and Altria Group, Inc.’s consolidated liability for tax contingencies were as follows:

 

     December 31,
2007
    January 1,
2007
 
     (in millions)  

Unrecognized tax benefits - Altria Group, Inc.

   $ 182     $ 269  

Unrecognized tax benefits - Kraft

     270       619  

Unrecognized tax benefits - PMI

     163       165  
                

    Unrecognized tax benefits

     615       1,053  

Accrued interest and penalties

     267       292  

Tax credits and other indirect benefits

     (102 )     (104 )
                

    Liability for tax contingencies

   $ 780     $ 1,241  
                

The amount of unrecognized tax benefits that, if recognized, would impact the effective tax rate at December 31, 2007 was $150 million, along with $32 million affecting deferred taxes, $163 million impacting discontinued operations, and the remainder of $270 million affecting the receivable from Kraft discussed below. The amount of unrecognized tax benefits that, if recognized, would impact the effective tax rate at January 1, 2007 was $198 million, along with $71 million affecting deferred taxes, and the remainder of $784 million impacting discontinued operations.

Altria Group, Inc.’s unrecognized tax benefits decreased to $615 million as of December 31, 2007, principally due to the spin-off of Kraft, as well as the expiration of statutes of limitations and audit closures in state and foreign jurisdictions. For the year ended December 31, 2007, Altria Group, Inc. recognized in its consolidated statement of earnings $13 million of interest and penalties.

Under the Tax Sharing Agreement between Altria Group, Inc. and Kraft, Kraft is responsible for its own pre-spin-off tax obligations. However, due to regulations governing the U.S. federal consolidated tax return, Altria Group, Inc. remains severally liable for Kraft’s pre-spin-off federal taxes. As a result, Altria Group, Inc. continues to include $270 million of Kraft’s unrecognized tax benefits in its liability for uncertain tax positions, and a corresponding receivable from Kraft of $270 million is included in other assets. Similarly, under the Tax Sharing Agreement between Altria Group, Inc. and PMI, PMI will be responsible for its own pre-spin-off tax obligations.

Altria Group, Inc. recognizes accrued interest and penalties associated with uncertain tax positions as part of the tax provision. As of January 1, 2007, Altria Group, Inc. had $292 million of accrued interest and penalties of which approximately $125 million and $26 million related to Kraft and PMI, respectively. The accrued interest and penalties decreased to $267 million at December 31, 2007, principally as a result of the Kraft spin-off, and the expiration of statutes of limitations and audit closures in state and foreign jurisdictions. The accrued interest and penalties at December 31, 2007 includes $88 million of Kraft federal interest for which Kraft is responsible under the Kraft Tax Sharing Agreement. The receivable from Kraft, which is included in other assets, includes related accrued interest and penalties. The accrued interest and penalties at December 31, 2007 also includes $25 million of PMI federal interest for which PMI will be responsible under the PMI Tax Sharing Agreement.

 

36


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

It is reasonably possible that within the next 12 months certain state and foreign examinations will be resolved, which could result in a decrease in unrecognized tax benefits, and interest and penalties of approximately $40 million and $12 million, respectively, of which $8 million and $3 million, respectively, related to PMI.

As previously discussed in Note 2. Summary of Significant Accounting Policies, Altria Group, Inc. adopted the provisions of FAS 13-2 effective January 1, 2007. The adoption of FAS 13-2 resulted in a reduction to stockholders’ equity of $124 million as of January 1, 2007.

The effective income tax rate on pre-tax earnings from continuing operations differed from the U.S. federal statutory rate for the following reasons for the years ended December 31, 2007, 2006 and 2005:

 

     2007     2006     2005  

U.S. federal statutory rate

   35.0 %   35.0 %   35.0 %

Increase (decrease) resulting from:

      

     State and local income taxes, net of federal tax benefit excluding IRS audit impacts

   3.6     3.9     4.1  

     Benefit principally related to reversal of federal and state reserves on conclusion of IRS audit

     (3.1 )  

     Reversal of tax reserves no longer required

   (2.4 )    

     Foreign dividend repatriation (benefit) cost

   (2.0 )   (1.4 )   0.7  

     Other

   (1.1 )   (1.3 )   (1.6 )
                  

Effective tax rate

   33.1 %   33.1 %   38.2 %
                  

The tax provision in 2007 includes net tax benefits of $111 million related to the reversal of tax reserves and associated interest resulting from the expiration of statutes of limitations ($55 million in the third quarter and $56 million in the fourth quarter). The tax provision in 2007 also includes the reversal of tax accruals of $57 million no longer required in the fourth quarter. The tax provision in 2006 includes $146 million of non-cash tax benefits principally representing the reversal of tax reserves after the U.S. IRS concluded its examination of Altria Group, Inc.’s consolidated tax returns for the years 1996 through 1999 in the first quarter of 2006. The tax provision in 2005 includes the impact of the domestic manufacturers’ deduction under the American Jobs Creation Act.

 

37


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

The tax effects of temporary differences that gave rise to consumer products deferred income tax assets and liabilities consisted of the following at December 31, 2007 and 2006:

 

     2007     2006  
     (in millions)  

Deferred income tax assets:

    

        Accrued postretirement and postemployment benefits

   $ 1,055     $ 970  

        Settlement charges

     1,642       1,449  
                

                Total deferred income tax assets

     2,697       2,419  
                

Deferred income tax liabilities:

    

        Property, plant and equipment

     (418 )     (465 )

        Prepaid pension costs

     (311 )     (267 )

        Other

     (1,133 )     (367 )
                

                Total deferred income tax liabilities

     (1,862 )     (1,099 )
                

Net deferred income tax assets

   $ 835     $ 1,320  
                

Financial services deferred income tax liabilities are primarily attributable to temporary differences relating to net investments in finance leases.

 

Note 15.   Segment Reporting:

The products of ALG’s subsidiaries include cigarettes and other tobacco products sold in the United States by PM USA, and cigars and pipe tobacco sold by John Middleton, Inc. Another subsidiary of ALG, PMCC, maintains a portfolio of leveraged and direct finance leases.

As discussed in Note 1. Background and Basis of Presentation, beginning with the first quarter of 2008, Altria Group, Inc. revised its reportable segments. Altria Group, Inc.’s reportable segments are Cigarettes and other tobacco products; Cigars; and Financial services.

Altria Group, Inc.’s management reviews operating companies income to evaluate segment performance and allocate resources. Operating companies income for the segments excludes general corporate expenses. Interest and other debt expense, net (consumer products), and provision for income taxes are centrally managed at the ALG level and, accordingly, such items are not presented by segment since they are excluded from the measure of segment profitability reviewed by Altria Group, Inc.’s management. Information about total assets by segment is not disclosed because such information is not reported to or used by Altria Group, Inc.’s chief operating decision maker. Segment goodwill and other intangible assets, net, are disclosed in Note 2. Summary of Significant Accounting Policies. The accounting policies of the segments are the same as those described in Note 2.

 

38


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Segment data were as follows:

 

     For the Years Ended December 31,  
     2007     2006     2005  
     (in millions)  

Net revenues:

      

Cigarettes and other tobacco products

   $ 18,470     $ 18,474     $ 18,134  

Cigars

     15      

Financial services

     179       316       318  
                        

Net revenues

   $ 18,664     $ 18,790     $ 18,452  
                        

Earnings from continuing operations before income taxes:

      

Operating companies income:

      

Cigarettes and other tobacco products

   $ 4,511     $ 4,812     $ 4,581  

Cigars

     7      

Financial services

     380       175       30  

General corporate expenses

     (525 )     (469 )     (507 )
                        

Operating income

     4,373       4,518       4,104  

Interest and other debt expense, net

     (205 )     (225 )     (427 )

Equity earnings in SABMiller

     510       460       446  
                        

Earnings from continuing operations before income taxes

   $ 4,678     $ 4,753     $ 4,123  
                        

PM USA’s largest customer, McLane Company, Inc., accounted for approximately 26%, 25% and 23% of Altria Group, Inc.’s consolidated net revenues for the years ended December 31, 2007, 2006 and 2005, respectively. These net revenues were reported in the Cigarettes and other tobacco products segment.

Items affecting the comparability of results from continuing operations were as follows:

Loss on Tobacco Pool – As further discussed in Note 19. Contingencies, in October 2004, the Fair and Equitable Tobacco Reform Act of 2004 (“FETRA”) was signed into law. Under the provisions of FETRA, PM USA was obligated to cover its share of potential losses that the government may incur on the disposition of pool tobacco stock accumulated under the previous tobacco price support program. In 2005, PM USA recorded a $138 million expense for its share of the loss, which is included in the operating companies income of the Cigarettes and other tobacco products segment.

Tobacco Quota Buy-Out – The provisions of FETRA require PM USA, along with other manufacturers and importers of tobacco products, to make quarterly payments that will be used to compensate tobacco growers and quota holders affected by the legislation. Payments made by PM USA under FETRA offset amounts due under the provisions of the National Tobacco Grower Settlement Trust (“NTGST”), a trust formerly established to compensate tobacco growers and quota holders. Disputes arose as to the applicability of FETRA to 2004 NTGST payments. During the third quarter of 2005, a North Carolina Supreme Court ruling determined that FETRA enactment had not triggered the offset provisions during 2004 and that tobacco companies were required to make full payment to the NTGST for the full year of 2004. The ruling, along with FETRA billings from the United States Department of Agriculture (“USDA”), established that FETRA was effective beginning in 2005. Accordingly, during the

 

39


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

third quarter of 2005, PM USA reversed a 2004 accrual for FETRA payments in the amount of $115 million, which is included in the operating companies income of the Cigarettes and other tobacco products segment.

Asset Impairment and Exit Costs – See Note 3. Asset Impairment and Exit Costs, for a breakdown of these charges by segment.

Recoveries/Provision from/for Airline Industry Exposure – As discussed in Note 8. Finance Assets, net, during 2007, PMCC recorded pre-tax gains of $214 million on the sale of its ownership interests and bankruptcy claims in certain leveraged lease investments in aircraft, which represented a partial recovery, in cash, of amounts that had been previously written down. During 2006, PMCC increased its allowance for losses by $103 million, due to issues within the airline industry. During 2005, PMCC increased its allowance for losses by $200 million, reflecting its exposure to the airline industry, particularly Delta and Northwest, both of which filed for bankruptcy protection during 2005.

See Notes 4 and 5, respectively, regarding divestitures and acquisitions.

 

     For the Years Ended December 31,
     2007    2006    2005
     (in millions)

Depreciation expense:

        

Cigarettes and other tobacco products

   $ 210    $ 202    $ 208

Corporate

     22      53      61
                    

Total depreciation expense

   $ 232    $ 255    $ 269
                    
     For the Years Ended December 31,
     2007    2006    2005
     (in millions)

Capital expenditures:

        

Cigarettes and other tobacco products

   $ 352    $ 361    $ 228

Corporate

     34      38      71
                    

Total capital expenditures

   $ 386    $ 399    $ 299
                    

 

40


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Note 16.   Benefit Plans:

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”). SFAS No. 158 requires that employers recognize the funded status of their defined benefit pension and other postretirement plans on the consolidated balance sheet and record as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that have not been recognized as components of net periodic benefit cost. Altria Group, Inc. adopted SFAS No. 158, prospectively, on December 31, 2006.

The incremental effect of applying SFAS No. 158 on individual line items in the consolidated balance sheet at December 31, 2006 was as follows:

 

   Before

Application

of

SFAS No. 158    

   Adjustments    After

Application

of

    SFAS No. 158

   (in millions)

Current assets of discontinued operations

   $  19,058         (94)        $  18,964     

Other current assets

   1,839         (29)        1,810     

Total current assets

   26,275         (123)        26,152     

Prepaid pension assets

   1,831         (1,173)        658     

Long-term assets of discontinued operations

   65,276         (2,354)        62,922     

Other assets

   1,151         554         1,705     

Total consumer products assets

   100,833         (3,096)        97,737     

Total assets

   107,366         (3,096)        104,270     

Accrued liabilities - other

   944         9         953     

Current liabilities of discontinued operations

   16,161         7         16,168     

Total current liabilities

   25,411         16         25,427     

Deferred income taxes

   619         (159)        460     

Accrued pension costs

   157         36         193     

Accrued postretirement health care costs

   1,595         414         2,009     

Long-term liabilities of discontinued operations

   24,623         (136)        24,487     

Other liabilities

   1,411         119         1,530     

Total consumer products liabilities

   57,892         290         58,182     

Total liabilities

   64,361         290         64,651     

Accumulated other comprehensive losses

   (422)        (3,386)        (3,808)    

Total stockholders’ equity

   43,005         (3,386)        39,619     

Total liabilities and stockholders’ equity

   107,366         (3,096)        104,270     

 

41


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

The amounts recorded in accumulated other comprehensive earnings/losses at December 31, 2007 consisted of the following:

 

            Pensions             Postretirement     Postemployment       Total    
    (in millions)  

Net losses

  $ (939 )   $ (356 )   $ (149 )   $ (1,444 )

Prior service cost

    (55 )     100         45  

Deferred income taxes

    386       95       58       539  
                               

Amounts to be amortized–continuing operations

    (608 )     (161 )     (91 )     (860 )

Amounts related to discontinued operations

    (49 )       (51 )     (100 )
                               

Amounts recorded in accumulated other comprehensive earnings/losses

  $ (657 )   $ (161 )   $ (142 )   $ (960 )
                               

 

The amounts recorded in accumulated other comprehensive earnings/losses at December 31, 2006 consisted of the following:

 

            Pensions             Postretirement     Postemployment       Total    
    (in millions)  

Net losses

  $ (1,251 )   $ (505 )   $ (136 )   $ (1,892 )

Prior service cost

    (82 )     91         9  

Deferred income taxes

    525       159       53       737  
                               

Amounts to be amortized–continuing operations

    (808 )     (255 )     (83 )     (1,146 )

Reverse additional minimum pension liability, net of taxes

    79           79  
                               

Initial adoption of SFAS No. 158 -continuing operations

    (729 )     (255 )     (83 )     (1,067 )

Initial adoption of SFAS No. 158 -discontinued operations

    (1,879 )     (437 )     (3 )     (2,319 )
                               

Initial adoption of SFAS No. 158

  $ (2,608 )   $ (692 )   $ (86 )   $ (3,386 )
                               

 

42


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

The movements in other comprehensive earnings/losses during the year ended December 31, 2007 were as follows:

 

          Pensions           Postretirement     Postemployment       Total    
    (in millions)  

Amounts transferred to earnings as components of net periodic benefit cost:

       

Amortization:

       

Net losses

  $ 82     $ 20     $ 10     $ 112  

Prior service cost (credit)

    10       (8 )       2  

Other income/expense:

       

Net losses

    62       33         95  

Prior service cost (credit)

    25       (6 )       19  

Deferred income taxes

    (71 )     (15 )     (4 )     (90 )
                               
    108       24       6       138  
                               

Other movements during the year:

       

Net losses

    168       96       (23 )     241  

Prior service cost

    (8 )     23         15  

Deferred income taxes

    (68 )     (49 )     9       (108 )
                               
    92       70       (14 )     148  
                               

Amounts related to continuing operations

    200       94       (8 )     286  

Amounts related to discontinued operations

    467       4       (13 )     458  
                               

Total movements in other comprehensive earnings/ losses

  $ 667     $ 98     $ (21 )   $ 744  
                               

Altria Group, Inc. sponsors noncontributory defined benefit pension plans covering substantially all employees. In addition, ALG and its subsidiaries provide health care and other benefits to substantially all retired employees.

The plan assets and benefit obligations of Altria Group, Inc.’s pension plans are measured at December 31 of each year. The benefit obligations of Altria Group, Inc.’s postretirement plans are measured at December 31 of each year.

 

43


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Pension Plans

Obligations and Funded Status

The benefit obligations, plan assets and funded status of Altria Group, Inc.’s pension plans at December 31, 2007 and 2006, were as follows:

 

     2007     2006  
     (in millions)  

Benefit obligation at January 1

   $ 5,255     $ 5,045  

Service cost

     103       115  

Interest cost

     309       291  

Benefits paid

     (281 )     (268 )

Termination, settlement and curtailment

     (50 )     13  

Actuarial (gains) losses

     (200 )     60  

Acquisitions

     7    

Other

       (1 )
                

Benefit obligation at December 31

     5,143       5,255  
                

Fair value of plan assets at January 1

     5,697       4,896  

Actual return on plan assets

     397       779  

Employer contributions

     37       289  

Benefits paid

     (281 )     (268 )

Actuarial (losses) gains

     (9 )     1  
                

Fair value of plan assets at December 31

     5,841       5,697  
                

Net pension asset recognized at December 31

   $ 698     $ 442  
                

 

The net pension asset recognized in Altria Group, Inc.’s consolidated balance sheets at December 31, 2007 and 2006, was as follows:

 

     2007     2006  
     (in millions)  

Prepaid pension assets

   $ 912     $ 658  

Other accrued liabilities

     (16 )     (23 )

Accrued pension costs

     (198 )     (193 )
                
   $ 698     $ 442  
                

The accumulated benefit obligation, which represents benefits earned to date, for the pension plans was $4.6 billion and $4.7 billion at December 31, 2007 and 2006, respectively.

For plans with accumulated benefit obligations in excess of plan assets, the projected benefit obligation, accumulated benefit obligation and fair value of plan assets were $211 million, $145 million and $2 million, respectively, as of December 31, 2007, and $219 million, $183 million and $4 million, respectively, as of December 31, 2006. The majority of these relate to plans for salaried employees that cannot be funded under IRS regulations.

 

44


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

The following weighted-average assumptions were used to determine Altria Group, Inc.’s benefit obligations under the plans at December 31:

 

     2007     2006  

Discount rate

   6.20 %   5.90 %

Rate of compensation increase

   4.50     4.50  

The discount rates for Altria Group, Inc.’s plans were developed from a model portfolio of high-quality, fixed-income debt instruments with durations that match the expected future cash flows of the benefit obligations.

Components of Net Periodic Benefit Cost

Net periodic pension cost consisted of the following for the years ended December 31, 2007, 2006 and 2005:

 

     2007     2006     2005  
     (in millions)  

Service cost

   $ 103     $ 115     $ 112  

Interest cost

     309       291       271  

Expected return on plan assets

     (429 )     (393 )     (362 )

Amortization:

      

Net loss

     82       154       106  

Prior service cost

     10       12       14  

Termination, settlement and curtailment

     37       15       9  
                        

Net periodic pension cost

   $ 112     $ 194     $ 150  
                        

During 2007, PM USA’s announced closure of its Cabarrus, North Carolina manufacturing facility, and workforce reduction programs resulted in curtailment losses and termination benefits of $37 million. This curtailment prompted a revaluation of the plans at a discount rate of 6.3%, resulting in an increase in prepaid pension assets of approximately $500 million and a corresponding increase, net of income taxes, to stockholders’ equity. During 2006 and 2005, employees left Altria Group, Inc. under voluntary early retirement and workforce reduction programs. These events resulted in settlement losses, curtailment losses and termination benefits for the plans in 2006 and 2005 of $15 million and $9 million, respectively.

 

45


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

The amounts included in termination, settlement and curtailment in the table above for the year ended December 31, 2007 were comprised of the following changes:

 

     2007  
     (in millions)  

Benefit obligation

   $ (50 )

Other comprehensive earnings/losses:

  

Net losses

     62  

Prior service cost

     25  
        
   $ 37  
        

For the pension plans, the estimated net loss and prior service cost that are expected to be amortized from accumulated other comprehensive income into net periodic benefit cost during 2008 are $65 million and $8 million, respectively.

The following weighted-average assumptions were used to determine Altria Group, Inc.’s net pension cost for the years ended December 31:

 

     2007     2006     2005  

Discount rate

   6.10 %   5.70 %   5.75 %

Expected rate of return on plan assets

   8.00     8.00     8.00  

Rate of compensation increase

   4.50     4.50     4.50  

Altria Group, Inc.’s expected rate of return on plan assets is determined by the plan assets’ historical long-term investment performance, current asset allocation and estimates of future long-term returns by asset class.

ALG and certain of its subsidiaries sponsor deferred profit-sharing plans covering certain salaried, non-union and union employees. Contributions and costs are determined generally as a percentage of pre-tax earnings, as defined by the plans. Certain other subsidiaries of ALG also maintain defined contribution plans. Amounts charged to expense for defined contribution plans totaled $119 million, $119 million and $124 million in 2007, 2006 and 2005, respectively.

Plan Assets

The percentage of fair value of pension plan assets at December 31, 2007 and 2006, was as follows:

 

Asset Category

   2007     2006  

Equity securities

   72 %   72 %

Debt securities

   28     27  

Other

     1  
            

Total

   100 %   100 %
            

Altria Group, Inc.’s investment strategy is based on an expectation that equity securities will outperform debt securities over the long term. Accordingly, the composition of Altria Group, Inc.’s U.S. plan assets is broadly characterized as a 70%/30% allocation between equity and debt securities. Beginning in 2008, Altria Group, Inc. decided to change the allocation between

 

46


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

equity and debt securities to 55%/45%, reflecting the impact of the changing demographic mix of plan participants on benefit obligations. The strategy utilizes indexed U.S. equity securities, actively managed international equity securities and actively managed investment grade debt securities (which constitute 80% or more of debt securities) with lesser allocations to high-yield and international debt securities.

Altria Group, Inc. attempts to mitigate investment risk by rebalancing between equity and debt asset classes as Altria Group, Inc.’s contributions and monthly benefit payments are made.

Altria Group, Inc. presently makes, and plans to make, contributions, to the extent that they are tax deductible and do not generate an excise tax liability, in order to maintain plan assets in excess of the accumulated benefit obligation of its funded plans. Currently, Altria Group, Inc. anticipates making contributions of $16 million in 2008 to its plans based on current tax law. However, these estimates are subject to change as a result of changes in tax and other benefit laws, as well as asset performance significantly above or below the assumed long-term rate of return on pension assets, or changes in interest rates.

The estimated future benefit payments from the Altria Group, Inc. pension plans at December 31, 2007, were as follows:

 

     (in millions)

2008

   $    280

2009

   289

2010

   299

2011

   312

2012

   327

2013-2017

   1,849

Postretirement Benefit Plans

Net postretirement health care costs consisted of the following for the years ended December 31, 2007, 2006 and 2005:

 

     2007     2006     2005  
     (in millions)  

Service cost

   $ 41     $ 49     $ 48  

Interest cost

     120       121       110  

Amortization:

      

Net loss

     20       39       22  

Prior service credit

     (8 )     (4 )     (4 )

Other (income) expense

     (2 )     3       3  
                        

Net postretirement health care costs

   $ 171     $ 208     $ 179  
                        

During 2007, Altria Group, Inc. had curtailment gains related to PM USA’s announced closure of its Cabarrus, North Carolina manufacturing facility, which are included in other (income) expense, above. During 2006 and 2005, Altria Group, Inc. instituted early retirement programs. These actions resulted in special termination benefits and curtailment losses in 2006 and 2005, which are included in other (income) expense, above.

 

47


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

The amounts included in other (income) expense in the table above for the year ended December 31, 2007 were comprised of the following changes:

 

     2007  
     (in millions)  

Accumulated postretirement health care costs

   $ (29 )

Other comprehensive earnings/losses:

  

Net losses

     33  

Prior service credit

     (6 )
        

Other income

   $ (2 )
        

For the postretirement benefit plans, the estimated net loss and prior service credit that are expected to be amortized from accumulated other comprehensive income into net postretirement health care costs during 2008 are $24 million and $(9) million, respectively.

The following weighted-average assumptions were used to determine Altria Group, Inc.’s net postretirement cost for the years ended December 31:

 

     2007     2006     2005  

Discount rate

   6.10 %   5.70 %   5.75 %

Health care cost trend rate

   8.00     8.00     8.00  

Altria Group, Inc.’s postretirement health care plans are not funded. The changes in the accumulated benefit obligation and net amount accrued at December 31, 2007 and 2006, were as follows:

 

     2007     2006  
     (in millions)  

Accumulated postretirement benefit obligation at January 1

   $ 2,113     $ 2,132  

Service cost

     41       49  

Interest cost

     120       121  

Benefits paid

     (93 )     (86 )

Curtailments

     (29 )     5  

Plan amendments

     (23 )     (77 )

Assumption changes

       (10 )

Actuarial gains

     (96 )     (21 )
                

Accrued postretirement health care costs at December 31

   $ 2,033     $ 2,113  
                

 

The current portion of Altria Group, Inc.’s accrued postretirement health care costs of $117 million and $104 million at December 31, 2007 and 2006, respectively, is included in other accrued liabilities on the consolidated balance sheets.

 

48


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

The following assumptions were used to determine Altria Group, Inc.’s postretirement benefit obligations at December 31:

 

     2007     2006  

Discount rate

   6.20 %   5.90 %

Health care cost trend rate assumed for next year

   8.00     8.00  

Ultimate trend rate

   5.00     5.00  

Year that the rate reaches the ultimate trend rate

   2011     2010  

Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects as of December 31, 2007:

 

     One-Percentage-Point
Increase
  One-Percentage-Point
Decrease

Effect on total of service and interest cost

   11.2%   (10.6)%

Effect on postretirement benefit obligation

   9.9    (8.2) 

Altria Group, Inc.’s estimated future benefit payments for its postretirement health care plans at December 31, 2007, were as follows:

 

     (in millions)

2008

   $    117

2009

   125

2010

   134

2011

   143

2012

   147

2013-2017

   772

Postemployment Benefit Plans

ALG and certain of its subsidiaries sponsor postemployment benefit plans covering substantially all salaried and certain hourly employees. The cost of these plans is charged to expense over the working life of the covered employees. Net postemployment costs consisted of the following for the years ended December 31, 2007, 2006 and 2005:

 

     2007    2006    2005
     (in millions)

Service cost

   $ 16    $ 11    $ 7

Interest cost

     3      4   

Amortization of net loss

     10      5      11

Other expense

     281      21      30
                    

Net postemployment costs

   $ 310    $ 41    $ 48
                    

 

49


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

As discussed in Note 3. Asset Impairment and Exit Costs, certain employees left Altria Group, Inc. under separation programs. These programs resulted in incremental postemployment costs, which are included in other expense, above.

For the postemployment benefit plans, the estimated net loss that is expected to be amortized from accumulated other comprehensive income into net postemployment costs during 2008 is approximately $12 million.

Altria Group, Inc.’s postemployment plans are not funded. The changes in the benefit obligations of the plans at December 31, 2007 and 2006, were as follows:

 

     2007     2006  
     (in millions)  

Accrued postemployment costs at January 1

   $ 174     $ 139  

Service cost

     16       11  

Interest cost

     3       4  

Benefits paid

     (36 )     (36 )

Actuarial losses and assumption changes

     1       35  

Other

     281       21  
                

Accrued postemployment costs at December 31

   $ 439     $ 174  
                

The accrued postemployment costs were determined using a discount rate of 6.2% and 5.7% in 2007 and 2006, respectively, an assumed ultimate annual turnover rate of 0.5% and 0.6% in 2007 and 2006, respectively, assumed compensation cost increases of 4.5% in 2007 and 2006, and assumed benefits as defined in the respective plans. Postemployment costs arising from actions that offer employees benefits in excess of those specified in the respective plans are charged to expense when incurred.

Note 17.  Additional Information:

The amounts shown below are for continuing operations.

 

     For the Years Ended December 31,  
     2007     2006     2005  
   (in millions)  

Research and development expense

   $269     $282     $273  
                  

Advertising expense

   $    5     $    7     $    7  
                  

Interest and other debt expense, net:

      

Interest expense

   $475     $629     $722  

Interest income

   (270 )   (404 )   (295 )
                  
   $205     $225     $427  
                  

Interest expense of financial services operations included in cost of sales

   $  54     $  81     $107  
                  

Rent expense

   $  67     $100     $111  
                  

 

50


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Minimum rental commitments under non-cancelable operating leases in effect at December 31, 2007, were as follows (in millions):

 

          
 

2008

   $ 59
 

2009

     50
 

2010

     42
 

2011

     25
 

2012

     17
 

Thereafter

     93
        
     $ 286
        

 

Note 18.  Financial Instruments:

Derivative Financial Instruments

Derivative financial instruments are used by ALG and its subsidiaries, principally to reduce exposures to market risks resulting from fluctuations in foreign exchange rates by creating offsetting exposures. Altria Group, Inc. is not a party to leveraged derivatives and, by policy, does not use derivative financial instruments for speculative purposes. Financial instruments qualifying for hedge accounting must maintain a specified level of effectiveness between the hedging instrument and the item being hedged, both at inception and throughout the hedged period. Altria Group, Inc. formally documents the nature and relationships between the hedging instruments and hedged items, as well as its risk-management objectives, strategies for undertaking the various hedge transactions and method of assessing hedge effectiveness. Additionally, for hedges of forecasted transactions, the significant characteristics and expected terms of the forecasted transaction must be specifically identified, and it must be probable that each forecasted transaction will occur. If it were deemed probable that the forecasted transaction will not occur, the gain or loss would be recognized in earnings currently.

Altria Group, Inc. (primarily PMI) uses forward foreign exchange contracts, foreign currency swaps and foreign currency options to mitigate its exposure to changes in exchange rates from third-party and intercompany, actual and forecasted transactions. The primary currencies to which Altria Group, Inc. (primarily PMI) is exposed include the Japanese yen, Swiss franc, euro, Turkish lira, Russian ruble and Indonesian rupiah. At December 31, 2007 and 2006, Altria Group, Inc. had contracts with aggregate notional amounts of $6.9 billion and $3.2 billion, respectively, of which $6.9 billion and $3.1 billion, respectively, were at PMI. The effective portion of unrealized gains and losses associated with qualifying contracts is deferred as a component of accumulated other comprehensive earnings (losses) until the underlying hedged transactions are reported on Altria Group, Inc.’s consolidated statement of earnings. A portion of Altria Group, Inc.’s foreign currency swaps, while effective as economic hedges, do not qualify for hedge accounting and therefore the unrealized gain (loss) relating to these contracts is reported in Altria Group, Inc.’s consolidated statements of earnings. For the years ended December 31, 2007, 2006 and 2005, the unrealized gain (loss) with regard to the contracts that do not qualify for hedge accounting was insignificant.

In addition, Altria Group, Inc. uses foreign currency swaps to mitigate its exposure to changes in exchange rates related to foreign currency denominated debt. These swaps typically convert fixed-rate foreign currency denominated debt to fixed-rate debt denominated in the functional currency of the borrowing entity, and are accounted for as cash flow hedges. At December 31,

 

51


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

2007 and 2006, the notional amounts of foreign currency swap agreements aggregated $1.5 billion and $1.4 billion, respectively.

Altria Group, Inc. also designates certain foreign currency denominated debt and forwards as net investment hedges of foreign operations. During the years ended December 31, 2007 and 2006, these hedges of net investments resulted in losses, net of income taxes, of $45 million and $164 million, respectively, and during the year ended December 31, 2005 resulted in a gain, net of income taxes, of $369 million. These gains and losses were reported as a component of accumulated other comprehensive earnings (losses) within currency translation adjustments.

During the years ended December 31, 2007, 2006 and 2005, ineffectiveness related to fair value hedges and cash flow hedges was not material. Altria Group, Inc. is hedging forecasted transactions for periods not exceeding the next twelve months. At December 31, 2007, Altria Group, Inc. expects an insignificant amount of gains reported in accumulated other comprehensive earnings (losses) to be reclassified to the consolidated statement of earnings within the next twelve months.

Derivative gains or losses reported in accumulated other comprehensive earnings (losses) are a result of qualifying hedging activity. Transfers of gains or losses from accumulated other comprehensive earnings (losses) to earnings are offset by the corresponding gains or losses on the underlying hedged item. Hedging activity affected accumulated other comprehensive earnings (losses), net of income taxes, during the years ended December 31, 2007, 2006 and 2005, as follows (in millions):

 

       2007        2006        2005  

Gain (loss) as of January 1

     $ 13        $ 24        $ (14 )

Derivative gains transferred to earnings

       (45 )        (35 )        (95 )

Change in fair value

       25          24          133  

Kraft spin-off

       2            
                                

(Loss) gain as of December 31

     $ (5 )      $ 13        $ 24  
                                

Credit exposure and credit risk

Altria Group, Inc. is exposed to credit loss in the event of nonperformance by counterparties. Altria Group, Inc. does not anticipate nonperformance within its consumer products businesses. However, see Note 8. Finance Assets, net regarding certain leases.

Fair value

The aggregate fair value, based on market quotes, of Altria Group, Inc.’s total debt at December 31, 2007, was $5.0 billion, as compared with its carrying value of $4.7 billion. The aggregate fair value, based on market quotes, of Altria Group, Inc.’s total debt at December 31, 2006, was $6.0 billion, as compared with its carrying value of $5.7 billion.

The fair value, based on market quotes, of Altria Group, Inc.’s equity investment in SABMiller at December 31, 2007, was $12.1 billion, as compared with its carrying value of $4.0 billion. The fair value, based on market quotes, of Altria Group, Inc.’s equity investment in SABMiller at December 31, 2006, was $9.9 billion, as compared with its carrying value of $3.7 billion.

 

52


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

In September 2006, the FASB issued SFAS No. 157 “Fair Value Measurements,” which will be effective for financial statements issued for fiscal years beginning after November 15, 2007. This statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Altria Group, Inc. anticipates that the adoption of this statement will not have a material impact on its financial statements.

See Notes 9 and 10 for additional disclosures of fair value for short-term borrowings and long-term debt.

Note 19.  Contingencies:

Legal proceedings covering a wide range of matters are pending or threatened in various United States and foreign jurisdictions against ALG, its subsidiaries and affiliates, including PM USA and its respective indemnitees. Various types of claims are raised in these proceedings, including product liability, consumer protection, antitrust, tax, contraband shipments, patent infringement, employment matters, claims for contribution and claims of competitors and distributors.

 

Overview of Tobacco-Related Litigation

Types and Number of Cases

Claims related to tobacco products generally fall within the following categories: (i) smoking and health cases alleging personal injury brought on behalf of individual plaintiffs, (ii) smoking and health cases primarily alleging personal injury or seeking court-supervised programs for ongoing medical monitoring and purporting to be brought on behalf of a class of individual plaintiffs, including cases in which the aggregated claims of a number of individual plaintiffs are to be tried in a single proceeding, (iii) health care cost recovery cases brought by governmental (both domestic and foreign) and non-governmental plaintiffs seeking reimbursement for health care expenditures allegedly caused by cigarette smoking and/or disgorgement of profits, (iv) class action suits alleging that the uses of the terms “Lights” and “Ultra Lights” constitute deceptive and unfair trade practices, common law fraud, or violations of the Racketeer Influenced and Corrupt Organizations Act (“RICO”), and (v) other tobacco-related litigation described below. Damages claimed in some of the tobacco-related litigation are significant, and in certain cases, range into the billions of dollars. The variability in pleadings in multiple jurisdictions, together with the actual experience of management in litigating claims, demonstrate that the monetary relief that may be specified in a lawsuit bears little relevance to the ultimate outcome. Plaintiffs’ theories of recovery and the defenses raised in pending smoking and health, health care cost recovery and Lights/Ultra Lights cases are discussed below.

 

53


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

The table below lists the number of certain tobacco-related cases pending in the United States against PM USA and, in some instances, ALG, as of December 31, 2007, December 31, 2006 and December 31, 2005, and a page-reference to further discussions of each type of case.

 

Type of Case       

Number of Cases    

Pending as of    

December 31,    

2007    

      

Number of Cases    

Pending as of    

December 31,    
2006    

      

Number of Cases

Pending as of

December 31,

2005

             Page
References
Individual Smoking and
Health Cases (1)
     105      196      228         64 - 65
Smoking and Health Class
Actions and Aggregated
Claims Litigation (2)
     10      10      9         65
Health Care Cost Recovery
Actions
     3      5      4         65 - 72
Lights/Ultra Lights Class
Actions
     17      20      24         72 - 75
Tobacco Price Cases      2      2      2         75

Cigarette Contraband Cases

     0      0      1         75

 

 

  (1)

Does not include 2,622 cases brought by flight attendants seeking compensatory damages for personal injuries allegedly caused by exposure to environmental tobacco smoke (“ETS”). The flight attendants allege that they are members of an ETS smoking and health class action, which was settled in 1997. The terms of the court-approved settlement in that case allow class members to file individual lawsuits seeking compensatory damages, but prohibit them from seeking punitive damages. Also, does not include nine individual smoking and health cases brought against certain retailers that are indemnitees of PM USA. Additionally, does not include approximately 1,282 individual smoking and health cases brought by or on behalf of approximately 7,266 plaintiffs in Florida following the decertification of the Engle case discussed below. It is possible that additional cases have been filed but not yet recorded on the courts’ dockets.

 

  (2)

Includes as one case the aggregated claims of 728 individuals (of which 414 individuals have claims against PM USA) that are proposed to be tried in a single proceeding in West Virginia. The West Virginia Supreme Court of Appeals has ruled that the United States Constitution does not preclude a trial in two phases in this case. Issues related to defendants’ conduct, plaintiffs’ entitlement to punitive damages and a punitive damages multiplier, if any, would be determined in the first phase. The second phase would consist of individual trials to determine liability, if any, and compensatory damages. In November 2007, the West Virginia Supreme Court of Appeals denied defendants’ renewed motion for review of the trial plan. In December 2007, defendants filed a petition for writ of certiorari with the United States Supreme Court.

 

54


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

PM USA is also a named defendant in a smoking and health putative class action in Israel, a “Lights” class action in Israel and health care cost recovery actions in Israel and Canada.

Pending and Upcoming Trials

On November 16, 2007, the jury in a flight attendant litigation found in favor of the defendants. In addition, as of December 31, 2007, 11 individual smoking and health cases against PM USA are scheduled for trial through the end of 2008. Cases against other tobacco companies are also scheduled for trial through the end of 2008. Trial dates are subject to change.

Recent Trial Results

Since January 1999, verdicts have been returned in 45 smoking and health, Lights/Ultra Lights and health care cost recovery cases in which PM USA was a defendant. Verdicts in favor of PM USA and other defendants were returned in 28 of the 45 cases. These 28 cases were tried in California (4), Florida (9), Mississippi (1), Missouri (2), New Hampshire (1), New Jersey (1), New York (3), Ohio (2), Pennsylvania (1), Rhode Island (1), Tennessee (2), and West Virginia (1). Plaintiffs’ appeals or post-trial motions challenging the verdicts are pending in California, the District of Columbia and Florida. A motion for a new trial has been granted in one of the cases in Florida. In addition, in December 2002, a court dismissed an individual smoking and health case in California at the end of trial.

In July 2005, a jury in Tennessee returned a verdict in favor of PM USA in a case in which plaintiffs had challenged PM USA’s retail promotional and merchandising programs under the Robinson-Patman Act.

Of the 17 cases in which verdicts were returned in favor of plaintiffs, eight have reached final resolution. A verdict against defendants in a health care cost recovery case has been reversed and all claims were dismissed with prejudice. In addition, a verdict against defendants in a purported Lights class action in Illinois has been reversed and the case has been dismissed with prejudice. After exhausting all appeals, PM USA has paid six judgments totaling $71,826,707, and interest totaling $33,806,665.

The chart below lists the verdicts and post-trial developments in the nine pending cases that have gone to trial since January 1999 in which verdicts were returned in favor of plaintiffs.

 

55


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

  Date  

  

Location of

Court/

Name of

Plaintiff

  

Type of Case

  

Verdict

  

Post-Trial Developments

May

2007

  

California/

Whiteley

  

Individual

Smoking and

Health

   Approximately $2.5 million in compensatory damages against PM USA and the other defendant in the case, as well as $250,000 in punitive damages against the other defendant in the case.    In July 2007, the trial court granted plaintiff’s motion for a limited re-trial against PM USA on the question of whether plaintiffs are entitled to punitive damages against PM USA, and if so, the amount. On October 31, 2007, the jury found that plaintiffs are not entitled to punitive damages against PM USA. In November, the trial court entered final judgment and PM USA filed a motion for a new trial and for judgment notwithstanding the verdict. The trial court rejected these motions on January 24, 2008. Defendants intend to appeal.
August 2006   

District of

Columbia/

United States

of America

   Health Care Cost Recovery    Finding that defendants, including ALG and PM USA, violated the civil provisions of the Racketeer Influenced and Corrupt Organizations Act (RICO). No monetary damages assessed, but court made specific findings and issued injunctions. See Federal Government’s Lawsuit, below.    Defendants filed notices of appeal to the United States Court of Appeals in September 2006 and the Department of Justice filed its notice of appeal in October. In October 2006, a three-judge panel of the Court of Appeals stayed implementation of the trial court’s remedies order pending its review of the decision. In March 2007, the trial court denied in part and granted in part defendants’ post-trial motion for clarification of portions of the court’s remedial order. Briefing of the parties’ consolidated appeal is scheduled to conclude in May 2008. See Federal Government’s Lawsuit, below.

 

56


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

  Date  

  

Location of

Court/

Name of

Plaintiff

  

Type of Case

  

Verdict

  

Post-Trial Developments

March

2005

  

New York/

Rose

  

Individual

Smoking and

Health

   $3.42 million in compensatory damages against two defendants, including PM USA, and $17.1 million in punitive damages against PM USA.    PM USA’s appeal is pending.

May

2004

  

Louisiana/

Scott

  

Smoking and

Health Class

Action

   Approximately $590 million against all defendants, including PM USA, jointly and severally, to fund a 10- year smoking cessation program.    In June 2004, the state trial court entered judgment in the amount of the verdict of $590 million, plus prejudgment interest accruing from the date the suit commenced. As of February 15, 2007, the amount of prejudgment interest was approximately $444 million. PM USA’s share of the verdict and prejudgment interest has not been allocated. Defendants, including PM USA, appealed. In February 2007, the Louisiana Court of Appeal upheld the class certification and finding of liability, but reduced the judgment by approximately $312 million and vacated the award of prejudgment interest. The Court of Appeal also remanded the case to the trial court with instructions to further reduce the remaining $279 million judgment to eliminate amounts awarded to any individual who began smoking after the Louisiana Product Liability Act became effective on September 1, 1988. In March 2007, the Louisiana Court of Appeal rejected defendants’ motion for rehearing and clarification. Plaintiffs’ and defendants’ petitions for writ of certiorari with the Louisiana Supreme Court were denied in January 2008. Following this denial, PM USA recorded a provision of $26 million in connection with the case. See Scott Class Action below.

 

57


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

  Date  

  

Location of

Court/

Name of

Plaintiff

  

Type of Case

  

Verdict

  

Post-Trial Developments

October

2002

  

California/

Bullock

  

Individual

Smoking and

Health

   $850,000 in compensatory damages and $28 billion in punitive damages against PM USA.    On January 30, 2008, the California Court of Appeal reversed the judgment with respect to the $28 million punitive damages award, affirmed the judgment in all other respects, and remanded the case to the trial court to conduct a new trial on the amount of punitive damages. See discussion (1) below.

June

2002

  

Florida/

Lukacs

  

Individual

Smoking and

Health

   $37.5 million in compensatory damages against all defendants, including PM USA.    In March 2003, the trial court reduced the damages award to $24.86 million. PM USA’s share of the damages award is approximately $6 million. The court has not yet entered the judgment on the jury verdict. In January 2007, defendants petitioned the trial court to set aside the jury’s verdict and dismiss plaintiffs’ punitive damages claim. On August 1, 2007, the trial court deferred ruling on plaintiff’s motion for entry of judgment until after the United States Supreme Court’s review of Engle is complete and after further submissions by the parties. If a judgment is entered in this case, PM USA intends to appeal.

 

58


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

  Date  

  

Location of

Court/

Name of

Plaintiff

  

Type of Case

  

Verdict

  

Post-Trial Developments

March

2002

  

Oregon/

Schwarz

  

Individual

Smoking and

Health

   $168,500 in compensatory damages and $150 million in punitive damages against PM USA.    In May 2002, the trial court reduced the punitive damages award to $100 million. In May 2006, the Oregon Court of Appeals affirmed the compensatory damages verdict, reversed the award of punitive damages and remanded the case to the trial court for a second trial to determine the amount of punitive damages, if any. In June 2006, plaintiff petitioned the Oregon Supreme Court to review the portion of the Court of Appeals’ decision reversing and remanding the case for a new trial on punitive damages. In October 2006, the Oregon Supreme Court announced that it would hold this petition in abeyance until the United States Supreme Court decided the Williams case discussed below. In February 2007, the United States Supreme Court vacated the punitive damages judgment in Williams and remanded the case to the Oregon Supreme Court for proceedings consistent with its decision. The parties have submitted their briefs to the Oregon Supreme Court setting forth their respective views on how the Williams decision impacts the plaintiff’s pending petition for review.

 

59


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

  Date  

  

Location of

Court/

Name of

Plaintiff

  

Type of Case

  

Verdict

  

Post-Trial Developments

July

2000

  

Florida/

Engle

  

Smoking and

Health Class

Action

   $145 billion in punitive damages against all defendants, including $74 billion against PM USA.    In July 2006, the Florida Supreme Court ordered that the punitive damages award be vacated, that the class approved by the trial court be decertified, that certain Phase I trial court findings be allowed to stand as against the defendants in individual actions that individual former class members may bring within one year of the issuance of the mandate, compensatory damage awards totaling approximately $6.9 million to two individual class members be reinstated and that a third former class member’s claim was barred by the statute of limitations. In December 2006, the Florida Supreme Court denied all motions by the parties for rehearing but issued a revised opinion. In January 2007, the Florida Supreme Court issued the mandate from its revised December opinion and defendants filed a motion with the Florida Third District Court of Appeal requesting the court’s review of legal errors previously raised but not ruled upon. This motion was denied in February 2007. In May 2007, defendants’ motion for a partial stay of the mandate pending the completion of appellate review was denied by the Third District Court of Appeal. In May 2007, defendants filed a petition for writ of certiorari with the United States Supreme Court. On October 1, 2007, the United States Supreme Court denied defendants’ petition. In November 2007, the United States Supreme Court denied defendants’ petition for rehearing from the denial of their petition for certiorari. See “Engle Class Action” below. As of the January 11, 2008 deadline for

 

60


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

  Date  

  

Location of

Court/

Name of

Plaintiff

  

Type of Case

  

Verdict

  

Post-Trial Developments

            bringing an action approximately 1,282 individual smoking and health cases have been brought by or on behalf of approximately 7,266 plaintiffs in Florida following the Florida Supreme Court’s decertification decision. It is possible that additional cases have been filed but not yet recorded on the courts’ dockets.

March

1999

  

Oregon/

Williams

  

Individual

Smoking and

Health

   $800,000 in compensatory damages, $21,500 in medical expenses and $79.5 million in punitive damages against PM USA.    See discussion (2) below.

 

  (1)

Bullock: In August 2006, the California Supreme Court denied plaintiffs’ petition to overturn the trial court’s reduction of the punitive damages award and granted PM USA’s petition for review challenging the punitive damages award. The court granted review of the case on a “grant and hold” basis under which further action by the court is deferred pending the United States Supreme Court’s decision on punitive damages in the Williams case described below. In February 2007, the United States Supreme Court vacated the punitive damages judgment in Williams and remanded the case to the Oregon Supreme Court for proceedings consistent with its decision. Parties to the appeal in Bullock requested that the court establish a briefing schedule on the merits of the pending appeal. In May 2007, the California Supreme Court transferred the case to the Second District of the California Court of Appeal with directions that the court vacate its 2006 decision and reconsider the case in light of the United States Supreme Court’s decision in Williams. On January 30, 2008, the California Court of Appeal reversed the judgment with respect to the $28 million punitive damages award, affirmed the judgment in all other respects, and remanded the case to the trial court to conduct a new trial on the amount of punitive damages.

 

  (2)

Williams: The trial court reduced the punitive damages award to $32 million, and PM USA and plaintiff appealed. In June 2002, the Oregon Court of Appeals reinstated the $79.5 million punitive damages award. Following the Oregon Supreme Court’s refusal to hear PM USA’s appeal, PM USA recorded a provision of $32 million in connection with this case and petitioned the United States Supreme Court for further review. In October 2003, the United States Supreme Court set aside the Oregon appellate court’s ruling and directed the Oregon court to reconsider the case in light of the 2003 State Farm decision by the United States Supreme Court, which limited punitive damages. In June 2004, the Oregon Court of Appeals reinstated the $79.5 million punitive damages award. In February 2006, the Oregon Supreme Court affirmed the Court of Appeals’ decision. Following this

 

61


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

 

decision, PM USA recorded an additional provision of approximately $25 million in interest charges related to this case. The United States Supreme Court granted PM USA’s petition for writ of certiorari in May 2006. In February 2007, the United States Supreme Court vacated the $79.5 million punitive damages award, holding that the United States Constitution prohibits basing punitive damages awards on harm to non-parties. The Court also found that states must assure that appropriate procedures are in place so that juries are provided with proper legal guidance as to the constitutional limitations on awards of punitive damages. Accordingly, the Court remanded the case to the Oregon Supreme Court for further proceedings consistent with this decision. On January 31, 2008, the Oregon Supreme Court affirmed the Oregon Court of Appeals’ June 2004 decision, which in turn, upheld the jury’s compensatory damage award and reinstated the jury’s award of $79.5 million in punitive damages. PM USA intends to appeal.

With respect to certain adverse verdicts currently on appeal, as of December 31, 2007, PM USA has posted various forms of security totaling approximately $193 million, the majority of which have been collateralized with cash deposits, to obtain stays of judgments pending appeals. The cash deposits are included in other assets on the consolidated balance sheets.

Engle Class Action

In July 2000, in the second phase of the Engle smoking and health class action in Florida, a jury returned a verdict assessing punitive damages totaling approximately $145 billion against various defendants, including $74 billion against PM USA. Following entry of judgment, PM USA posted a bond in the amount of $100 million and appealed.

In May 2001, the trial court approved a stipulation providing that execution of the punitive damages component of the Engle judgment will remain stayed against PM USA and the other participating defendants through the completion of all judicial review. As a result of the stipulation, PM USA placed $500 million into a separate interest-bearing escrow account that, regardless of the outcome of the judicial review, will be paid to the court and the court will determine how to allocate or distribute it consistent with Florida Rules of Civil Procedure. In July 2001, PM USA also placed $1.2 billion into an interest-bearing escrow account, which was returned to PM USA in December 2007. In addition, the $100 million bond related to the case has been discharged. The $1.2 billion escrow account and the deposit of $100 million related to the bonding requirement were included in the December 31, 2006 consolidated balance sheet as other assets. Interest income on the $1.2 billion escrow account, prior to its return to PM USA, was paid to PM USA quarterly and was being recorded as earned in interest and other debt expense, net, in the consolidated statements of earnings. In connection with the stipulation, PM USA recorded a $500 million pre-tax charge in its consolidated statement of earnings for the quarter ended March 31, 2001. In May 2003, the Florida Third District Court of Appeal reversed the judgment entered by the trial court and instructed the trial court to order the decertification of the class. Plaintiffs petitioned the Florida Supreme Court for further review.

In July 2006, the Florida Supreme Court ordered that the punitive damages award be vacated, that the class approved by the trial court be decertified, and that members of the decertified class could file individual actions against defendants within one year of issuance of the mandate. The court further declared the following Phase I findings are entitled to “res judicata” effect in such individual actions brought within one year of the issuance of the mandate: (i) that smoking causes various diseases; (ii) that nicotine in cigarettes is addictive; (iii) that defendants’ cigarettes were defective and unreasonably dangerous; (iv) that defendants concealed or

 

62


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

omitted material information not otherwise known or available knowing that the material was false or misleading or failed to disclose a material fact concerning the health effects or addictive nature of smoking; (v) that all defendants agreed to misrepresent information regarding the health effects or addictive nature of cigarettes with the intention of causing the public to rely on this information to their detriment; (vi) that defendants agreed to conceal or omit information regarding the health effects of cigarettes or their addictive nature with the intention that smokers would rely on the information to their detriment; (vii) that all defendants sold or supplied cigarettes that were defective; and (viii) that all defendants were negligent. The court also reinstated compensatory damage awards totaling approximately $6.9 million to two individual plaintiffs and found that a third plaintiff’s claim was barred by the statute of limitations.

In August 2006, PM USA sought rehearing from the Florida Supreme Court on parts of its July 2006 opinion, including the ruling (described above) that certain jury findings have res judicata effect in subsequent individual trials timely brought by Engle class members. The rehearing motion also asked, among other things, that legal errors that were raised but not expressly ruled upon in the Third District Court of Appeal or in the Florida Supreme Court now be addressed. Plaintiffs also filed a motion for rehearing in August 2006 seeking clarification of the applicability of the statute of limitations to non-members of the decertified class. In December 2006, the Florida Supreme Court refused to revise its July 2006 ruling, except that it revised the set of Phase I findings entitled to res judicata effect by excluding finding (v) listed above (relating to agreement to misrepresent information), and added the finding that defendants sold or supplied cigarettes that, at the time of sale or supply, did not conform to the representations of fact made by defendants. On January 11, 2007, the Florida Supreme Court issued the mandate from its revised opinion. Defendants then filed a motion with the Florida Third District Court of Appeal requesting that the court address legal errors that were previously raised by defendants but have not yet been addressed either by the Third District or by the Florida Supreme Court. In February 2007, the Third District Court of Appeal denied defendants’ motion. In May 2007, defendants’ motion for a partial stay of the mandate pending the completion of appellate review was denied by the District Court of Appeal. In May 2007, defendants filed a petition for writ of certiorari with the United States Supreme Court. On October 1, 2007, the United States Supreme Court denied defendants’ petition. In November 2007, the United States Supreme Court denied defendants’ petition for rehearing from the denial of their petition for writ of certiorari.

By the January 11, 2008 deadline required by the Florida Supreme Court’s decision, approximately 1,282 cases had been served upon PM USA or ALG asserting individual claims on or on behalf of approximately 7,266 plaintiffs. It is possible that additional cases have been filed but not yet recorded on the courts’ dockets. Some of these cases have been removed from various Florida state courts to the federal district courts in Florida, while others were filed in federal court. In July 2007, PM USA and other defendants requested that the multi-district litigation panel order the transfer of all such cases pending in the federal courts, as well as any other Engle progeny cases that may be filed, to the Middle District of Florida for pretrial coordination. The panel denied this request in December 2007. In October 2007, attorneys for plaintiffs filed a motion to consolidate all pending and future cases filed in the state trial court in Hillsborough County. The court denied this motion in November 2007.

 

63


ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Scott Class Action

In July 2003, following the first phase of the trial in the Scott class action, in which plaintiffs sought creation of a fund to pay for medical monitoring and smoking cessation programs, a Louisiana jury returned a verdict in favor of defendants, including PM USA, in connection with plaintiffs’ medical monitoring claims, but also found that plaintiffs could benefit from smoking cessation assistance. The jury also found that cigarettes as designed are not defective but that the defendants failed to disclose all they knew about smoking and diseases and marketed their products to minors. In May 2004, in the second phase of the trial, the jury awarded plaintiffs approximately $590 million against all defendants jointly and severally, to fund a 10-year smoking cessation program.

In June 2004, the court entered judgment, which awarded plaintiffs the approximately $590 million jury award plus prejudgment interest accruing from the date the suit commenced. As of February 15, 2007, the amount of prejudgment interest was approximately $444 million. PM USA’s share of the jury award and prejudgment interest has not been allocated. Defendants, including PM USA, appealed. Pursuant to a stipulation of the parties, the trial court entered an order setting the amount of the bond at $50 million for all defendants in accordance with an article of the Louisiana Code of Civil Procedure, and a Louisiana statute (the “bond cap law”) fixing the amount of security in civil cases involving a signatory to the MSA (as defined below). Under the terms of the stipulation, plaintiffs reserve the right to contest, at a later date, the sufficiency or amount of the bond on any grounds including the applicability or constitutionality of the bond cap law. In September 2004, defendants collectively posted a bond in the amount of $50 million.

In February 2007, the Louisiana Court of Appeal issued a ruling on defendants’ appeal that, among other things: affirmed class certification but limited the scope of the class; struck certain of the categories of damages that comprised the judgment, reducing the amount of the award by approximately $312 million; vacated the award of prejudgment interest, which totaled approximately $444 million as of February 15, 2007; and ruled that the only class members who are eligible to participate in the smoking cessation program are those who began smoking before, and whose claims accrued by, September 1, 1988. As a result, the Louisiana Court of Appeal remanded for proceedings consistent with its opinion, including further reduction of the amount of the award based on the size of the new class. In March 2007, the Louisiana Court of Appeal rejected defendants’ motion for rehearing and clarification. In January 2008, the Louisiana Supreme Court denied plaintiffs’ and defendants’ petitions for writ of certiorari. Following the Louisiana Supreme Court’s denial of defendants’ petition for writ of certiorari, PM USA recorded a provision of $26 million in connection with the case.

Smoking and Health Litigation

Overview

Plaintiffs’ allegations of liability in smoking and health cases are based on various theories of recovery, including negligence, gross negligence, strict liability, fraud, misrepresentation, design defect, failure to warn, nuisance, breach of express and implied warranties, breach of special duty, conspiracy, concert of action, violations of deceptive trade practice laws and consumer protection statutes, and claims under the federal and state anti-racketeering statutes. Plaintiffs in the smoking and health actions seek various forms of relief, including

 

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compensatory and punitive damages, treble/multiple damages and other statutory damages and penalties, creation of medical monitoring and smoking cessation funds, disgorgement of profits, and injunctive and equitable relief. Defenses raised in these cases include lack of proximate cause, assumption of the risk, comparative fault and/or contributory negligence, statutes of limitations and preemption by the Federal Cigarette Labeling and Advertising Act.

Smoking and Health Class Actions

Since the dismissal in May 1996 of a purported nationwide class action brought on behalf of allegedly addicted smokers, plaintiffs have filed numerous putative smoking and health class action suits in various state and federal courts. In general, these cases purport to be brought on behalf of residents of a particular state or states (although a few cases purport to be nationwide in scope) and raise addiction claims and, in many cases, claims of physical injury as well.

Class certification has been denied or reversed by courts in 57 smoking and health class actions involving PM USA in Arkansas (1), the District of Columbia (2), Florida (2), Illinois (2), Iowa (1), Kansas (1), Louisiana (1), Maryland (1), Michigan (1), Minnesota (1), Nevada (29), New Jersey (6), New York (2), Ohio (1), Oklahoma (1), Pennsylvania (1), Puerto Rico (1), South Carolina (1), Texas (1) and Wisconsin (1). A class remains certified in the Scott class action discussed above.

There are currently pending two purported class actions against PM USA brought in New York (Caronia, filed in January 2006 in the United States District Court for the Eastern District of New York) and Massachusetts (Donovan, filed in March 2007 in the United States District Court for the District of Massachusetts) on behalf of each state’s respective residents who: are age 50 or older; have smoked the Marlboro brand for 20 pack-years or more; and have neither been diagnosed with lung cancer nor are under examination by a physician for suspected lung cancer. Plaintiffs in these cases seek to impose liability under various product-based causes of action and the creation of a court-supervised program providing members of the purported class Low Dose CT Scanning in order to identify and diagnose lung cancer. Neither claim seeks punitive damages. Plaintiffs’ motion for class certification is pending in Caronia.

 

Health Care Cost Recovery Litigation

Overview

In health care cost recovery litigation, domestic and foreign governmental entities and non-governmental plaintiffs seek reimbursement of health care cost expenditures allegedly caused by tobacco products and, in some cases, of future expenditures and damages as well. Relief sought by some but not all plaintiffs includes punitive damages, multiple damages and other statutory damages and penalties, injunctions prohibiting alleged marketing and sales to minors, disclosure of research, disgorgement of profits, funding of anti-smoking programs, additional disclosure of nicotine yields, and payment of attorney and expert witness fees.

The claims asserted include the claim that cigarette manufacturers were “unjustly enriched” by plaintiffs’ payment of health care costs allegedly attributable to smoking, as well as claims of indemnity, negligence, strict liability, breach of express and implied warranty, violation of a voluntary undertaking or special duty, fraud, negligent misrepresentation, conspiracy, public nuisance, claims under federal and state statutes governing consumer fraud, antitrust, deceptive

 

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trade practices and false advertising, and claims under federal and state anti-racketeering statutes.

Defenses raised include lack of proximate cause, remoteness of injury, failure to state a valid claim, lack of benefit, adequate remedy at law, “unclean hands” (namely, that plaintiffs cannot obtain equitable relief because they participated in, and benefited from, the sale of cigarettes), lack of antitrust standing and injury, federal preemption, lack of statutory authority to bring suit, and statutes of limitations. In addition, defendants argue that they should be entitled to “set off” any alleged damages to the extent the plaintiffs benefit economically from the sale of cigarettes through the receipt of excise taxes or otherwise. Defendants also argue that these cases are improper because plaintiffs must proceed under principles of subrogation and assignment. Under traditional theories of recovery, a payor of medical costs (such as an insurer) can seek recovery of health care costs from a third party solely by “standing in the shoes” of the injured party. Defendants argue that plaintiffs should be required to bring any actions as subrogees of individual health care recipients and should be subject to all defenses available against the injured party.

Although there have been some decisions to the contrary, most judicial decisions have dismissed all or most health care cost recovery claims against cigarette manufacturers. Nine federal circuit courts of appeals and six state appellate courts, relying primarily on grounds that plaintiffs’ claims were too remote, have ordered or affirmed dismissals of health care cost recovery actions. The United States Supreme Court has refused to consider plaintiffs’ appeals from the cases decided by five circuit courts of appeals.

In March 1999, in the first health care cost recovery case to go to trial, an Ohio jury returned a verdict in favor of defendants on all counts. In addition, a $17.8 million verdict against defendants (including $6.8 million against PM USA) was reversed in a health care cost recovery case in New York, and all claims were dismissed with prejudice in February 2005 (Blue Cross/Blue Shield). The trial in the health care cost recovery case brought by the City of St. Louis, Missouri and approximately 50 Missouri hospitals, in which PM USA and ALG are defendants, is scheduled to begin in January 2009.

Individuals and associations have also sued in purported class actions or as private attorneys general under the Medicare As Secondary Payer statute to recover from defendants Medicare expenditures allegedly incurred for the treatment of smoking-related diseases. Cases brought in New York (Mason), Florida (Glover) and Massachusetts (United Seniors Association) have been dismissed by federal courts, and plaintiffs’ appealed in United Seniors Association. In August 2007, the United States Court of Appeals for the First Circuit affirmed the district court’s dismissal in United Seniors Association. In November 2007, plaintiffs filed a petition for writ of certiorari with the United States Supreme Court, which was denied on January 22, 2008.

In addition to the cases brought in the United States, health care cost recovery actions have also been brought against tobacco industry participants, and PM USA, in Israel (1), the Marshall Islands (1 dismissed) and Canada (1) and other entities have stated that they are considering filing such actions. In September 2005, in the case in Canada, the Canadian Supreme Court ruled that legislation passed in British Columbia permitting the lawsuit is constitutional, and, as a result, the case which had previously been dismissed by the trial court was permitted to proceed. PM USA and other defendants’ challenge to the British Columbia court’s exercise of jurisdiction was rejected by the Court of Appeals of British Columbia and, in April 2007, the

 

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Supreme Court of Canada denied review of that decision. Several other provinces in Canada have enacted similar legislation or are in the process of enacting similar legislation.

Settlements of Health Care Cost Recovery Litigation

In November 1998, PM USA and certain other United States tobacco product manufacturers entered into the Master Settlement Agreement (the “MSA”) with 46 states, the District of Columbia, Puerto Rico, Guam, the United States Virgin Islands, American Samoa and the Northern Marianas to settle asserted and unasserted health care cost recovery and other claims. PM USA and certain other United States tobacco product manufacturers had previously settled similar claims brought by Mississippi, Florida, Texas and Minnesota (together with the MSA, the “State Settlement Agreements”). The State Settlement Agreements require that the original participating manufacturers make substantial annual payments of $9.4 billion each year (excluding future annual payments, if any, under the National Tobacco Grower Settlement Trust discussed below), subject to adjustments for several factors, including inflation, market share and industry volume. In addition, the original participating manufacturers are required to pay settling plaintiffs’ attorneys’ fees, subject to an annual cap of $500 million.

The State Settlement Agreements also include provisions relating to advertising and marketing restrictions, public disclosure of certain industry documents, limitations on challenges to certain tobacco control and underage use laws, restrictions on lobbying activities and other provisions.

Possible Adjustments in MSA Payments for 2003, 2004 and 2005

Pursuant to the provisions of the MSA, domestic tobacco product manufacturers, including PM USA, who are original signatories to the MSA (“OPMs”), are participating in proceedings that may result in downward adjustments to the amounts paid by the OPMs and the other MSA participating manufacturers to the states and territories that are parties to the MSA for the years 2003, 2004 and 2005. The proceedings are based on the collective loss of market share for 2003, 2004 and 2005, respectively, by all manufacturers who are subject to the payment obligations and marketing restrictions of the MSA to non-participating manufacturers (“NPMs”) who are not subject to such obligations and restrictions.

In these proceedings, an independent economic consulting firm jointly selected by the MSA parties is required to determine whether the disadvantages of the MSA were a “significant factor” contributing to the collective loss of market share for the year in question. If the firm determines that the disadvantages of the MSA were such a “significant factor,” each state may avoid a downward adjustment to its share of the participating manufacturers’ annual payments for that year by establishing that it diligently enforced a qualifying escrow statute during the entirety of that year. Any potential downward adjustment would then be reallocated to those states that do not establish such diligent enforcement. PM USA believes that the MSA’s arbitration clause requires a state to submit its claim to have diligently enforced a qualifying escrow statute to binding arbitration before a panel of three former federal judges in the manner provided for in the MSA. A number of states have taken the position that this claim should be decided in state court on a state-by-state basis.

In March of 2006, an independent economic consulting firm determined that the disadvantages of the MSA were a significant factor contributing to the participating manufacturers’ collective loss of market share for the year 2003. In February 2007, this same firm determined that the disadvantages of the MSA were a significant factor contributing to the participating

 

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manufacturers’ collective loss of market share for the year 2004. As of October 2007, PM USA is also participating in another such proceeding before the same economic consulting firm to determine whether the disadvantages of the MSA were a significant factor contributing to the participating manufacturers’ collective loss of market share for the year 2005. The economic consulting firm is expected to render its final determination on the significant factor issue for 2005 sometime in February 2008. Following the economic consulting firm’s determination with respect to 2003, thirty-eight states filed declaratory judgment actions in state courts seeking a declaration that the state diligently enforced its escrow statute during 2003. The OPMs and other MSA-participating manufacturers have responded to these actions by filing motions to compel arbitration in accordance with the terms of the MSA, including filing motions to compel arbitration in eleven MSA states and territories that have not filed declaratory judgment actions. Courts in over 45 states have ruled that the question of whether a state diligently enforced its escrow statute during 2003 is subject to arbitration and only one state court ruling to the contrary currently stands, and it remains subject to appeal. Many of these rulings, including the one ruling against arbitration, remain subject to appeal or further review. Additionally, Ohio filed a declaratory judgment action in state court with respect to the 2004 diligent enforcement issue. The action has been stayed pending the decision about the 2003 payments.

The availability and the precise amount of any NPM Adjustment for 2003 and 2004 will not be finally determined until 2008 or thereafter. The availability and the precise amount of any NPM Adjustment for 2005 will not be finally determined until late 2008 or thereafter. There is no certainty that the OPMs and other MSA-participating manufacturers will ultimately receive any adjustment as a result of these proceedings. If the OPMs do receive such an adjustment through these proceedings, the adjustment would be allocated among the OPMs pursuant to the MSA’s provisions, and PM USA’s share would likely be applied as a credit against a future MSA payment.

National Grower Settlement Trust

As part of the MSA, the settling defendants committed to work cooperatively with the tobacco-growing states to address concerns about the potential adverse economic impact of the MSA on tobacco growers and quota holders. To that end, in 1999, four of the major domestic tobacco product manufacturers, including PM USA, established the National Tobacco Grower Settlement Trust (“NTGST”), a trust fund to provide aid to tobacco growers and quota holders. The trust was to be funded by these four manufacturers over 12 years with payments, prior to application of various adjustments, scheduled to total $5.15 billion. Provisions of the NTGST allowed for offsets to the extent that industry-funded payments were made for the benefit of growers or quota holders as part of a legislated end to the federal tobacco quota and price support program.

In October 2004, the Fair and Equitable Tobacco Reform Act of 2004 (“FETRA”) was signed into law. FETRA provides for the elimination of the federal tobacco quota and price support program through an industry-funded buy-out of tobacco growers and quota holders. The cost of the buy-out, which is estimated at approximately $9.5 billion, is being paid over 10 years by manufacturers and importers of each kind of tobacco product. The cost is being allocated based on the relative market shares of manufacturers and importers of each kind of tobacco product. The quota buy-out payments offset already scheduled payments to the NTGST. However, two of the grower states, Maryland and Pennsylvania, have filed claims in the North Carolina state courts, asserting that the companies which established the NTGST (including PM USA) must

 

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continue making payments under the NTGST through 2010 for the benefit of Maryland and Pennsylvania growers (such continuing payments would represent slightly more than one percent of the originally scheduled payments that would have been due to the NTGST for the years 2005 through 2010) notwithstanding the offsets resulting from the FETRA payments. The North Carolina trial court has held in favor of Maryland and Pennsylvania, and the companies (including PM USA) have appealed. In addition to the approximately $9.5 billion cost of the buy-out, FETRA also obligated manufacturers and importers of tobacco products to cover any losses (up to $500 million) that the government incurred on the disposition of tobacco pool stock accumulated under the previous tobacco price support program. PM USA has paid $138 million for its share of the tobacco pool stock losses. The quota buy-out did not have a material adverse impact on ALG’s consolidated results in 2007. ALG does not currently anticipate that the quota buy-out will have a material adverse impact on its consolidated results in 2008 and beyond.

Other MSA-Related Litigation

In June 2004, a putative class of California smokers filed a complaint against PM USA and the MSA’s other “Original Participating Manufacturers” (“OPMs”) seeking damages from the OPMs for post-MSA price increases and an injunction against their continued compliance with the MSA’s terms. The complaint alleges that the MSA and related legislation protect the OPMs from competition in a manner that violates federal and state antitrust and consumer protection laws. The complaint also names the California Attorney General as a defendant and seeks to enjoin him from enforcing California’s Escrow Statute. In March 2005, the United States District Court for the Northern District of California granted defendants’ motion to dismiss the case. On September 26, 2007, the United States Court of Appeals for the Ninth Circuit affirmed the dismissal.

Without naming PM USA or any other private party as a defendant, manufacturers that have elected not to sign the MSA (“Non-Participating Manufacturers” or “NPMs”) and/or their distributors or customers have filed several other legal challenges to the MSA and related legislation. New York state officials are defendants in a lawsuit pending in the United States District Court for the Southern District of New York in which cigarette importers allege that the MSA and/or related legislation violates federal antitrust laws and the Commerce Clause of the United States Constitution. In a separate proceeding pending in the same court, plaintiffs assert the same theories against not only New York officials but also the Attorneys General for thirty other states. The United States Court of Appeals for the Second Circuit has held that the allegations in both actions, if proven, establish a basis for relief on antitrust and Commerce Clause grounds and that the trial courts in New York have personal jurisdiction sufficient to enjoin other states’ officials from enforcing their MSA-related legislation. On remand in those two actions, one trial judge preliminarily enjoined New York from enforcing its “allocable share” amendment to the MSA’s Model Escrow Statute against the plaintiffs, while another trial judge refused to do so after concluding that the plaintiffs were unlikely to prove their allegations. Summary judgment motions are pending in one of those cases.

In another action, the United States Court of Appeals for the Fifth Circuit reversed a trial court’s dismissal of challenges to MSA-related legislation in Louisiana under the First and Fourteenth Amendments to the United States Constitution. The case will now proceed to motions for summary judgment and, if necessary, a trial. Summary judgment proceedings in another challenge to Louisiana’s participation in the MSA and its MSA-related legislation may begin in mid-2008. Yet another proceeding has been initiated before an international arbitration tribunal

 

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under the provisions of the North American Free Trade Agreement. Appeals from trial court decisions holding that plaintiffs have failed either to make allegations establishing a claim for relief or to submit evidence supporting those allegations are currently, or will soon be, pending before the United States Court of Appeals for the Eighth and Tenth Circuits. The United States Court of Appeals for the Sixth Circuit has affirmed the dismissal of two similar challenges.

Federal Government’s Lawsuit

In 1999, the United States government filed a lawsuit in the United States District Court for the District of Columbia against various cigarette manufacturers, including PM USA, and others, including ALG, asserting claims under three federal statutes, the Medical Care Recovery Act (“MCRA”), the Medicare Secondary Payer (“MSP”) provisions of the Social Security Act and the civil provisions of RICO. Trial of the case ended in June 2005. The lawsuit sought to recover an unspecified amount of health care costs for tobacco-related illnesses allegedly caused by defendants’ fraudulent and tortious conduct and paid for by the government under various federal health care programs, including Medicare, military and veterans’ health benefits programs, and the Federal Employees Health Benefits Program. The complaint alleged that such costs total more than $20 billion annually. It also sought what it alleged to be equitable and declaratory relief, including disgorgement of profits which arose from defendants’ allegedly tortious conduct, an injunction prohibiting certain actions by the defendants, and a declaration that the defendants are liable for the federal government’s future costs of providing health care resulting from defendants’ alleged past tortious and wrongful conduct. In September 2000, the trial court dismissed the government’s MCRA and MSP claims, but permitted discovery to proceed on the government’s claims for relief under the civil provisions of RICO.

The government alleged that disgorgement by defendants of approximately $280 billion is an appropriate remedy. In May 2004, the trial court issued an order denying defendants’ motion for partial summary judgment limiting the disgorgement remedy. In February 2005, a panel of the United States Court of Appeals for the District of Columbia Circuit held that disgorgement is not a remedy available to the government under the civil provisions of RICO and entered summary judgment in favor of defendants with respect to the disgorgement claim. In April 2005, the Court of Appeals denied the government’s motion for rehearing. In July 2005, the government petitioned the United States Supreme Court for further review of the Court of Appeals’ ruling that disgorgement is not an available remedy, and in October 2005, the Supreme Court denied the petition.

In June 2005, the government filed with the trial court its proposed final judgment seeking remedies of approximately $14 billion, including $10 billion over a five-year period to fund a national smoking cessation program and $4 billion over a ten-year period to fund a public education and counter-marketing campaign. Further, the government’s proposed remedy would have required defendants to pay additional monies to these programs if targeted reductions in the smoking rate of those under 21 are not achieved according to a prescribed timetable. The government’s proposed remedies also included a series of measures and restrictions applicable to cigarette business operations – including, but not limited to, restrictions on advertising and marketing, potential measures with respect to certain price promotional activities and research and development, disclosure requirements for certain confidential data and implementation of a monitoring system with potential broad powers over cigarette operations.

 

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In August 2006, the federal trial court entered judgment in favor of the government. The court held that certain defendants, including ALG and PM USA, violated RICO and engaged in 7 of the 8 “sub-schemes” to defraud that the government had alleged. Specifically, the court found that:

 

   

defendants falsely denied, distorted and minimized the significant adverse health consequences of smoking;

 

   

defendants hid from the public that cigarette smoking and nicotine are addictive;

 

   

defendants falsely denied that they control the level of nicotine delivered to create and sustain addiction;

 

   

defendants falsely marketed and promoted “low tar/light” cigarettes as less harmful than full-flavor cigarettes;

 

   

defendants falsely denied that they intentionally marketed to youth;

 

   

defendants publicly and falsely denied that ETS is hazardous to non-smokers; and

 

   

defendants suppressed scientific research.

The court did not impose monetary penalties on the defendants, but ordered the following relief: (i) an injunction against “committing any act of racketeering” relating to the manufacturing, marketing, promotion, health consequences or sale of cigarettes in the United States; (ii) an injunction against participating directly or indirectly in the management or control of the Council for Tobacco Research, the Tobacco Institute, or the Center for Indoor Air Research, or any successor or affiliated entities of each; (iii) an injunction against “making, or causing to be made in any way, any material false, misleading, or deceptive statement or representation or engaging in any public relations or marketing endeavor that is disseminated to the United States public and that misrepresents or suppresses information concerning cigarettes”; (iv) an injunction against conveying any express or implied health message through use of descriptors on cigarette packaging or in cigarette advertising or promotional material, including “lights,” “ultra lights” and “low tar,” which the court found could cause consumers to believe a cigarette brand is less hazardous than another brand; (v) the issuance of “corrective statements” in various media regarding the adverse health effects of smoking, the addictiveness of smoking and nicotine, the lack of any significant health benefit from smoking “low tar” or “light” cigarettes, defendants’ manipulation of cigarette design to ensure optimum nicotine delivery and the adverse health effects of exposure to environmental tobacco smoke; (vi) the disclosure on defendants’ public document websites and in the Minnesota document repository of all documents produced to the government in the lawsuit or produced in any future court or administrative action concerning smoking and health until 2021, with certain additional requirements as to documents withheld from production under a claim of privilege or confidentiality; (vii) the disclosure of disaggregated marketing data to the government in the same form and on the same schedule as defendants now follow in disclosing such data to the Federal Trade Commission, for a period of ten years; (viii) certain restrictions on the sale or transfer by defendants of any cigarette brands, brand names, formulas or cigarette businesses within the United States; and (ix) payment of the government’s costs in bringing the action.

 

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In September 2006, defendants filed notices of appeal to the United States Court of Appeals for the District of Columbia Circuit. In September 2006, the trial court denied defendants’ motion to stay the judgment pending defendants’ appeals, and defendants then filed an emergency motion with the Court of Appeals to stay enforcement of the judgment pending their appeals. In October 2006, the government filed a notice of appeal to the Court of Appeals in which it appeals the denial of certain remedies, including the disgorgement of profits and the cessation remedies it had sought. In October 2006, a three-judge panel of the United States Court of Appeals granted defendants’ motion and stayed the trial court’s judgment pending its review of the decision. Certain defendants, including PM USA and ALG, filed a motion to clarify the trial court’s August 2006 Final Judgment and Remedial Order. In March 2007, the trial court denied in part and granted in part defendants’ post-trial motion for clarification of portions of the court’s remedial order. As noted above, the trial court’s judgment and remedial order remain stayed pending the appeal to the Court of Appeals. In May 2007, the United States Court of Appeals for the District of Columbia scheduled briefing of the parties’ consolidated appeal to begin in August 2007 and conclude in May 2008.

Lights/Ultra Lights Cases

Overview

Plaintiffs in these class actions (some of which have not been certified as such), allege, among other things, that the uses of the terms “Lights” and/or “Ultra Lights” constitute deceptive and unfair trade practices, common law fraud, or RICO violations, and seek injunctive and equitable relief, including restitution and, in certain cases, punitive damages. These class actions have been brought against PM USA and, in certain instances, ALG, on behalf of individuals who purchased and consumed various brands of cigarettes, including Marlboro Lights, Marlboro Ultra Lights, Virginia Slims Lights and Superslims, Merit Lights and Cambridge Lights. Defenses raised in these cases include lack of misrepresentation, lack of causation, injury, and damages, the statute of limitations, express preemption by the Federal Cigarette Labeling and Advertising Act and implied preemption by the policies and directives of the Federal Trade Commission, non-liability under state statutory provisions exempting conduct that complies with federal regulatory directives, and the First Amendment. Seventeen cases are pending in Arkansas (2), Delaware (1), Florida (1), Illinois (1), Maine (1), Massachusetts (1), Minnesota (1), Missouri (1), New Hampshire (1), New Jersey (1), New Mexico (1), New York (1), Oregon (1), Tennessee (1), and West Virginia (2). In addition, there are two cases pending in Israel. Other entities have stated that they are considering filing such actions against ALG and PM USA.

To date, 11 courts in 12 cases have refused to certify class actions, reversed prior class certification decisions or have entered judgment in favor of PM USA. Trial courts in Arizona, Kansas, New Mexico, Oregon, Washington and New Jersey have refused to certify a class, an appellate court in Florida has overturned class certification by a trial court, the Ohio Supreme Court has overturned class certifications in two cases, the United States Court of Appeals for the Fifth Circuit has dismissed a purported Lights class action brought in Louisiana federal court (Sullivan) on the grounds that plaintiffs’ claims were preempted by the Federal Cigarette Labeling and Advertising Act, a federal trial court in Maine has dismissed a purported class action on federal preemption grounds (Good), plaintiffs voluntarily dismissed an action in a federal trial court in Michigan after the court dismissed claims asserted under the Michigan

 

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Unfair Trade and Consumer Protection Act, and the Supreme Court of Illinois has overturned a judgment in favor of a plaintiff class in the Price case. The United States Court of Appeals for the First Circuit vacated the district court’s grant of PM USA’s motion for summary judgment in the Good case on federal preemption grounds and remanded the case to district court. The district court stayed proceedings pending the ruling of the United States Supreme Court on defendants’ petition for a writ of certiorari, which was granted on January 18, 2008. An intermediate appellate court in Oregon and the Supreme Court in Washington have denied plaintiffs’ motions for interlocutory review of the trial courts’ refusals to certify a class. Plaintiffs in the Oregon case failed to appeal by the deadline for doing so and the trial court subsequently entered judgment against plaintiffs on the ground of express preemption under the Federal Cigarette Labeling and Advertising Act. In November, plaintiffs in that case (Pearson) filed a notice of appeal of the trial court’s decisions with the Oregon Court of Appeals. Plaintiffs in the case in Washington voluntarily dismissed the case with prejudice. Plaintiffs in the New Mexico case renewed their motion for class certification. Plaintiffs in the Florida case (Hines) petitioned the Florida Supreme Court for further review, and on January 14, 2008, the Florida Supreme Court denied this petition.

Trial courts have certified classes against PM USA in Massachusetts (Aspinall), Minnesota (Curtis), Missouri (Craft) and New York (Schwab). PM USA has appealed or otherwise challenged these class certification orders, and the appeal in Schwab is pending. In addition, the United States Supreme Court has reversed the trial and appellate courts’ rulings denying plaintiffs’ motion to remand the case to state trial court in a purported Lights class action brought in Arkansas (Watson). Developments in these cases include:

 

   

Watson:    In June 2007, the United States Supreme Court reversed the lower court rulings that denied plaintiffs’ motion to have the case heard in a state, as opposed to federal, trial court. The Supreme Court rejected defendants’ contention that the case must be tried in federal court under the “federal officer” statute. The case has been remanded to the state trial court in Arkansas. In December 2007, the court rejected the parties’ proposed stipulation to stay the case pending the United States Supreme Court’s decision on defendants’ petition for writ of certiorari in Good, which was granted on January 18, 2008.

 

   

Aspinall:    In August 2004, the Massachusetts Supreme Judicial Court affirmed the class certification order. In April 2006, plaintiffs filed a motion to redefine the class to include all persons who after November 25, 1994 purchased packs or cartons of Marlboro Lights cigarettes in Massachusetts that displayed the legend “Lower Tar & Nicotine” (the original class definition did not include a reference to lower tar and nicotine). In August 2006, the trial court denied PM USA’s motion for summary judgment based on the state consumer protection statutory exemption and federal preemption. On motion of the parties, the trial court has subsequently reported its decision to deny summary judgment to the appeals court for review and the trial court proceedings are stayed pending completion of the appellate review. Motions for direct appellate review with the Massachusetts Supreme Judicial Court were granted in April 2007 and oral arguments were heard in January 2008.

 

   

Curtis:    In April 2005, the Minnesota Supreme Court denied PM USA’s petition for interlocutory review of the trial court’s class certification order. In September 2005, PM USA removed Curtis to federal court based on the Eighth Circuit’s decision in Watson, which upheld the removal of a Lights case to federal court based on the federal officer jurisdiction of the Federal Trade Commission. In February 2006, the federal court denied plaintiffs’ motion to remand the case to state court. The case was stayed pending the

 

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outcome of Dahl v. R. J. Reynolds Tobacco Co., which was argued before the United States Court of Appeals for the Eighth Circuit in December 2006. In February 2007, the United States Court of Appeals for the Eighth Circuit issued its ruling in Dahl, and reversed the federal district court’s denial of plaintiffs’ motion to remand that case to the state trial court. On October 17, 2007, the district court remanded the Curtis case to state court. In December 2007, the Minnesota Court of Appeals reversed the trial court’s determination in Dahl that plaintiffs’ claims in that case were subject to express preemption and defendant in that case has petitioned the Minnesota Supreme Court for review. In December 2007, defendants in Curtis moved to stay proceedings pending any appellate review by the Minnesota Supreme Court in Dahl and the United States Supreme Court in Good, which was granted on January 18, 2008.

 

   

Craft:    In August 2005, a Missouri Court of Appeals affirmed the class certification order. In September 2005, PM USA removed Craft to federal court based on the Eighth Circuit’s decision in Watson. In March 2006, the federal trial court granted plaintiffs’ motion and remanded the case to the Missouri state trial court. In May 2006, the Missouri Supreme Court declined to review the trial court’s class certification decision. Trial has been set for January 2009.

 

   

Schwab:    In September 2005, the trial court granted in part defendants’ motion for partial summary judgment dismissing plaintiffs’ claims for equitable relief and denied a number of plaintiffs’ motions for summary judgment. In November 2005, the trial court ruled that the plaintiffs would be permitted to calculate damages on an aggregate basis and use “fluid recovery” theories to allocate them among class members. In September 2006, the trial court denied defendants’ summary judgment motions and granted plaintiffs’ motion for certification of a nationwide class of all United States residents that purchased cigarettes in the United States that were labeled “light” or “lights” from the first date defendants began selling such cigarettes until the date trial commences. The court also declined to certify the order for interlocutory appeal, declined to stay the case and ordered jury selection to begin in January 2007, with trial scheduled to begin immediately after the jury is impaneled. In October 2006, a single judge of the United States Court of Appeals for the Second Circuit granted PM USA’s petition for a temporary stay of pre-trial and trial proceedings pending disposition of the petitions for stay and interlocutory review by a three-judge panel of the Court of Appeals. In November 2006, the Second Circuit granted interlocutory review of the trial court’s class certification order and stayed the case before the trial court pending the appeal. Oral argument was heard on July 10, 2007.

In addition to these cases, in December 2005, in the Miner case which was pending at that time in the United States District Court for the Western District of Arkansas, plaintiffs moved for certification of a class composed of individuals who purchased Marlboro Lights or Cambridge Lights brands in Arkansas, California, Colorado, and Michigan. PM USA’s motion for summary judgment based on preemption and the Arkansas statutory exemption is pending. Following the filing of this motion, plaintiffs moved to voluntarily dismiss Miner without prejudice, which PM USA opposed. The court then stayed the case pending the United States Supreme Court’s decision on a petition for writ of certiorari in the Watson case discussed above. In July 2007, the case was remanded to a state trial court in Arkansas. In August 2007, plaintiffs renewed their motion for class certification. In October 2007, the court denied PM USA’s motion to dismiss on procedural grounds and the court entered a case management order. The case is currently stayed pending the outcome of the United States Supreme Court’s

 

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decision in Good. The United States Supreme Court granted defendants’ petition on January 18, 2008. In addition, plaintiffs’ motion for class certification is pending in a case in Tennessee.

Certain Other Tobacco-Related Litigation

Tobacco Price Cases:    As of December 31, 2007, two cases were pending in Kansas and New Mexico in which plaintiffs allege that defendants, including PM USA, conspired to fix cigarette prices in violation of antitrust laws. ALG is a defendant in the case in Kansas. Plaintiffs’ motions for class certification have been granted in both cases. In February 2005, the New Mexico Court of Appeals affirmed the class certification decision. In June 2006, defendants’ motion for summary judgment was granted in the New Mexico case. Plaintiffs in the New Mexico case have appealed. The case in Kansas has been stayed pending the Kansas Supreme Court’s decision on defendants’ petition regarding certain procedural rulings by the trial court.

Cigarette Contraband Cases:    In May 2000 and August 2001, various departments of Colombia and the European Community and 10 Member States filed suits in the United States against ALG and certain of its subsidiaries, including PM USA, and other cigarette manufacturers and their affiliates, alleging that defendants sold to distributors cigarettes that would be illegally imported into various jurisdictions. In February 2002, the federal district court granted defendants’ motions to dismiss the actions. In January 2004, the United States Court of Appeals for the Second Circuit affirmed the dismissals of the cases based on the common law Revenue Rule, which bars a foreign government from bringing civil claims in U.S. courts for the recovery of lost taxes. It is possible that future litigation related to cigarette contraband issues may be brought. In this regard, ALG believes that Canadian authorities are contemplating a legal proceeding based on an investigation of ALG entities relating to allegations of contraband shipments of cigarettes into Canada in the early to mid-1990s.

Cases Under the California Business and Professions Code:    In June 1997 and July 1998, two suits (Brown and Daniels) were filed in California state court alleging that domestic cigarette manufacturers, including PM USA and others, have violated California Business and Professions Code Sections 17200 and 17500 regarding unfair, unlawful and fraudulent business practices. Class certification was granted in both cases as to plaintiffs’ claims that class members are entitled to reimbursement of the costs of cigarettes purchased during the class periods and injunctive relief. In September 2002, the court granted defendants’ motion for summary judgment as to all claims in one of the cases (Daniels), and plaintiffs appealed. In October 2004, the California Fourth District Court of Appeal affirmed the trial court’s ruling, and also denied plaintiffs’ motion for rehearing. In February 2005, the California Supreme Court agreed to hear plaintiffs’ appeal. In August 2007, the California Supreme Court affirmed the dismissal of the Daniels class action on federal preemption grounds. In December 2007, plaintiffs filed a petition for writ of certiorari with the United States Supreme Court.

In September 2004, the trial court in the Brown case granted defendants’ motion for summary judgment as to plaintiffs’ claims attacking defendants’ cigarette advertising and promotion and denied defendants’ motion for summary judgment on plaintiffs’ claims based on allegedly false affirmative statements. Plaintiffs’ motion for rehearing was denied. In March 2005, the court granted defendants’ motion to decertify the class based on a recent change in California law, which, in two July 2006 opinions, the California Supreme Court ruled applicable to pending cases. Plaintiffs’ motion for reconsideration of the order that decertified the class was denied, and plaintiffs have appealed. In September 2006, an intermediate appellate court affirmed the

 

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trial court’s order decertifying the class in Brown. In November 2006, the California Supreme Court accepted review of the appellate court’s decision.

In May 2004, a lawsuit (Gurevitch) was filed in California state court on behalf of a purported class of all California residents who purchased the Merit brand of cigarettes since July 2000 to the present alleging that defendants, including PM USA, violated California’s Business and Professions Code Sections 17200 and 17500 regarding unfair, unlawful and fraudulent business practices, including false and misleading advertising. The complaint also alleges violations of California’s Consumer Legal Remedies Act. Plaintiffs seek injunctive relief, disgorgement, restitution, and attorneys’ fees. In July 2005, defendants’ motion to dismiss was granted; however, plaintiffs’ motion for leave to amend the complaint was also granted, and plaintiffs filed an amended complaint in September 2005. In October 2005, the court stayed this action pending the California Supreme Court’s rulings on two cases not involving PM USA. In July 2006, the California Supreme Court issued rulings in the two cases and held that a recent change in California law known as Proposition 64, which limits the ability to bring a lawsuit to only those plaintiffs who have “suffered injury in fact” and “lost money or property” as a result of defendant’s alleged statutory violations, properly applies to pending cases. In September 2006, the stay was lifted and defendants filed their demurrer to plaintiffs’ amended complaint. In March 2007, the court, without ruling on the demurrer, again stayed the action pending rulings from the California Supreme Court in another case involving Proposition 64 that is relevant to PM USA’s demurrer.

Certain Other Actions

IRS Challenges to PMCC Leases:    The IRS concluded its examination of ALG’s consolidated tax returns for the years 1996 through 1999, and issued a final Revenue Agent’s Report (“RAR”) on March 15, 2006. The RAR disallowed benefits pertaining to certain PMCC leveraged lease transactions for the years 1996 through 1999. Altria Group, Inc. has agreed with all conclusions of the RAR, with the exception of the disallowance of benefits pertaining to several PMCC leveraged lease transactions for the years 1996 through 1999. PMCC will continue to assert its position regarding these leveraged lease transactions and contest approximately $150 million of tax and net interest assessed and paid with regard to them. The IRS may in the future challenge and disallow more of PMCC’s leveraged leases based on Revenue Rulings, an IRS Notice and subsequent case law addressing specific types of leveraged leases (lease-in/lease-out (“LILO”) and sale-in/lease-out (“SILO”) transactions). PMCC believes that the position and supporting case law described in the RAR, Revenue Rulings and the IRS Notice are incorrectly applied to PMCC’s transactions and that its leveraged leases are factually and legally distinguishable in material respects from the IRS’s position. PMCC and ALG intend to vigorously defend against any challenges based on that position through litigation. In this regard, on October 16, 2006, PMCC filed a complaint in the U.S. District Court for the Southern District of New York to claim refunds for a portion of these tax payments and associated interest. However, should PMCC’s position not be upheld, PMCC may have to accelerate the payment of significant amounts of federal income tax and significantly lower its earnings to reflect the recalculation of the income from the affected leveraged leases, which could have a material effect on the earnings and cash flows of Altria Group, Inc. in a particular fiscal quarter or fiscal year. PMCC considered this matter in its adoption of FASB Interpretation No. 48 and FASB Staff Position No. FAS 13-2.

 

 

 

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ALTRIA GROUP, INC. and SUBSIDIARIES

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It is possible that there could be adverse developments in pending cases. An unfavorable outcome or settlement of pending tobacco related litigation could encourage the commencement of additional litigation. Although PM USA has historically been able to obtain required bonds or relief from bonding requirements in order to prevent plaintiffs from seeking to collect judgments while adverse verdicts have been appealed, there remains a risk that such relief may not be obtainable in all cases. This risk has been substantially reduced given that 42 states now limit the dollar amount of bonds or require no bond at all.

ALG and its subsidiaries record provisions in the consolidated financial statements for pending litigation when they determine that an unfavorable outcome is probable and the amount of the loss can be reasonably estimated. Except as discussed elsewhere in this Note 19. Contingencies: (i) management has not concluded that it is probable that a loss has been incurred in any of the pending tobacco-related cases; (ii) management is unable to estimate the possible loss or range of loss that could result from an unfavorable outcome of any of the pending tobacco-related cases; and (iii) accordingly, management has not provided any amounts in the consolidated financial statements for unfavorable outcomes, if any.

It is possible that PM USA’s or Altria Group, Inc.’s consolidated results of operations, cash flows or financial position could be materially affected in a particular fiscal quarter or fiscal year by an unfavorable outcome or settlement of certain pending litigation. Nevertheless, although litigation is subject to uncertainty, management believes the litigation environment has substantially improved. ALG and each of its subsidiaries named as a defendant believe, and each has been so advised by counsel handling the respective cases, that it has a number of valid defenses to the litigation pending against it, as well as valid bases for appeal of adverse verdicts against it. All such cases are, and will continue to be, vigorously defended. However, ALG and its subsidiaries may enter into settlement discussions in particular cases if they believe it is in the best interests of ALG’s stockholders to do so.

Third-Party Guarantees

At December 31, 2007, Altria Group, Inc.’s third-party guarantees from continuing operations which are related to divestiture activities, were $22 million. These guarantees have no specified expiration dates. Altria Group, Inc. is required to perform under these guarantees in the event that a third party fails to make contractual payments. Altria Group, Inc. has a liability of $22 million on its consolidated balance sheet at December 31, 2007, 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.

 

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Note 20.   Quarterly Financial Data (Unaudited):

 

     2007 Quarters
     1st      2nd      3rd      4th
             (in millions, except per share data)        

Net revenues

   $ 4,288    $ 4,861    $ 4,987    $ 4,528
                           

Gross profit

   $ 1,700    $ 1,941    $ 1,964    $ 1,780
                           

Earnings from continuing operations

   $ 696    $ 715    $ 900    $ 820

Earnings from discontinued operations

     2,054      1,500      1,733      1,368
                           

Net earnings

   $ 2,750    $ 2,215    $ 2,633    $ 2,188
                           

Per share data:

           

Basic EPS:

           

Continuing operations

   $ 0.33    $ 0.34    $ 0.43    $ 0.39

Discontinued operations

     0.98      0.71      0.82      0.65
                           

Net earnings

   $ 1.31    $ 1.05    $ 1.25    $ 1.04
                           

Diluted EPS:

           

Continuing operations

   $ 0.33    $ 0.34    $ 0.43    $ 0.39

Discontinued operations

     0.97      0.71      0.81      0.64
                           

Net earnings

   $ 1.30    $ 1.05    $ 1.24    $ 1.03
                           

Dividends declared

   $ 0.86    $ 0.69    $ 0.75    $ 0.75
                           

Market price      - high

   $ 90.50    $ 72.20    $ 72.20    $ 78.51

                           - low

   $ 81.17    $ 66.91    $ 63.13    $ 69.09

The first quarter 2007 market price information in the table above reflects historical market prices which are not adjusted to reflect the Kraft spin-off.

 

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     2006 Quarters
     1st      2nd      3rd      4th
             (in millions, except per share data)        

Net revenues

   $ 4,431    $ 4,840    $ 4,939    $ 4,580
                           

Gross profit

   $ 1,841    $ 2,021    $ 2,080    $ 1,844
                           

Earnings from continuing operations

   $ 874    $ 706    $ 838    $ 764

Earnings from discontinued operations

     2,603      2,005      2,037      2,195
                           

Net earnings

   $ 3,477    $ 2,711    $ 2,875    $ 2,959
                           

Per share data:

           

Basic EPS:

           

Continuing operations

   $ 0.42    $ 0.34    $ 0.40    $ 0.37

Discontinued operations

     1.25      0.96      0.98      1.04
                           

Net earnings

   $ 1.67    $ 1.30    $ 1.38    $ 1.41
                           

Diluted EPS:

           

Continuing operations

   $ 0.42    $ 0.34    $ 0.40    $ 0.36

Discontinued operations

     1.23      0.95      0.96      1.04
                           

Net earnings

   $ 1.65    $ 1.29    $ 1.36    $ 1.40
                           

Dividends declared

   $ 0.80    $ 0.80    $ 0.86    $ 0.86
                           

Market price       - high

   $ 77.37    $ 74.39    $ 85.00    $ 86.45

             - low

   $ 70.55    $ 68.36    $ 72.61    $ 75.45

Basic and diluted EPS are computed independently for each of the periods presented. Accordingly, the sum of the quarterly EPS amounts may not agree to the total for the year.

During 2007 and 2006, Altria Group, Inc. recorded the following pre-tax charges or (gains) in earnings from continuing operations:

 

     2007 Quarters
     1st     2nd     3rd     4th
     (in millions)

Recoveries from airline industry exposure

   $ (129 )   $ (78 )   $ (7 )   $ -

Asset impairment and exit costs

     61       318       13       50
                              
   $ (68 )   $ 240     $ 6     $ 50
                              
     2006 Quarters
     1st       2nd       3rd       4th
     (in millions)

Provision for airline industry exposure

   $ -     $ 103     $ -     $ -

Asset impairment and exit costs

       32       3       17
                              
   $ -     $ 135     $ 3     $ 17
                              

As discussed in Note 14. Income Taxes, Altria Group, Inc. has recognized income tax benefits in the consolidated statements of earnings during 2007 and 2006 as a result of various tax events.

 

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ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Note 21.   Subsequent Events:

Spin-Off of PMI

On January 30, 2008, the Board of Directors announced Altria Group, Inc.’s plans to spin off all of its interest in PMI to Altria Group, Inc. stockholders in a tax-free distribution. The distribution of all the PMI shares owned by Altria Group, Inc. was made on March 28, 2008 (the “PMI Distribution Date”), to Altria Group, Inc. stockholders of record as of the close of business on March 19, 2008 (the “PMI Record Date”). Altria Group, Inc. distributed one share of PMI common stock for every share of Altria Group, Inc. common stock outstanding as of the PMI Record Date. Following the PMI Distribution Date, Altria Group, Inc. does not own any shares of PMI stock. Altria Group, Inc. intends to adjust its dividend so that its stockholders who retain their Altria Group, Inc. and PMI shares will receive, in the aggregate, the same dividend dollars as before the PMI Distribution Date. Following the distribution, PMI’s initial annualized dividend rate will be $1.84 per common share and Altria Group, Inc.’s initial annualized dividend rate will be $1.16 per common share. All decisions regarding dividends are made independently by the Altria Group, Inc. Board of Directors and the PMI Board of Directors, for their respective companies.

Stock Compensation

Holders of Altria Group, Inc. stock options were treated similarly to public stockholders and, accordingly, had their stock awards split into two instruments. Holders of Altria Group, Inc. stock options received the following stock options, which, immediately after the spin-off, had an aggregate intrinsic value equal to the intrinsic value of the pre-spin Altria Group, Inc. options:

 

   

a new PMI option to acquire the same number of shares of PMI common stock as the number of Altria Group, Inc. options held by such person on the PMI Distribution Date; and

 

   

an adjusted Altria Group, Inc. option for the same number of shares of Altria Group, Inc. common stock with a reduced exercise price.

As set forth in the Employee Matters Agreement, the exercise price of each option was developed to reflect the relative market values of PMI and Altria Group, Inc. shares, by allocating the share price of Altria Group, Inc. common stock before the spin-off ($73.83) to PMI shares ($51.44) and Altria Group, Inc. shares ($22.39) and then multiplying each of these allocated values by the Option Conversion Ratio. The Option Conversion Ratio is equal to the exercise price of the Altria Group, Inc. option, prior to any adjustment for the spin-off, divided by the share price of Altria Group, Inc. common stock before the spin-off ($73.83). As a result, the new PMI option and the adjusted Altria Group, Inc. option have an aggregate intrinsic value equal to the intrinsic value of the pre-spin Altria Group, Inc. option.

Holders of Altria Group, Inc. restricted stock or deferred stock awarded prior to January 30, 2008, retained their existing awards and received the same number of shares of restricted or deferred stock of PMI. The restricted stock and deferred stock will not vest until the completion of the original restriction period (typically, three years from the date of the original grant). Recipients of Altria Group, Inc. deferred stock awarded on January 30, 2008, who were employed by Altria Group, Inc. after the PMI Distribution Date, received additional shares of deferred stock

 

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ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

of Altria Group, Inc. to preserve the intrinsic value of the award. Recipients of Altria Group, Inc. deferred stock awarded on January 30, 2008, who were employed by PMI after the PMI Distribution Date, received substitute shares of deferred stock of PMI to preserve the intrinsic value of the award.

To the extent that employees of the remaining Altria Group, Inc. received PMI stock options, Altria Group, Inc. reimbursed PMI in cash for the Black-Scholes fair value of the stock options received. To the extent that PMI employees hold Altria Group, Inc. stock options, PMI reimbursed Altria Group, Inc. in cash for the Black-Scholes fair value of the stock options. To the extent that employees of the remaining Altria Group, Inc. received PMI deferred stock, Altria Group, Inc. paid to PMI the fair value of the PMI deferred stock less the value of projected forfeitures. To the extent that PMI employees hold Altria Group, Inc. restricted stock or deferred stock, PMI reimbursed Altria Group, Inc. in cash for the fair value of the restricted or deferred stock less the value of projected forfeitures and any amounts previously charged to PMI for the restricted or deferred stock. Based upon the number of Altria Group, Inc. stock awards outstanding at the PMI Distribution Date, the net amount of these reimbursements resulted in a payment of $449 million from Altria Group, Inc. to PMI ($427 million of which was paid in March 2008).

Other Matters

In connection with the spin-off, PMI paid to Altria Group, Inc. $4.0 billion in special dividends in addition to its normal dividends to Altria Group, Inc. PMI paid $3.1 billion of these special dividends in 2007 and paid the additional $900 million in the first quarter of 2008.

Prior to the PMI spin-off, PMI was included in the Altria Group, Inc. consolidated federal income tax return, and PMI’s federal income tax contingencies were recorded as liabilities on the balance sheet of ALG. ALG reimbursed PMI in cash for these liabilities, which were $97 million.

Prior to the PMI spin-off, certain employees of PMI participated in the U.S. benefit plans offered by Altria Group, Inc. After the PMI Distribution Date, the benefits previously provided by Altria Group, Inc. will be provided by PMI. As a result, new plans were established by PMI, and the related plan assets (to the extent that the benefit plans were previously funded) and liabilities were transferred to the PMI plans. The transfer of these benefits resulted in Altria Group, Inc. reducing its benefit plan liabilities by $129 million and increasing its prepaid pension assets by $33 million in its consolidated balance sheet, partially offset by the related deferred tax assets ($23 million) and the corresponding Statement of Financial Accounting Standards (“SFAS”) No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” adjustment to stockholders’ equity ($27 million). Altria Group, Inc. paid PMI a corresponding amount of $112 million in cash, which is net of the related tax benefit.

A subsidiary of ALG previously provided PMI with certain corporate services at cost plus a management fee. After the PMI Distribution Date, PMI independently undertook most of these activities. Any remaining limited services provided to PMI by the ALG service subsidiary under the Transition Services Agreement are expected to cease in 2008. The settlement of the intercompany accounts (including the amounts discussed above related to stock awards, tax contingencies and benefit plans) resulted in a net payment from Altria Group, Inc. to PMI of $332 million. In March 2008, Altria Group, Inc. made an estimated payment of $427 million to

 

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ALTRIA GROUP, INC. and SUBSIDIARIES

NOTES to CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

PMI, thereby resulting in PMI reimbursing $95 million to Altria Group, Inc. in the second quarter of 2008.

Under the terms of the Distribution Agreement between Altria Group, Inc. and PMI, liabilities concerning tobacco products will be allocated based in substantial part on the manufacturer. PMI will indemnify Altria Group, Inc. and PM USA for liabilities related to tobacco products manufactured by PMI or contract manufactured for PMI by PM USA, and PM USA will indemnify PMI for liabilities related to tobacco products manufactured by PM USA, excluding tobacco products contract manufactured for PMI. Altria Group, Inc. does not have a liability recorded on its condensed consolidated balance sheet at March 31, 2008 as the fair value of this indemnification is insignificant.

Altria Group, Inc. estimates that, if the distribution had occurred on December 31, 2007, it would have resulted in a net decrease to Altria Group, Inc.’s stockholders’ equity of approximately $15 billion.

Altria Group, Inc. Tender Offer for Debt

On January 30, 2008, the Board of Directors announced that Altria Group, Inc. will commence a tender offer to purchase for cash all of Altria Group, Inc.’s notes outstanding, including $2.6 billion of domestic notes denominated in U.S. dollars and €1.0 billion in euro-denominated notes. Altria Group, Inc. expects to record a charge in the range of $340 million to $380 million upon completion of the tender offer. In order to finance the tender offer, Altria Group, Inc. has arranged a $4.0 billion, 364-day credit facility. Subsequent to the spin-off, Altria Group, Inc. intends to access the public debt market to refinance debt incurred in connection with the tender offer.

Share Repurchase Programs

On January 30, 2008, the Altria Group, Inc. Board of Directors approved a $7.5 billion two-year share repurchase program which is expected to begin in April, after completion of the PMI spin-off. In addition, the Altria Group, Inc. Board of Directors approved a $13.0 billion two-year share repurchase program for PMI which is expected to begin in May 2008.

 

82

EX-99.4 7 dex994.htm FINANCIAL STATEMENT SCHEDULE Financial Statement Schedule

Exhibit 99.4

Altria Group, Inc. and Subsidiaries

Valuation and Qualifying Accounts

For the Years Ended December 31, 2007, 2006 and 2005

(in millions)

 

        Additions        
Description   Balance at the
Beginning of the
Period
  Charged to
Costs and

Expense
    Charged to
Other
Accounts
  Deductions   Balance at the
end of the
Period
        a.     b.  

2007

         

Consumer Products:

         

Allowance for discounts

  $ -       $ 493     $ -       $ 493   $ -    

Allowance for doubtful accounts

    6     -           1     4     3

Allowance for returned goods

    1     3       -         2     2
                               
  $ 7   $ 496     $ 1   $ 499   $ 5
                               

Financial Services:

         

Allowance for losses

  $ 480   $ -         $ -       $ 276   $ 204
                               

2006

         

Consumer Products:

         

Allowance for discounts

  $ -       $ 516     $ -       $ 516   $ -    

Allowance for doubtful accounts

    2     4       -         -         6

Allowance for returned goods

    2     1       -         2     1
                               
  $ 4   $ 521     $ -       $ 518   $ 7
                               

Financial Services:

         

Allowance for losses

  $ 596   $ 103     $ -       $ 219   $ 480
                               

2005

         

Consumer Products:

         

Allowance for discounts

  $ -       $ 529     $ -       $ 529   $ -    

Allowance for doubtful accounts

    2     -           -         -         2

Allowance for returned goods

    14     (6 )     -         6     2
                               
  $ 16   $ 523     $ -       $ 535   $ 4
                               

Financial Services:

         

Allowance for losses

  $ 497   $ 200     $ -       $ 101   $ 596
                               

a.  Primarily related to an acquisition.

b.  Represents charges for which allowances were created.

EX-99.5 8 dex995.htm REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Report of Independent Registered Public Accounting Firm

Exhibit 99.5

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

ON FINANCIAL STATEMENT SCHEDULE

To the Board of Directors and Stockholders of

ALTRIA GROUP, INC.:

Our audits of the consolidated financial statements and of the effectiveness of internal control over financial reporting referred to in our report dated January 28, 2008, except for Notes 19 and 21 which are as of February 4, 2008, and except for the impact of presenting Philip Morris International Inc. as a discontinued operation as discussed in Notes 1 and 4, the impact of the spin-off of Philip Morris International Inc. as discussed in Note 21 and the change in reportable segments as discussed in Notes 1 and 15, all of which are as of June 5, 2008, appearing in this Current Report on Form 8-K also included an audit of the financial statement schedule appearing in this Form 8-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.

/s/ PricewaterhouseCoopers LLP

New York, New York

January 28, 2008, except for Notes 19 and 21 which are as of February 4, 2008, and except for the impact of presenting Philip Morris International Inc. as a discontinued operation as discussed in Notes 1 and 4, the impact of the spin-off of Philip Morris International Inc. as discussed in Note 21 and the change in reportable segments as discussed in Notes 1 and 15, all of which are as of June 5, 2008

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