EX-13 7 dex13.htm PAGES 17 TO 100 OF THE 2008 ANNUAL REPORT Pages 17 to 100 of the 2008 Annual Report

Exhibit 13

Financial Review

 

Financial Contents

  

Selected Financial Data — Five-Year Review

   page 18

Consolidated Statements of Earnings

   page 19

Consolidated Balance Sheets

   page 20

Consolidated Statements of Cash Flows

   page 22

Consolidated Statements of Stockholders’ Equity

   page 24

Notes to Consolidated Financial Statements

   page 25

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

   page 76

Report of Independent Registered Public Accounting Firm

   page 99

Report of Management on Internal Control Over Financial Reporting

   page 100

 

Guide To Select Disclosures

 

For easy reference, areas that may be of interest to investors are highlighted in the index below.

 

  

Asset Impairment and Exit Costs—Note 3

   page 31

Benefit Plans—Note 16 includes a discussion of pension plans

   page 42

Capital Stock—Note 11

   page 37

Contingencies—Note 20 includes a discussion of the litigation environment

   page 48

Finance Assets, net—Note 8 includes a discussion of leasing activities

   page 33

Long-Term Debt—Note 10

   page 36

Segment Reporting—Note 15

   page 41

Short-Term Borrowings and Borrowing Arrangements—Note 9

   page 35

Stock Plans—Note 12 includes a discussion of stock compensation

   page 37

 

17


Selected Financial Data — Five-Year Review

(in millions of dollars, except per share data)

 

        2008     2007     2006     2005     2004  

Summary of Operations:

           

Net revenues

    $ 19,356     $ 18,664     $ 18,790     $ 18,452     $ 17,901  

Cost of sales

      8,270       7,827       7,387       7,274       6,956  

Excise taxes on products

      3,399       3,452       3,617       3,659       3,694  
                                         

Operating income

      4,882       4,373       4,518       4,104       4,082  

Interest and other debt expense, net

    167       205       225       427       506  

Equity earnings in SABMiller

    467       510       460       446       507  

Earnings from continuing operations before income taxes

    4,789       4,678       4,753       4,123       4,083  

Pre-tax profit margin from continuing operations

    24.7 %     25.1 %     25.3 %     22.3 %     22.8 %

Provision for income taxes

      1,699       1,547       1,571       1,574       1,502  
                                         

Earnings from continuing operations

    3,090       3,131       3,182       2,549       2,581  

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

    1,840       6,655       8,840       7,886       6,835  

Net earnings

      4,930       9,786       12,022       10,435       9,416  
                                         
Basic earnings per share   — continuing operations     1.49       1.49       1.52       1.23       1.26  
  — discontinued operations     0.89       3.17       4.24       3.81       3.34  
  — net earnings     2.38       4.66       5.76       5.04       4.60  
Diluted earnings per share   — continuing operations     1.48       1.48       1.51       1.22       1.25  
  — discontinued operations     0.88       3.14       4.20       3.77       3.31  
  — net earnings     2.36       4.62       5.71       4.99       4.56  

Dividends declared per share

      1.68       3.05       3.32       3.06       2.82  

Weighted average shares (millions) — Basic

    2,075       2,101       2,087       2,070       2,047  

Weighted average shares (millions) — Diluted

    2,087       2,116       2,105       2,090       2,063  
                                         

Capital expenditures

      241       386       399       299       243  

Depreciation

      208       232       255       269       269  

Property, plant and equipment, net (consumer products)

    2,199       2,422       2,343       2,259       2,278  

Inventories (consumer products)

    1,069       1,254       1,605       1,821       1,780  

Total assets

      27,215       57,746       104,531       107,949       101,648  

Total long-term debt

      7,339       2,385       5,195       6,459       8,960  

Total debt — consumer products

    6,974       4,239       4,580       6,462       7,740  

— financial services

    500       500       1,119       2,014       2,221  
                                         

Stockholders’ equity

      2,828       18,902       39,789       35,707       30,714  

Common dividends declared as a % of Basic EPS

    70.6 %     65.5 %     57.6 %     60.7 %     61.3 %

Common dividends declared as a % of Diluted EPS

    71.2 %     66.0 %     58.1 %     61.3 %     61.8 %

Book value per common share outstanding

    1.37       8.97       18.97       17.13       14.91  

Market price per common share — high/low

    79.59-14.34       90.50-63.13       86.45-68.36       78.68-60.40       61.88-44.50  
                                         

Closing price of common share at year end

    15.06       75.58       85.82       74.72       61.10  

Price/earnings ratio at year end — Basic

    6       16       15       15       13  

Price/earnings ratio at year end — Diluted

    6       16       15       15       13  

Number of common shares outstanding at year end (millions)

    2,061       2,108       2,097       2,084       2,060  

Number of employees

      10,400       84,000       175,000       199,000       156,000  
                                         

 

The Selected Financial Data should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 1. Background and Basis of Presentation (“Note 1”) to the consolidated financial statements. As discussed in Note 1, in 2008, Altria Group, Inc. corrected its 2007 and 2006 financial statements to record its share of other comprehensive earnings or losses of SABMiller plc.

 

18


Consolidated Statements of Earnings

(in millions of dollars, except per share data)

 

for the years ended December 31,

   2008     2007     2006  

Net revenues

   $ 19,356     $ 18,664     $ 18,790  

Cost of sales

     8,270       7,827       7,387  

Excise taxes on products

     3,399       3,452       3,617  
                        

Gross profit

     7,687       7,385       7,786  

Marketing, administration and research costs

     2,753       2,784       3,113  

Asset impairment and exit costs

     449       442       52  

Gain on sale of corporate headquarters building

     (404 )    

(Recoveries) provision (from) for airline industry exposure

       (214 )     103  

Amortization of intangibles

     7      
                        

Operating income

     4,882       4,373       4,518  

Interest and other debt expense, net

     167       205       225  

Loss on early extinguishment of debt

     393      

Equity earnings in SABMiller

     (467 )     (510 )     (460 )
                        

Earnings from continuing operations before income taxes

     4,789       4,678       4,753  

Provision for income taxes

     1,699       1,547       1,571  
                        

Earnings from continuing operations

     3,090       3,131       3,182  

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

     1,840       6,655       8,840  
                        

Net earnings

   $ 4,930     $ 9,786     $ 12,022  
                        

Per share data:

      

Basic earnings per share:

      

Continuing operations

   $ 1.49     $ 1.49     $ 1.52  

Discontinued operations

     0.89       3.17       4.24  
                        

Net earnings

   $ 2.38     $ 4.66     $ 5.76  
                        

Diluted earnings per share:

      

Continuing operations

   $ 1.48     $ 1.48     $ 1.51  

Discontinued operations

     0.88       3.14       4.20  
                        

Net earnings

   $ 2.36     $ 4.62     $ 5.71  
                        

See notes to consolidated financial statements.

 

     
     

 

19


Consolidated Balance Sheets

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

 

at December 31,

   2008    2007

Assets

     

Consumer products

     

Cash and cash equivalents

   $ 7,916    $ 4,842

Receivables (less allowances of $3 in 2008 and 2007)

     44      83

Inventories:

     

Leaf tobacco

     727      861

Other raw materials

     145      160

Finished product

     197      233
             
     1,069      1,254

Current assets of discontinued operations

        14,767

Deferred income taxes

     1,690      1,713

Other current assets

     357      231
             

Total current assets

     11,076      22,890

Property, plant and equipment, at cost:

     

Land and land improvements

     174      171

Buildings and building equipment

     1,678      1,787

Machinery and equipment

     3,122      3,305

Construction in progress

     370      363
             
     5,344      5,626

Less accumulated depreciation

     3,145      3,204
             
     2,199      2,422

Goodwill

     77      76

Other intangible assets, net

     3,039      3,049

Prepaid pension assets

        912

Investment in SABMiller

     4,261      4,495

Long-term assets of discontinued operations

        16,969

Other assets

     1,080      870
             

Total consumer products assets

     21,732      51,683

Financial services

     

Finance assets, net

     5,451      6,029

Other assets

     32      34
             

Total financial services assets

     5,483      6,063
             

Total Assets

   $ 27,215    $ 57,746
             

See notes to consolidated financial statements.

 

     
     

 

20


at December 31,

   2008     2007  

Liabilities

    

Consumer products

    

Current portion of long-term debt

   $ 135     $ 2,354  

Accounts payable

     494       611  

Payable to Philip Morris International Inc.

     16       257  

Accrued liabilities:

    

Marketing

     374       327  

Taxes, except income taxes

     98       70  

Employment costs

     248       283  

Settlement charges

     3,984       3,986  

Other

     1,128       849  

Income taxes

       184  

Dividends payable

     665       1,588  

Current liabilities of discontinued operations

       8,273  
                

Total current liabilities

     7,142       18,782  

Long-term debt

     6,839       1,885  

Deferred income taxes

     351       1,155  

Accrued pension costs

     1,393       198  

Accrued postretirement health care costs

     2,208       1,916  

Long-term liabilities of discontinued operations

       8,065  

Other liabilities

     1,208       1,240  
                

Total consumer products liabilities

     19,141       33,241  

Financial services

    

Long-term debt

     500       500  

Deferred income taxes

     4,644       4,911  

Other liabilities

     102       192  
                

Total financial services liabilities

     5,246       5,603  
                

Total liabilities

     24,387       38,844  

Contingencies (Note 20)

    

Stockholders’ Equity

    

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

     935       935  

Additional paid-in capital

     6,350       6,884  

Earnings reinvested in the business

     22,131       34,426  

Accumulated other comprehensive (losses) earnings

     (2,181 )     111  

Cost of repurchased stock (744,589,733 shares in 2008 and 698,284,555 shares in 2007)

     (24,407 )     (23,454 )
                

Total stockholders’ equity

     2,828       18,902  
                

Total Liabilities and Stockholders’ Equity

   $ 27,215     $ 57,746  
                

 

21


Consolidated Statements of Cash Flows

(in millions of dollars)

 

for the years ended December 31,

   2008     2007     2006  

Cash Provided by (Used in) Operating Activities

      

Earnings from continuing operations — Consumer products

   $ 3,065     $ 2,910     $ 3,059  

— Financial services

     25       221       123  

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

     1,840       6,655       8,840  
                        

Net earnings

     4,930       9,786       12,022  

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

     (1,840 )     (6,655 )     (8,840 )

Adjustments to reconcile net earnings to operating cash flows:

      

Consumer products

      

Depreciation and amortization

     215       232       255  

Deferred income tax provision (benefit)

     121       101       (332 )

Equity earnings in SABMiller

     (467 )     (510 )     (460 )

Dividends from SABMiller

     249       224       193  

Escrow bond for the Engle tobacco case

       1,300    

Escrow bond for the Price tobacco case

         1,850  

Asset impairment and exit costs, net of cash paid

     197       333       7  

Gain on sale of corporate headquarters building

     (404 )    

Loss on early extinguishment of debt

     393      

Income tax reserve reversal

         (1,006 )

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

      

Receivables, net

     (84 )     162       150  

Inventories

     185       375       216  

Accounts payable

     (162 )     (82 )     (105 )

Income taxes

     (201 )     (900 )     (398 )

Accrued liabilities and other current assets

     (27 )     (247 )     (45 )

Accrued settlement charges

     5       434       50  

Pension plan contributions

     (45 )     (37 )     (288 )

Pension provisions and postretirement, net

     192       165       318  

Other

     139       302       299  

Financial services

      

Deferred income tax benefit

     (259 )     (320 )     (238 )

Allowance for losses

     100         103  

Other

     (22 )     (83 )     (102 )
                        

Net cash provided by operating activities, continuing operations

     3,215       4,580       3,649  

Net cash provided by operating activities, discontinued operations

     1,666       5,736       9,937  
                        

Net cash provided by operating activities

     4,881       10,316       13,586  
                          

See notes to consolidated financial statements.

 

     
     

 

22


for the years ended December 31,

   2008     2007     2006  

Cash Provided by (Used in) Investing Activities

      

Consumer products

      

Capital expenditures

   $ (241 )         $ (386 )         $ (399 )

Proceeds from sale of corporate headquarters building

     525      

Purchase of businesses, net of acquired cash

       (2,898 )  

Other

     110       108       (6 )

Financial services

      

Investments in finance assets

     (1 )     (5 )     (15 )

Proceeds from finance assets

     403       486       357  
                        

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

     796       (2,695 )     (63 )

Net cash used in investing activities, discontinued operations

     (317 )     (2,560 )     (555 )
                        

Net cash provided by (used in) investing activities

     479       (5,255 )     (618 )
                        

Cash Provided by (Used in) Financing Activities

      

Consumer products

      

Net issuance of short-term borrowings

       2       1  

Long-term debt proceeds

     6,738      

Long-term debt repaid

     (4,057 )     (500 )     (2,052 )

Financial services

      

Long-term debt repaid

       (617 )     (1,015 )

Repurchase of Altria Group, Inc. common stock

     (1,166 )    

Dividends paid on Altria Group, Inc. common stock

     (4,428 )     (6,652 )     (6,815 )

Issuance of Altria Group, Inc. common stock

     89       423       486  

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

       728       1,369  

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

     3,019       6,560       2,780  

Debt issuance costs

     (46 )    

Tender and consent fees related to the early extinguishment of debt

     (371 )    

Changes in amounts due to/from discontinued operations

     (664 )     (370 )     (166 )

Other

     (51 )     278       164  
                        

Net cash used in financing activities, continuing operations

     (937 )     (148 )     (5,248 )

Net cash used in financing activities, discontinued operations

     (1,648 )     (3,531 )     (9,118 )
                        

Net cash used in financing activities

     (2,585 )     (3,679 )     (14,366 )
                        

Effect of exchange rate changes on cash and cash equivalents

      

Continuing operations

         34  

Discontinued operations

     (126 )     347       126  
                        
     (126 )     347       160  
                        

Cash and cash equivalents, continuing operations:

      

Increase (decrease)

     3,074       1,737       (1,628 )

Balance at beginning of year

     4,842       3,105       4,733  
                        

Balance at end of year

   $ 7,916     $ 4,842     $ 3,105  
                            

Cash paid, continuing operations: 

  Interest   — Consumer products    $ 208     $ 348     $ 377  
                            
    — Financial services    $ 38     $ 62     $ 108  
                            
  Income taxes    $ 1,837     $ 2,241     $ 3,074  
                            

 

23


Consolidated Statements of Stockholders’ Equity

(in millions of dollars, except per share data)

 

     Common
Stock
   Additional
Paid-in
Capital
    Earnings
Reinvested in
the Business
    Accumulated Other
Comprehensive Earnings (Losses)
    Cost of
Repurchased
Stock
    Total
Stockholders’
Equity
 
            Currency
Translation
Adjustments
    Other     Total      

Balances, January 1, 2006

   $ 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 )

Ownership share of SABMiller other comprehensive earnings, and other

              159       159         159  
                       

Total other comprehensive earnings

                    1,601  
                       

Total comprehensive earnings

                    13,623  
                       

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 )     (3,541 )     (3,638 )     (23,743 )     39,789  

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 )

Ownership share of SABMiller other comprehensive earnings

              178       178         178  
                       

Total other comprehensive earnings

                    1,640  
                       

Total comprehensive earnings

                    11,426  
                       

Adoption of FIN 48 and FAS 13-2

          711               711  

Exercise of stock options and issuance of other stock awards

        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       (617 )     111       (23,454 )     18,902  

Comprehensive earnings:

                 

Net earnings

          4,930               4,930  

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

                 

Currency translation adjustments

            233         233         233  

Change in net loss and prior service cost

              (1,385 )     (1,385 )       (1,385 )

Change in fair value of derivatives accounted for as hedges

              (177 )     (177 )       (177 )

Ownership share of SABMiller other comprehensive losses

              (308 )     (308 )       (308 )
                       

Total other comprehensive losses

                    (1,637 )
                       

Total comprehensive earnings

                    3,293  
                       

Exercise of stock options and issuance of other stock awards

        (534 )             213       (321 )

Cash dividends declared ($1.68 per share)

          (3,505 )             (3,505 )

Stock repurchased

                  (1,166 )     (1,166 )

Spin-off of Philip Morris International Inc.

          (13,720 )     (961 )     306       (655 )       (14,375 )
                                                               

Balances, December 31, 2008

   $ 935    $ 6,350     $ 22,131     $ —       $ (2,181 )   $ (2,181 )   $ (24,407 )   $ 2,828  
                                                               

See notes to consolidated financial statements.

 

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Notes to Consolidated Financial Statements

Note 1.

Background and Basis of Presentation:

• Background: At December 31, 2008, Altria Group, Inc.’s wholly-owned subsidiaries included 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 Co. (“Middleton”), which is engaged in the manufacture and sale of machine-made large cigars and pipe tobacco. Philip Morris Capital Corporation (“PMCC”), another wholly-owned subsidiary, maintains a portfolio of leveraged and direct finance leases. In addition, Altria Group, Inc. held a 28.5% economic and voting interest in SABMiller plc (“SABMiller”) at December 31, 2008. Altria Group, Inc.’s access to the operating cash flows of its subsidiaries consists principally of cash received from the payment of dividends by its subsidiaries.

UST Acquisition: As further discussed in Note 23. Subsequent Events, on January 6, 2009, Altria Group, Inc. acquired all of the outstanding common stock of UST Inc. (“UST”), which owns operating companies engaged in the manufacture and sale of moist smokeless tobacco products and wine. As a result of the acquisition, UST has become an indirect wholly-owned subsidiary of Altria Group, Inc.

PMI Spin-Off: On March 28, 2008 (the “PMI Distribution Date”), Altria Group, Inc. distributed all of its interest in Philip Morris International Inc. (“PMI”) to Altria Group, Inc. stock-holders of record as of the close of business on March 19, 2008 (the “PMI Record Date”), 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 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. has reflected the results of PMI prior to the PMI 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 PMI were reclassified and reflected as discontinued operations on the consolidated balance sheet at December 31, 2007. The distribution resulted in a net decrease to Altria Group, Inc.’s stockholders’ equity of $14.4 billion on the PMI Distribution 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 was 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).

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 held 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 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 held 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. The reimbursement to PMI is reflected as a decrease to the additional paid-in capital of Altria Group, Inc. on the December 31, 2008 consolidated balance sheet.

 

25


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 Altria Group, Inc. Altria Group, Inc. reimbursed PMI in cash for these liabilities. See Note 14. Income Taxes for a discussion of the Tax Sharing Agreement between Altria Group, Inc. and PMI.

Prior to the PMI spin-off, certain employees of PMI participated in the U.S. benefit plans offered by Altria Group, Inc. The benefits previously provided by Altria Group, Inc. are now 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. Altria Group, Inc. paid PMI in cash for these transfers.

A subsidiary of Altria Group, Inc. 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 ceased in 2008. The settlement of the inter-company accounts as of the PMI Distribution Date (including amounts related to stock awards, tax contingencies and benefit plans discussed above) 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.

Kraft Spin-Off: On March 30, 2007 (the “Kraft Distribution Date”), Altria Group, Inc. distributed all of its remaining interest in Kraft Foods Inc. (“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. Altria Group, Inc. has 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 the years ended December 31, 2007 and 2006. The distribution resulted in a net decrease to Altria Group, Inc.’s stockholders’ equity of $27.4 billion on the Kraft Distribution 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 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 is 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.

Prior to the Kraft spin-off, Kraft was included in the Altria Group, Inc. consolidated federal income tax return, and Kraft’s federal income tax contingencies were recorded as liabilities on the balance sheet of Altria Group, Inc. Altria Group, Inc. reimbursed Kraft in cash for these liabilities. See Note 14. Income Taxes for a discussion of the Tax Sharing Agreement between Altria Group, Inc. and Kraft.

A subsidiary of Altria Group, Inc. previously provided Kraft with certain services at cost plus a management fee. After the Kraft Distribution Date, Kraft independently undertook most of these activities, and any remaining limited services provided to Kraft ceased during 2007. All intercompany

 

26


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

Dividends and Share Repurchases: Following the Kraft spin-off, Altria Group, Inc. lowered its dividend so that holders of both Altria Group, Inc. and Kraft shares would receive initially, in the aggregate, the same dividends paid by Altria Group, Inc. prior to the Kraft spin-off. Similarly, following the PMI spin-off, Altria Group, Inc. lowered its dividend so that holders of both Altria Group, Inc. and PMI shares would receive initially, in the aggregate, the same dividends paid by Altria Group, Inc. prior to the PMI spin-off.

During the third quarter of 2008, Altria Group, Inc.’s Board of Directors approved a 10.3% increase in the quarterly dividend rate from $0.29 per common share to $0.32 per common share. The present annualized dividend rate is $1.28 per Altria Group, Inc. common share. Payments of dividends remain subject to the discretion of the Board of Directors.

During 2008, Altria Group, Inc. repurchased 53.5 million shares of its common stock at an aggregate cost of approximately $1.2 billion, or an average price of $21.81 per share. Altria Group, Inc.’s share repurchase program is at the discretion of the Board of Directors.

Basis of presentation: The consolidated financial statements include Altria Group, Inc., as well as its wholly-owned subsidiaries. Investments in which Altria Group, Inc. 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 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.

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 Middleton 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. Accordingly, prior period segment results have been revised.

During the fourth quarter of 2008, Altria Group, Inc. identified that it had not recorded its share of other comprehensive earnings or losses of SABMiller. This resulted in a non-cash $535 million and $187 million understatement of the investment in SABMiller and long-term deferred income taxes, respectively, as of December 31, 2007 and a $348 million and $170 million overstatement of accumulated other comprehensive losses as of December 31, 2007 and 2006, respectively. Additionally, total comprehensive earnings was understated by $178 million and $170 million for the years ended December 31, 2007 and 2006, respectively. The impact for all years prior to 2006 was de minimis and therefore the consolidated financial statements for those years have not been revised. There is no impact to reported earnings from continuing operations, net earnings, earnings per share or cash flows. We assessed the materiality of the revisions on the 2007 and 2006 financial statements in accordance with the Securities and Exchange Commission’s (“SEC”) Staff Accounting Bulletin No. 99 “Materiality” and concluded that the impact was not material to those periods. We also concluded that had the cumulative adjustment as of December 31, 2007 been made to the 2008 consolidated financial statements, the impact would have been material. Therefore, in accordance with the SEC’s Staff Accounting Bulletin No. 108 “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”, the consolidated balance sheet as of December 31, 2007 and the consolidated statements of stockholders’ equity for the years ended December 31, 2007 and 2006 herein have been corrected.

Certain prior year amounts have been reclassified to conform with the current year’s presentation, due primarily to the classification of PMI as a discontinued operation and revised segment information.

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. Cash equivalents are stated at cost plus accrued interest, which approximates fair value.

• 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 non-amortizable 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

 

     
     

 

27


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 2008 and 2007, Altria Group, Inc. completed its annual review of goodwill and non-amortizable intangible assets, and no charges resulted from these reviews.

Goodwill and other intangible assets, net, by segment were as follows:

 

     Goodwill    Other Intangible Assets, net

(in millions)

   December 31,
2008
   December 31,
2007
   December 31,
2008
   December 31,
2007

Cigarettes and other tobacco products

   $ —      $ —      $ 283    $ 283

Cigars

     77      76      2,756      2,766
                           

Total

   $ 77    $ 76    $ 3,039    $ 3,049
                           

Intangible assets were as follows:

 

     December 31, 2008    December 31, 2007

(in millions)

   Gross
Carrying
Amount
   Accumulated
Amortization
   Gross
Carrying
Amount
   Accumulated
Amortization

Non-amortizable intangible assets

   $ 2,642       $ 2,894   

Amortizable intangible assets

     404    $ 7      155    $ —  
                           

Total intangible assets

   $ 3,046    $ 7    $ 3,049    $ —  
                           

Non-amortizable intangible assets substantially consist of trademarks from the December 2007 acquisition of Middleton. Amortizable intangible assets consist primarily of customer relationships. Pre-tax amortization expense for intangible assets during the year ended December 31, 2008 was $7 million. There was no pre-tax amortization expense for intangible assets during the years ended December 31, 2007 and 2006. In the fourth quarter of 2008, due to a change in estimated useful life, $281 million of non-amortizable intangible assets were reclassified to amortizable intangible assets. Annual amortization expense for each of the next five years is estimated to be approximately $20 million, excluding any impact from the UST acquisition and assuming no additional transactions occur that require the amortization of intangible assets. Based on the preliminary estimates of definite life intangible assets acquired from the UST acquisition, amortization resulting from the acquisition is expected to approximate $20 million annually.

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

 

     2008     2007

(in millions)

   Goodwill    Other
Intangible
Assets
    Goodwill    Other
Intangible
Assets

Balance at January 1

   $ 76    $ 3,049     $ —      $ 283

Changes due to:

          

Acquisition of Middleton

          76      2,766

Purchase price revisions

     1      (3 )     
                            

Balance at December 31

   $ 77    $ 3,046     $ 76    $ 3,049
                            

The changes in goodwill and intangible assets during 2008 resulted from revisions to the purchase price allocation as appraisals for the acquisition of Middleton were finalized during the first quarter of 2008. See Note 5. Acquisitions for a further discussion of the Middleton 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 subsidiaries of Altria Group, Inc. may undertake in the future, in the opinion of management, environmental remediation and compliance costs 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. 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. There were no adjustments in 2008.

 

28


Foreign currency translation: Altria Group, Inc. translated the results of operations of its foreign subsidiaries using average exchange rates during each period, whereas balance sheet accounts were translated using exchange rates at the end of each period. Currency translation adjustments were recorded as a component of stockholders’ equity. The accumulated currency translation adjustments were recognized and recorded in connection with the Kraft and PMI distributions. Transaction gains and losses were 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.” FASB 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 20. 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. At December 31, 2008, Altria Group, Inc. had no derivative financial instruments remaining.

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.

On January 1, 2007, Altria Group, Inc. adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 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.

Marketing costs: The consumer products businesses 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. Payments received in advance of shipments are deferred and recorded in other accrued

 

29


liabilities until shipment occurs. Altria Group, Inc.’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.

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, and the resulting gross cumulative effect was recorded in marketing, administration and research costs for the year ended December 31, 2006.

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) generally 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, as well as costs to restructure the acquired entity, are to be recognized as expenses in the periods in which the costs are incurred. As discussed in Note 23. Subsequent Events, Altria Group, Inc. closed its acquisition of UST on January 6, 2009. Accordingly, the acquisition will be accounted for under SFAS No. 141(R).

Additionally, in December 2007, the FASB issued SFAS No. 160 “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”). SFAS 160 changes the reporting for 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 will be applied retrospectively for all periods presented. In compliance with SFAS 160, in 2009 Altria Group, Inc. will (i) adjust earnings from discontinued operations to include $61 million, $351 million and $623 million of net earnings attributable to noncontrolling interests for the years ended December 31, 2008, 2007 and 2006, respectively; (ii) disclose the net earnings attributable to the noncontrolling interests and net earnings attributable to Altria Group, Inc. on the consolidated statements of earnings and (iii) reclassify to stockholders’ equity $418 million of noncontrolling interests reported at December 31, 2007 as long-term liabilities of discontinued operations. Altria Group, Inc. had no noncontrolling interests at December 31, 2008.

In June 2008, the FASB issued FASB Staff Position No. EITF 03-6-1 “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“FSP EITF 03-6-1”). FSP EITF 03-6-1 states that unvested share-based payment awards that contain nonforfeitable rights to dividends are participating securities and therefore will be included in the earnings per share calculation pursuant to the two class method described in SFAS No. 128, “Earnings Per Share.” FSP EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and requires all prior-period earnings per share data to be adjusted retrospectively. As required by FSP EITF 03-6-1, in 2009 Altria Group, Inc.’s basic earnings per share from discontinued operations and basic earnings per share from net earnings will each decrease by $0.01, $0.02 and $0.02 for the years ended December 31, 2008, 2007 and 2006, respectively. Basic earnings per share from continuing operations for the years ended December 31, 2008, 2007 and 2006 will remain unchanged. In addition, as required by FSP EITF 03-6-1, in 2009 Altria Group, Inc.’s diluted earnings per share from discontinued operations and diluted earnings per share from net earnings will each decrease by $0.01 for the year ended December 31, 2006. Diluted earnings per share from continuing operations for the year ended December 31, 2006 will remain unchanged. Diluted earnings per share for the years ended December 31, 2008 and 2007 will remain unchanged.

In November 2008, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 08-6, “Equity Method Investment Accounting Considerations” (“EITF 08-6”). EITF 08-6 addresses the initial measurement of an equity method investment, the impairment assessment of an underlying indefinite-lived intangible asset of an equity method investment, and the accounting for changes in the level of ownership or the degree of influence caused by a share issuance by an investee. EITF 08-6 is effective on a prospective basis in fiscal years beginning on or after December 15, 2008, and interim periods within those fiscal years. Earlier application by an entity that has previously adopted an alternative accounting policy is not permitted. With the adoption of EITF 08-6, Altria Group, Inc. will account for a share issuance by an equity method investee as if it had sold a proportionate share of its investment and recognize any resulting gain or loss in earnings.

In November 2008, the FASB ratified EITF Issue No. 08-7, “Accounting for Defensive Intangible Assets” (“EITF 08-7”). EITF 08-7 addresses the accounting for defensive intangible assets subsequent to initial measurement. A defensive intangible asset is an intangible asset acquired in a business combination or asset acquisition that an entity does not intend to actively use. EITF 08-7 is effective for intangible assets acquired on or after the beginning of the first annual

 

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reporting period beginning on or after December 15, 2008. The adoption of EITF 08-7 could impact Altria Group, Inc.’s accounting for future acquisitions. However, Altria Group, Inc. does not anticipate that EITF 08-7 will impact the accounting for the acquisition of UST.

In December 2008, the FASB issued FASB Staff Position No. FAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets” (“FSP FAS 132(R)-1”). FSP FAS 132(R)-1 will expand the disclosures regarding investments held by employer defined benefit pension plans and other postretirement plans, with the purpose of providing additional information related to the valuation methodologies for these assets similar to SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). Additionally, FSP FAS 132(R)-1 will require disclosures on how investment allocation decisions are made as well as significant concentrations of risk within plan assets. FSP FAS 132(R)-1 is effective for financial statements issued for fiscal years ending after December 15, 2009. Altria Group, Inc. will amend its disclosures accordingly.

Note 3.

Asset Impairment and Exit Costs:

For the years ended December 31, 2008, 2007 and 2006, pre-tax asset impairment and exit costs consisted of the following:

 

(in millions)

        2008    2007    2006

Separation programs

   Cigarettes and other tobacco products    $ 97    $ 309    $ 10

Separation program

   Financial services      2      

Separation program

   General corporate      295      17      32
                       

Total separation programs

        394      326      42
                       

Asset impairment

   Cigarettes and other tobacco products         35   

Asset impairment

   General corporate            10
                       

Total asset impairment

        —        35      10
                       

Spin-off fees

   General corporate      55      81      —  
                       

Asset impairment and exit costs

      $ 449    $ 442    $ 52
                       

The movement in the severance liability, and details of asset impairment and exit costs for Altria Group, Inc. for the years ended December 31, 2008 and 2007 was as follows:

 

(in millions)

   Severance     Asset
Write-downs
    Other     Total  

Severance liability balance,

        

January 1, 2007

   $ 21     $ —       $ —       $ 21  

Charges

     281       35       126       442  

Cash spent

     (20 )       (89 )     (109 )

Charges against assets

       (35 )       (35 )

Liability recorded in pension and postretirement plans, and other

     (3 )       (37 )     (40 )
                                

Severance liability balance,

        

December 31, 2007

     279       —         —         279  

Charges, net

     216         233       449  

Cash spent

     (149 )       (103 )     (252 )

Liability recorded in pension and postretirement plans, and other

     2         (130 )     (128 )
                                

Severance liability balance,

        

December 31, 2008

   $ 348     $ —       $ —       $ 348  
                                

Other charges in the table above primarily represent pension and postretirement termination benefits, as well as Kraft and PMI spin-off fees. Charges, net in the table above include the reversal of $14 million of severance associated with the Manufacturing Optimization Program.

Integration and Restructuring Program

In December 2008, Altria Group, Inc. initiated a company-wide integration and restructuring program, pursuant to which, over the next two years Altria Group, Inc. expects to restructure its manufacturing and corporate functions as it integrates UST into its operations and continues to focus on optimizing company-wide cost structures.

As part of this program, Altria Group, Inc., PM USA and PMCC began to reorganize certain of their functions. This restructuring resulted in pre-tax charges of $76 million, $48 million and $2 million, respectively, for the year ended December 31, 2008, consisting primarily of employee separation costs. Substantially all of these charges will result in cash expenditures. There were no cash payments related to this restructuring for the year ended December 31, 2008.

Corporate Restructuring and Headquarters Relocation

During 2008, in connection with the spin-off of PMI, which included the relocation of Altria Group, Inc.’s corporate headquarters functions to Richmond, Virginia, Altria Group, Inc. restructured its corporate headquarters and incurred pre-tax charges of $219 million for the year ended December 31, 2008. These charges consisted primarily of employee separation costs. Substantially all of these charges will result in cash expenditures. Cash payments of $136 million related to this restructuring were made for the year ended December 31, 2008.

 

     
     

 

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For the years ended December 31, 2008 and 2007, corporate asset impairment and exit costs also included investment banking and legal fees associated with the PMI and Kraft spin-offs, as well as the streamlining of various corporate functions in 2007 and 2006.

Manufacturing Optimization Program

PM USA is in the process of closing its Cabarrus, North Carolina manufacturing facility and consolidating cigarette manufacturing for the U.S. market at its Richmond, Virginia manufacturing center. PM USA decided in 2007 to consolidate its manufacturing in response to declining U.S. cigarette volume and notice from PMI that it would no longer source cigarettes from PM USA. PM USA’s cigarette production for PMI, which ended in December 2008, approximated 21 billion and 57 billion cigarettes in 2008 and 2007, respectively. PM USA expects to close its Cabarrus manufacturing facility by the end of 2010.

As a result of this program, from 2007 through 2010, PM USA expects to incur total pre-tax charges of approximately $670 million, comprised of accelerated depreciation of $184 million (including the asset impairment charge of $35 million recorded in 2007), employee separation costs of $342 million and other charges of $144 million, primarily related to the relocation of employees and equipment, net of estimated gains on sales of land and buildings. Approximately $400 million, or 60% of the total pre-tax charges, will result in cash expenditures.

PM USA recorded pre-tax charges for this program as follows:

 

     For the Years Ended
December 31,
     2008    2007

Asset impairment and exit costs

   $ 49    $ 344

Implementation costs

     69      27
             

Total

   $ 118    $ 371
             

The pre-tax implementation costs were primarily related to accelerated depreciation and were included in cost of sales in the consolidated statements of earnings for the years ended December 31, 2008 and 2007. Total pre-tax charges incurred since the inception of the program were $489 million. Pre-tax charges of approximately $180 million are expected during 2009 for the program. Cash payments related to the program of $85 million and $11 million were made during the years ended December 31, 2008 and 2007, respectively, for a total of $96 million since inception.

Note 4.

Divestitures:

As discussed in Note 1. Background and Basis of Presentation, on March 28, 2008, Altria Group, Inc. distributed all of its interest in PMI to Altria Group, Inc. stockholders in a tax-free distribution, and 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.

Summarized financial information for discontinued operations for the years ended December 31, 2008, 2007 and 2006 were as follows:

 

                 2008  

(in millions)

               PMI  

Net revenues

       $ 15,376  
            

Earnings before income taxes and minority interest

       $ 2,701  

Provision for income taxes

         (800 )

Minority interest in earnings from discontinued operations

         (61 )
            

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

       $ 1,840  
            
     2007  

(in millions)

   PMI     Kraft     Total  

Net revenues

   $ 55,137     $ 8,586     $ 63,723  
                        

Earnings before income taxes and minority interest

   $ 8,852     $ 1,059     $ 9,911  

Provision for income taxes

     (2,549 )     (356 )     (2,905 )

Minority interest in earnings from discontinued operations

     (273 )     (78 )     (351 )
                        

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

   $ 6,030     $ 625     $ 6,655  
                        
     2006  

(in millions)

   PMI     Kraft     Total  

Net revenues

   $ 48,261     $ 34,356     $ 82,617  
                        

Earnings before income taxes and minority interest

   $ 8,227     $ 4,016     $ 12,243  

Provision for income taxes

     (1,829 )     (951 )     (2,780 )

Minority interest in earnings from discontinued operations

     (251 )     (372 )     (623 )
                        

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

   $ 6,147     $ 2,693     $ 8,840  
                        

 

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Summarized assets and liabilities of discontinued operations for PMI as of December 31, 2007 were as follows:

 

(in millions)

   2007

Assets:

  

Cash and cash equivalents

   $ 1,656

Receivables, net

     3,240

Inventories

     9,317

Other current assets

     554
      

Current assets of discontinued operations

     14,767
      

Property, plant and equipment, net

     6,435

Goodwill

     7,925

Other intangible assets, net

     1,904

Prepaid pension assets

     408

Other assets

     297
      

Long-term assets of discontinued operations

     16,969
      

Liabilities:

  

Short-term borrowings

     638

Current portion of long-term debt

     91

Accounts payable

     595

Accrued liabilities

     6,479

Income taxes

     470
      

Current liabilities of discontinued operations

     8,273
      

Long-term debt

     5,578

Deferred income taxes

     1,214

Accrued pension costs

     190

Other liabilities

     1,083
      

Long-term liabilities of discontinued operations

     8,065
      

Net Assets

   $ 15,398
      

Note 5.

Acquisitions:

On December 11, 2007, Altria Group, Inc. acquired 100% of Middleton, a leading manufacturer of machine-made large cigars and pipe tobacco, for $2.9 billion in cash. The acquisition was financed with existing cash. Middleton’s balance sheet was 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, were included in Altria Group, Inc.’s consolidated operating results.

During the first quarter of 2008, the allocation of purchase price relating to the acquisition of Middleton was completed. 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.

As further discussed in Note 23. Subsequent Events, on January 6, 2009, Altria Group, Inc. acquired all of the outstanding common stock of UST, which owns operating companies engaged in the manufacture and sale of moist smokeless tobacco products and wine.

Note 6.

Inventories:

The cost of approximately 94% of inventories in 2008 and 2007 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, 2008 and 2007.

Note 7.

Investment in SABMiller:

At December 31, 2008, Altria Group, Inc. held a 28.5% economic and voting interest in SABMiller. Altria Group, Inc.’s investment in SABMiller is being accounted for under the equity method.

Summary financial data of SABMiller is as follows:

 

          At December 31,

(in millions)

        2008    2007

Current assets

      $ 4,266    $ 4,225

Long-term assets

      $ 30,007    $ 29,803

Current liabilities

      $ 5,403    $ 5,718

Long-term liabilities

      $ 12,170    $ 10,773

Non-controlling interests

      $ 660    $ 599
     For the Years Ended December 31,

(in millions)

   2008    2007    2006

Net revenues

   $ 20,466    $ 20,825    $ 18,103

Operating profit

   $ 2,854    $ 3,230    $ 2,990

Net earnings

   $ 1,635    $ 1,865    $ 1,588

The fair value, based on market quotes, of Altria Group, Inc.’s equity investment in SABMiller at December 31, 2008, was $7.3 billion, as compared with its carrying value of $4.3 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 $4.5 billion.

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 2008, 2007 and 2006, proceeds from asset sales, maturities and bankruptcy recoveries totaled $403 million, $486 million and $357 million, respectively, and gains totaled $87 million, $274 million and $132 million, respectively, in operating companies income.

 

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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, 2008, finance assets, net, of $5,451 million were comprised of an investment in finance leases of $5,743 million and an other receivable of $12 million, reduced by the allowance for losses of $304 million. At December 31, 2007, finance assets, net, of $6,029 million were comprised of an investment in finance leases of $6,221 million and an other receivable of $12 million, reduced by the allowance for losses of $204 million.

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

 

     Leveraged Leases     Direct Finance Leases     Total  

(in millions)

   2008     2007     2008     2007     2008     2007  

Rentals receivable, net

   $ 6,001     $ 6,628     $ 324     $ 371     $ 6,325     $ 6,999  

Unguaranteed residual values

     1,459       1,499       89       89       1,548       1,588  

Unearned income

     (2,101 )     (2,327 )     (26 )     (30 )     (2,127 )     (2,357 )

Deferred investment tax credits

     (3 )     (9 )         (3 )     (9 )
                                                

Investment in finance leases

     5,356       5,791       387       430       5,743       6,221  

Deferred income taxes

     (4,577 )     (4,790 )     (180 )     (196 )     (4,757 )     (4,986 )
                                                

Net investment in finance leases

   $ 779     $ 1,001     $ 207     $ 234     $ 986     $ 1,235  
                                                

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 $11.5 billion and $12.8 billion at December 31, 2008 and 2007, respectively, has been offset against the related rentals receivable. There were no leases with contingent rentals in 2008, 2007 and 2006.

At December 31, 2008, PMCC’s investment in finance leases was principally comprised of the following investment categories: electric power (27%), rail and surface transport (24%), aircraft (24%), manufacturing (14%), and real estate (11%). Investments located outside the United States, which are all U.S. dollar-denominated, represent 23% and 21% of PMCC’s investment in finance leases in 2008 and 2007, respectively.

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, 2008, were as follows:

 

(in millions)

   Leveraged
Leases
   Direct
Finance
Leases
   Total

2009

   $ 193    $ 48    $ 241

2010

     197      45      242

2011

     105      50      155

2012

     191      50      241

2013

     240      50      290

2014 and thereafter

     5,075      81      5,156
                    

Total

   $ 6,001    $ 324    $ 6,325
                    

Included in net revenues for the years ended December 31, 2008, 2007 and 2006, were leveraged lease revenues of $210 million, $163 million and $301 million, respectively, and direct finance lease revenues of $5 million, $15 million and $8 million, respectively. Income tax expense on leveraged lease revenues for the years ended December 31, 2008, 2007 and 2006, was $72 million, $57 million and $107 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, 2008, 2007 and 2006.

The activity in the allowance for losses on finance assets for the years ended December 31, 2008, 2007 and 2006 was as follows:

 

(in millions)

   2008    2007     2006  

Balance at beginning of year

   $ 204    $ 480     $ 596  

Amounts charged to earnings/(recovered)

     100      (129 )     103  

Amounts written-off

        (147 )     (219 )
                       

Balance at end of year

   $ 304    $ 204     $ 480  
                       

During 2008, PMCC increased its allowance for losses by $100 million primarily as a result of credit rating downgrades of certain lessees and financial market conditions. PMCC continues to monitor economic and credit conditions and may have to increase its allowance for losses if such conditions worsen.

The net impact to the allowance for losses for 2007 and 2006 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 in 2007, 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. Acceleration of taxes on

 

34


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 2008.

PMCC’s portfolio remains diversified by lessee, industry segment and asset type. As of December 31, 2008, 74% of PMCC’s lessees were investment grade as measured by Moody’s Investor Services and Standard & Poor’s. Excluding aircraft lease investments, 86% of PMCC’s lessees were investment grade. All of PMCC’s lessees are current on their lease obligations.

In 2008, the credit ratings of Ambac Assurance Corporation (“Ambac”) and American International Group, Inc. (“AIG”) were downgraded by Moody’s Investor Services and Standard & Poor’s. Ambac and AIG provided initial credit support on various structured lease transactions entered into by PMCC, which involved the financing of core operating assets to creditworthy lessees. The credit rating downgrades of Ambac and AIG triggered requirements for the lessees to post collateral or replace Ambac and AIG as credit support providers in these transactions. Additional collateral has been posted for one transaction, and AIG credit support was replaced on two transactions. Two leases were sold, one subsequent to December 31, 2008, and PMCC is engaged in discussions with two lessees to replace Ambac as credit support on the remaining leases.

In 2007, a guarantor (Calpine Corporation) of a lease was operating under bankruptcy protection, but emerged in February 2008. The lease was not included in the bankruptcy filing and not affected by the guarantor’s bankruptcy. With the emergence of Calpine Corporation from bankruptcy, there are no PMCC lessees or guarantors under bankruptcy protection.

As discussed in Note 20. Contingencies, 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, 2008 and 2007, Altria Group, Inc. had no short-term borrowings.

At December 31, 2008, the credit lines for Altria Group, Inc. and related activity were as follows:

 

     December 31, 2008

(in billions)

Type

   Credit
Lines
   Amount
Drawn
   Commercial
Paper
Outstanding
   Lines
Available

364-day bridge

   $ 4.3    $ —      $ —      $ 4.3

Multi-year facility

     3.5            3.5
                           
   $ 7.8    $ —      $ —      $ 7.8
                           

At December 31, 2008, Altria Group, Inc. had in place a multi-year revolving credit facility as amended on December 19, 2008 (as amended the “Revolving Facility”) in the amount of $3.5 billion, which expires April 15, 2010. The Revolving Facility requires Altria Group, Inc. to maintain a ratio of earnings before interest, taxes, depreciation and amortization (“EBITDA”) to interest expense (as defined in the Revolving Facility) of not less than 4.0 to 1.0 and, pursuant to the December 19, 2008 amendment, requires the maintenance of a ratio of debt to EBITDA (as defined in the Revolving Facility) of not more than 3.0 to 1.0 (prior to the amendment, such ratio was 2.5 to 1.0). At December 31, 2008, the ratios of EBITDA to interest expense, and debt to EBITDA, calculated in accordance with the agreement, were 17.6 to 1.0 and 1.4 to 1.0, respectively.

The Revolving Facility is used to support the issuance of commercial paper and to fund short-term cash needs when the commercial paper market is unavailable. At December 31, 2008, Altria Group, Inc. had no commercial paper outstanding and no borrowings under the Revolving Facility.

In connection with the acquisition of UST, in September 2008, Altria Group, Inc. entered into a commitment letter with certain financial institutions to provide up to $7.0 billion under a 364-day term bridge loan facility (the “Bridge Facility”). The commitment letter required that commitments under the Bridge Facility be reduced by an amount equal to 100% of the net proceeds of certain capital markets financing transactions, certain credit facility borrowings and certain asset sales in excess of $4.0 billion. As a result of Altria Group, Inc.’s November 2008 issuance of $6.0 billion in long-term notes (See Note 10. Long-Term Debt), commitments under the Bridge Facility were reduced by $1.9 billion to $5.1 billion. On December 19, 2008, Altria Group, Inc. entered into a definitive agreement for the Bridge Facility. Upon Altria Group, Inc.’s subsequent December 2008 issuance of $0.8 billion in long-term notes, commitments under the Bridge Facility were further reduced to $4.3 billion. On January 6, 2009, Altria Group, Inc. made its initial borrowing under the Bridge Facility in the amount of $4.3 billion, the full amount available for borrowing. The proceeds of this borrowing were used to fund in part the acquisition of UST. The Bridge Facility will expire in January 2010.

The Bridge Facility requires Altria Group, Inc. to maintain the same financial ratios as noted above for the Revolving Facility. The Bridge Facility requires prepayment of outstanding borrowings by an amount equal to 100% of the net proceeds of certain specified capital markets financing transactions, certain credit facility borrowings and certain asset sales.

Pricing under both the Revolving Facility and the Bridge Facility is modified in the event of a change in Altria Group, Inc.’s credit rating. Certain fees and interest rate adjustments are required under the Bridge Facility in the event borrowings under that facility are not refinanced within specified periods of time following the closing of the acquisition of UST. Altria Group, Inc. does not anticipate having to pay pricing changes or fees that would be material. Neither facility includes any other rating triggers; nor does either facility contain any provisions that could require the posting of collateral.

In January 2008, Altria Group, Inc. entered into a $4.0 billion 364-day bridge loan facility. The amount of Altria Group, Inc.’s borrowing capacity under that facility was reduced automatically by an amount equal to 100% of the net proceeds of any capital markets financing transaction.

 

35


In November 2008, this bridge loan facility expired in accordance with its terms upon receipt of the net proceeds from the issuance of $6.0 billion of long-term notes described in Note 10. Long-Term Debt.

Altria Group, Inc. expects to continue to meet its covenants associated with its credit facilities.

As discussed in Note 21. Condensed Consolidating Financial Information, borrowings under Altria Group, Inc.’s credit facilities are fully and unconditionally guaranteed by PM USA.

Note 10.

Long-Term Debt:

At December 31, 2008 and 2007, Altria Group, Inc.’s long-term debt consisted of the following:

 

(in millions)

   2008     2007  

Consumer products:

    

Notes, 7.00% to 9.95% (average interest rate 9.2%), due through 2038

   $ 6,797     $ 1,850  

Debenture, 7.75% due 2027

     42       750  

Foreign currency obligation:

    

Euro, 5.63% due 2008

       1,503  

Other

     135       136  
                
     6,974       4,239  

Less current portion of long-term debt

     (135 )     (2,354 )
                
   $ 6,839     $ 1,885  
                

Financial services:

    

Eurodollar bonds, 7.50%, due 2009

   $ 500     $ 500  
                

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

 

(in millions)

   Consumer Products    Financial Services

2009

   $ 135    $ 500

2010

     775   

2013

     1,459   

2018

     3,100   

2027

     42   

2038

     1,500   

The aggregate fair value, based substantially on readily available quoted market prices, of Altria Group, Inc.’s long-term debt at December 31, 2008, was $8.6 billion, as compared with its carrying value of $7.5 billion. The aggregate fair value, based on market quotes, of Altria Group, Inc.’s long-term debt at December 31, 2007, was $5.0 billion, as compared with its carrying value of $4.7 billion.

As discussed in Note 21. Condensed Consolidating Financial Information, substantially all long-term debt of Altria Group, Inc. is fully and unconditionally guaranteed by PM USA.

Debt Issued:

Altria Group, Inc. issued $6.0 billion of senior unsecured long-term notes in November 2008 and $775 million of senior unsecured long-term notes in December 2008 (collectively, the “Notes”), which are included in the tables above. As discussed further in Note 23. Subsequent Events, the net proceeds from the issuances of the Notes ($6.7 billion) were used along with borrowings under the Bridge Facility to finance the acquisition of UST on January 6, 2009.

The Notes are Altria Group, Inc.’s senior unsecured obligations and rank equally in right of payment with all of Altria Group, Inc.’s existing and future senior unsecured indebtedness. The interest rate payable on each series of Notes is subject to adjustment from time to time if the rating assigned to the Notes of such series by Moody’s Investors Service, Inc. or Standard & Poor’s Ratings Services is downgraded (or subsequently upgraded) as and to the extent set forth in the terms of the Notes. Upon the occurrence of both (i) a change of control of Altria Group, Inc. and (ii) the Notes ceasing to be rated investment grade by each of Moody’s Investors Service, Inc., Standard & Poor’s Ratings Services and Fitch Ratings within a specified time period, Altria Group, Inc. will be required to make an offer to purchase the Notes of each series at a price equal to 101% of the aggregate principal amount of such series, plus accrued interest to the date of repurchase as and to the extent set forth in the terms of the Notes.

The obligations of Altria Group, Inc. under the Notes are fully and unconditionally guaranteed by PM USA. See Note 21. Condensed Consolidating Financial Information. The Notes contain the following terms:

November Issuance

 

   

$1.4 billion at 8.50%, due 2013, interest payable semi-annually beginning May 2009

 

   

$3.1 billion at 9.70%, due 2018, interest payable semi-annually beginning May 2009

 

   

$1.5 billion at 9.95%, due 2038, interest payable semi-annually beginning May 2009

December Issuance

 

   

$0.8 billion at 7.125%, due 2010, interest payable semi-annually beginning June 2009

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.

As a result of the tender offers and consent solicitations, Altria Group, Inc. recorded a pre-tax loss of $393 million, which included tender and consent fees of $371 million, on the early extinguishment of debt in the first quarter of 2008.

 

36


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, 2006

   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  

Exercise of stock options and issuance of other stock awards

      7,144,822     7,144,822  

Repurchased

      (53,450,000 )   (53,450,000 )
                 

Balances, December 31, 2008

   2,805,961,317    (744,589,733 )   2,061,371,584  
                 

At December 31, 2008, 69,562,518 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 Stock Compensation Plan for Non-Employee Directors (the “2005 Directors Plan”). Shares available to be granted under the 2005 Plan and the 2005 Directors Plan at December 31, 2008 were 41,620,706 and 901,957, respectively.

As more fully described in Note 1. Background and Basis of Presentation, during 2008 certain modifications were made to stock options, restricted stock and deferred stock as a result of the PMI spin-off. In addition, similar modifications were made during 2007 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 Executive Ownership Stock Options (“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. During the years ended December 31, 2007 and 2006, Altria Group, Inc. granted 0.5 million and 0.7 million EOSOs, respectively.

Stock Option Plan

In connection with the PMI and Kraft spin-offs, Altria Group, Inc. employee stock options were modified through the issuance of PMI employee stock options (in connection with the PMI spin-off) and Kraft stock options (in connection with the Kraft spin-off), 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 each spin-off was not greater than the aggregate intrinsic value of the option immediately before each spin-off. Due to the fact that the Black-Scholes fair values of the awards immediately before and immediately after each 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 modifications 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  

 

37


Altria Group, Inc. stock option activity was as follows for the year ended December 31, 2008:

 

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

Balance at January 1, 2008

   29,536,591     $ 10.74      

Options exercised

   (6,846,763 )     13.05      

Options canceled

   (26,490 )     9.27      
                  

Balance/Exercisable at December 31, 2008

   22,663,338       10.04    2 years    $ 114 million
                  

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 PMI and Kraft spin-offs.

The aggregate intrinsic value shown in the table above was based on the December 31, 2008 closing price for Altria Group, Inc.’s common stock of $15.06. The weighted-average grant date fair value of options granted during the years ended December 31, 2007 and 2006 was $15.55 and $14.53, respectively. The total intrinsic value of options exercised during the years ended December 31, 2008, 2007 and 2006 was $119 million, $454 million and $456 million, respectively.

Restricted and Deferred 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, 2008, 2007 and 2006 of $38 million, $80 million and $59 million, respectively. The deferred tax benefit recorded related to this compensation expense was $15 million, $29 million and $22 million for the years ended December 31, 2008, 2007 and 2006, respectively. The unamortized compensation expense related to Altria Group, Inc. restricted stock and deferred stock was $59 million at December 31, 2008 and is expected to be recognized over a weighted average period of 2 years.

Altria Group, Inc. restricted stock and deferred stock activity was as follows for the year ended December 31, 2008:

 

     Number of
Shares
    Weighted-Average
Grant Date Fair Value
Per Share

Balance at January 1, 2008

   6,147,507     $ 65.11

Granted

   2,417,578       22.98

Vested

   (2,057,102 )     60.27

Forfeited

   (755,206 )     63.74
            

Balance at December 31, 2008

   5,752,777     $ 49.31
            

In January 2008, Altria Group, Inc. issued 1.9 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 2011. The market value per share was $76.76 on the date of grant. Recipients of 0.5 million of these Altria Group, Inc. deferred shares, who were employed by Altria Group, Inc. after the PMI spin-off, received 1.3 million additional shares of deferred stock of Altria Group, Inc. to preserve the intrinsic value of the award, and accordingly, the grant date fair value per share, in the table above, related to this grant was reduced. Recipients of 1.4 million shares of Altria Group, Inc. deferred stock awarded on January 30, 2008, who were employed by PMI after the PMI spin-off received substitute shares of deferred stock of PMI to preserve the intrinsic value of the award.

The grant price information for restricted stock and deferred stock awarded prior to January 30, 2008 reflects historical market prices which are not adjusted to reflect the PMI spin-off, and the grant price information for restricted 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 in Note 1. Background and Basis of Presentation, as a result of the PMI spin-off, holders of restricted stock and deferred stock awarded prior to January 30, 2008 retained their existing award and received restricted stock or deferred stock of PMI. In addition, as a result of the Kraft spin-off, holders of restricted 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, 2008, 2007 and 2006 was $56 million, $150 million and $146 million, respectively, or $22.98, $65.62 and $74.21 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, 2008, 2007 and 2006 was $140 million, $184 million and $215 million, respectively.

 

38


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,

(in millions)

   2008    2007    2006

Earnings from continuing operations

   $ 3,090    $ 3,131    $ 3,182

Earnings from discontinued operations

     1,840      6,655      8,840
                    

Net earnings

   $ 4,930    $ 9,786    $ 12,022
                    

Weighted average shares for basic EPS

     2,075      2,101      2,087

Plus incremental shares from assumed conversions:

        

Restricted stock and deferred stock

     3      3      4

Stock options

     9      12      14
                    

Weighted average shares for diluted EPS

     2,087      2,116      2,105
                    

For the 2008 and 2007 computations, there were no antidilutive stock options. For the 2006 computation, the number of stock options excluded from the calculation of weighted average shares for diluted EPS because their effects were antidilutive was immaterial.

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, 2008, 2007 and 2006:

 

(in millions)

   2008     2007     2006  

Earnings from continuing operations before income taxes:

      

United States

   $ 4,789     $ 4,674     $ 4,732  

Outside United States

     —         4       21  
                        

Total

   $ 4,789     $ 4,678     $ 4,753  
                        

Provision for income taxes:

      

United States federal:

      

Current

   $ 1,486     $ 1,665     $ 1,834  

Deferred

     (95 )     (211 )     (543 )
                        
     1,391       1,454       1,291  
                        

State and local:

      

Current

     351       98       303  

Deferred

     (43 )     (8 )     (27 )
                        
     308       90       276  
                        

Total United States

     1,699       1,544       1,567  
                        

Outside United States:

      

Current

     —         3       4  
                        

Total provision for income taxes

   $ 1,699     $ 1,547     $ 1,571  
                        

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”) in March 2006. Altria Group, Inc. has agreed with all conclusions of the RAR, with the exception of certain leasing matters discussed in Note 20. Contingencies. 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.’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.

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  

Additions based on tax positions related to the current year

     50  

Additions for tax positions of prior years

     70  

Reductions for tax positions of prior years

     (10 )

Settlements

     (2 )

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

     (54 )
        

Balance at December 31, 2008

   $ 669  
        

 

39


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

 

(in millions)

   December 31,
2008
    December 31,
2007
 

Unrecognized tax benefits —

    

Altria Group, Inc.

   $ 275     $ 182  

Unrecognized tax benefits —

    

Kraft

     274       270  

Unrecognized tax benefits —

    

PMI

     120       163  
                

Unrecognized tax benefits

     669       615  

Accrued interest and penalties

     302       267  

Tax credits and other indirect benefits

     (94 )     (102 )
                

Liability for tax contingencies

   $ 877     $ 780  
                

The amount of unrecognized tax benefits that, if recognized, would impact the effective tax rate at December 31, 2008 was $216 million, along with $59 million affecting deferred taxes and the remainder of $120 million and $274 million affecting the receivables from PMI and Kraft, respectively, discussed below. 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 and the remainder of $163 million and $270 million affecting the receivables from PMI and Kraft, respectively, discussed below.

For the years ended December 31, 2008 and 2007, Altria Group, Inc. recognized in its consolidated statements of earnings $41 million and $13 million of interest, respectively.

Under the Tax Sharing Agreements between Altria Group, Inc. and PMI, and between Altria Group, Inc. and Kraft, PMI and Kraft are responsible for their respective pre-spin-off tax obligations. However, due to regulations governing the U.S. federal consolidated tax return, Altria Group, Inc. remains severally liable for PMI’s and Kraft’s pre-spin-off federal taxes. As a result, Altria Group, Inc. continues to include $120 million and $274 million of unrecognized tax benefits for PMI and Kraft, respectively, in its liability for uncertain tax positions, and corresponding receivables from PMI and Kraft of $120 million and $274 million, respectively, are included in other assets.

Altria Group, Inc. recognizes accrued interest and penalties associated with uncertain tax positions as part of the tax provision. As of December 31, 2008, Altria Group, Inc. had $302 million of accrued interest and penalties, of which approximately $32 million and $100 million related to PMI and Kraft, respectively, for which PMI and Kraft are responsible under their respective Tax Sharing Agreements. The receivables from PMI and Kraft are included in other assets. As of December 31, 2007, Altria Group, Inc. had $267 million of accrued interest and penalties, of which approximately $53 million and $88 million related to PMI and Kraft, respectively.

It is reasonably possible that within the next 12 months certain state examinations will be resolved, which could result in a decrease in unrecognized tax benefits and interest of approximately $45 million.

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, 2008, 2007 and 2006:

 

     2008     2007     2006  

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

   4.2     3.6     3.9  

Benefit recognized on conclusion of IRS audit

       (3.1 )

Reversal of tax reserves no longer required

     (2.4 )  

Domestic manufacturing deduction

   (1.6 )   (1.7 )   (1.2 )

SABMiller dividend benefit

   (2.1 )   (2.0 )   (1.4 )

Other

     0.6     (0.1 )
                  

Effective tax rate

   35.5 %   33.1 %   33.1 %
                  

The tax provision in 2008 includes net tax benefits of $58 million primarily from the reversal of tax accruals no longer required in the fourth quarter. 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 $57 million related to the reversal of tax accruals no longer required in the fourth quarter. The tax provision in 2006 includes $146 million of non-cash tax benefits recognized 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 tax effects of temporary differences that gave rise to consumer products deferred income tax assets and liabilities consisted of the following at December 31, 2008 and 2007:

 

(in millions)

   2008     2007  

Deferred income tax assets:

    

Accrued postretirement and postemployment benefits

   $ 1,181     $ 1,055  

Settlement charges

     1,659       1,642  

Accrued pension costs

     495    

Net operating losses and tax credit carryforwards

     126       177  

Other

       94  
                

Total deferred income tax assets

     3,461       2,968  
                

Deferred income tax liabilities:

    

Property, plant and equipment

     (360 )     (418 )

Prepaid pension costs

       (311 )

Investment in SABMiller

     (1,389 )     (1,480 )

Other

     (51 )  
                

Total deferred income tax liabilities

     (1,800 )     (2,209 )
                

Valuation allowances

     (80 )     (111 )
                

Net deferred income tax assets

   $ 1,581     $ 648  
                

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

 

40


Altria Group, Inc. has state tax net operating losses of $2,780 million which, if unutilized, will expire in 2009 through 2029 and state tax credit carryforwards of $112 million which, if unutilized, will expire in 2009 through 2017. A valuation allowance is recorded against certain state net operating losses and state tax credit carryforwards due to uncertainty regarding their utilization.

Note 15.

Segment Reporting:

The products of Altria Group, Inc.’s consumer products subsidiaries include cigarettes and other tobacco products sold in the United States by PM USA, and machine-made large cigars and pipe tobacco sold by Middleton. Another subsidiary of Altria Group, Inc., 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 expense and amortization of intangibles. Interest and other debt expense, net (consumer products), and provision for income taxes are centrally managed at the corporate 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.

Segment data were as follows:

 

(in millions)

For the Years Ended December 31,

   2008     2007     2006  

Net revenues:

      

Cigarettes and other tobacco products

   $ 18,753     $ 18,470     $ 18,474  

Cigars

     387       15    

Financial services

     216       179       316  
                        

Net revenues

   $ 19,356     $ 18,664     $ 18,790  
                        

Earnings from continuing operations before income taxes:

      

Operating companies income:

      

Cigarettes and other tobacco products

   $ 4,866     $ 4,511     $ 4,812  

Cigars

     164       7    

Financial services

     71       380       175  

Amortization of intangibles

     (7 )    

Gain on sale of corporate headquarters building

     404      

General corporate expenses

     (266 )     (427 )     (427 )

Corporate asset impairment and exit costs

     (350 )     (98 )     (42 )
                        

Operating income

     4,882       4,373       4,518  

Interest and other debt expense, net

     (167 )     (205 )     (225 )

Loss on early extinguishment of debt

     (393 )    

Equity earnings in SABMiller

     467       510       460  
                        

Earnings from continuing operations before income taxes

   $ 4,789     $ 4,678     $ 4,753  
                        

PM USA and Middleton’s largest customer, McLane Company, Inc., accounted for approximately 27%, 26% and 25% of Altria Group, Inc.’s consolidated net revenues for the years ended December 31, 2008, 2007 and 2006, respectively. These net revenues were reported in the Cigarettes and other tobacco products and Cigars segments.

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

Asset Impairment and Exit Costs See Note 3. Asset Impairment and Exit Costs, for a breakdown of asset impairment and exit costs by segment.

Sales to PMI Subsequent to the PMI spin-off, PM USA recorded net revenues of $298 million, from contract volume manufactured for PMI under an agreement that terminated in the fourth quarter of 2008.

Gain on Sale of Corporate Headquarters Building — On March 25, 2008, Altria Group, Inc. sold its corporate headquarters building in New York City for $525 million and recorded a pre-tax gain on sale of $404 million.

 

     
     

 

41


Loss on Early Extinguishment of Debt As discussed in Note 10. Long-Term Debt, 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.

As a result of the tender offers and consent solicitations, Altria Group, Inc. recorded a pre-tax loss of $393 million, which included tender and consent fees of $371 million, on the early extinguishment of debt in the first quarter of 2008.

PMCC Allowance for Losses — During 2008, PMCC increased its allowance for losses by $100 million primarily as a result of credit rating downgrades of certain lessees and financial market conditions. See Note 8. Finance Assets, net.

Financing Fees During 2008, Altria Group, Inc. incurred structuring and arrangement fees for borrowing facilities related to the acquisition of UST. These fees are being amortized over the lives of the facilities. In 2008, Altria Group, Inc. recorded a pre-tax charge of $58 million for these fees, which are included in interest and other debt expense, net.

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.

SABMiller Intangible Asset Impairments Altria Group, Inc.’s 2008 equity earnings in SABMiller included intangible asset impairment charges of $85 million.

Acquisition of Middleton — In December 2007, Altria Group, Inc. acquired Middleton.

 

(in millions)

For the Years Ended December 31,

   2008    2007    2006

Depreciation expense:

        

Cigarettes and other tobacco products

   $ 182    $ 210    $ 202

Cigars

     1      

Corporate

     25      22      53
                    

Total depreciation expense

   $ 208    $ 232    $ 255
                    

(in millions)

For the Years Ended December 31,

   2008    2007    2006

Capital expenditures:

        

Cigarettes and other tobacco products

   $ 220    $ 352    $ 361

Cigars

     7      

Corporate

     14      34      38
                    

Total capital expenditures

   $ 241    $ 386    $ 399
                    

Note 16.

Benefit Plans:

Altria Group, Inc. sponsors noncontributory defined benefit pension plans covering substantially all employees, except that as of January 1, 2008, new employees are not eligible to participate in the defined benefit plans, but instead are eligible for a company match contribution in a defined contribution plan. In addition, Altria Group, Inc. provides 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.

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 initial adoption of SFAS No. 158 resulted in a reduction to stockholders’ equity of $3,386 million on December 31, 2006.

The amounts recorded in accumulated other comprehensive losses at December 31, 2008 consisted of the following:

 

(in millions)

   Pensions     Post-
retirement
    Post-
employment
    Total  

Net losses

   $ (2,907 )   $ (595 )   $ (140 )   $ (3,642 )

Prior service (cost) credit

     (71 )     79         8  

Deferred income taxes

     1,161       198       54       1,413  
                                

Amounts recorded in accumulated other comprehensive losses

   $ (1,817 )   $ (318 )   $ (86 )   $ (2,221 )
                                

 

42


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

 

(in millions)

   Pensions     Post-
retirement
    Post-
employment
    Total  

Net losses

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

Prior service

        

(cost) credit

     (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 losses

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

The movements in other comprehensive earnings/losses during the year ended December 31, 2008 were as follows:

 

(in millions)

   Pensions     Post-
retirement
    Post-
employment
    Total  

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

        

Amortization:

        

Net losses

   $ 59     $ 31     $ 9     $ 99  

Prior service cost/credit

     12       (9 )       3  

Other income/expense:

        

Net losses

     45           45  

Prior service cost/credit

     2       (5 )       (3 )

Deferred income taxes

     (46 )     (6 )     (4 )     (56 )
                                
     72       11       5       88  
                                

Other movements during the year:

        

Net losses

     (2,072 )     (270 )     —         (2,342 )

Prior service cost/credit

     (30 )     (7 )       (37 )

Deferred income taxes

     821       109         930  
                                
     (1,281 )     (168 )     —         (1,449 )
                                

Amounts related to continuing operations

     (1,209 )     (157 )     5       (1,361 )

Amounts related to discontinued operations

     (24 )         (24 )
                                

Total movements in other comprehensive earnings/losses

   $ (1,233 )   $ (157 )   $ 5     $ (1,385 )
                                

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

 

(in millions)

   Pensions     Post-
retirement
    Post-
employment
    Total  

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/credit

     (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  
                                

 

 

43


Pension Plans

Obligations and Funded Status

The projected benefit obligations, plan assets and funded status of Altria Group, Inc.’s pension plans at December 31, 2008 and 2007, were as follows:

 

(in millions)

   2008     2007  

Projected benefit obligation at January 1

   $ 5,143     $ 5,255  

Service cost

     99       103  

Interest cost

     304       309  

Benefits paid

     (298 )     (281 )

Termination, settlement and curtailment

     50       (50 )

Actuarial losses (gains)

     237       (200 )

Divestitures

     (223 )  

Acquisitions

       7  

Other

     30    
                

Projected benefit obligation at December 31

     5,342       5,143  
                

Fair value of plan assets at January 1

     5,841       5,697  

Actual return on plan assets

     (1,462 )     397  

Employer contributions

     45       37  

Benefits paid

     (298 )     (281 )

Actuarial gains (losses)

     14       (9 )

Divestitures

     (211 )  
                

Fair value of plan assets at December 31

     3,929       5,841  
                

Net pension (liability) asset recognized at December 31

   $ (1,413 )   $ 698  
                

The net pension (liability) asset recognized in Altria Group, Inc.’s consolidated balance sheets at December 31, 2008 and 2007, was as follows:

 

(in millions)

   2008     2007  

Prepaid pension assets

   $ —       $ 912  

Other accrued liabilities

     (20 )     (16 )

Accrued pension costs

     (1,393 )     (198 )
                
   $ (1,413 )   $ 698  
                

The accumulated benefit obligation, which represents benefits earned to date, for the pension plans was $4.9 billion and $4.6 billion at December 31, 2008 and 2007, respectively.

At December 31, 2008, the accumulated benefit obligations were in excess of plan assets for all pension plans. At December 31, 2007, 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.

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

 

     2008     2007  

Discount rate

   6.10 %   6.20 %

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 corporate bonds 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, 2008, 2007 and 2006:

 

(in millions)

   2008     2007     2006  

Service cost

   $ 99     $ 103     $ 115  

Interest cost

     304       309       291  

Expected return on plan assets

     (428 )     (429 )     (393 )

Amortization:

      

Net loss

     59       82       154  

Prior service cost

     12       10       12  

Termination, settlement and curtailment

     97       37       15  
                        

Net periodic pension cost

   $ 143     $ 112     $ 194  
                        

Termination, settlement and curtailment costs of $97 million during 2008, primarily reflects termination benefits related to Altria Group, Inc.’s restructuring programs (see Note 3. Asset Impairment and Exit Costs). 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, 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 of $15 million.

The amounts included in termination, settlement and curtailment in the table above for the years ended December 31, 2008 and 2007 were comprised of the following changes:

 

(in millions)

   2008    2007  

Benefit obligation

   $ 50    $ (50 )

Other comprehensive earnings/losses:

     

Net losses

     45      62  

Prior service cost

     2      25  
               
   $ 97    $ 37  
               

For the pension plans, the estimated net loss and prior service cost that are expected to be amortized from accumulated other comprehensive losses into net periodic benefit cost during 2009 are $110 million and $12 million, respectively.

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

 

     2008     2007     2006  

Discount rate

   6.20 %   6.10 %   5.70 %

Expected rate of return on plan assets

   8.00     8.00     8.00  

Rate of compensation increase

   4.50     4.50     4.50  

 

     
     

 

44


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.

Altria Group, Inc. sponsors 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. Amounts charged to expense for these defined contribution plans totaled $128 million, $130 million and $140 million in 2008, 2007 and 2006, respectively.

Plan Assets

The percentage of fair value of pension plan assets at December 31, 2008 and 2007, was as follows:

 

Asset Category

   2008     2007  

Equity securities

   51 %   72 %

Debt securities

   40     28  

Cash

   9    
            

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 was broadly characterized as a 70%/30% allocation between equity and debt securities. Beginning in 2008, Altria Group, Inc. decided to change the allocation between 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 to pay benefits that relate to plans for salaried employees that cannot be funded under Internal Revenue Service regulations. Currently, Altria Group, Inc. anticipates making contributions of $20 million in 2009 to its pension 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, 2008, were as follows:

 

(in millions)

    

2009

   $ 289

2010

     296

2011

     305

2012

     316

2013

     324

2014 – 2018

     1,796

Postretirement Benefit Plans

Net postretirement health care costs consisted of the following for the years ended December 31, 2008, 2007 and 2006:

 

(in millions)

   2008     2007     2006  

Service cost

   $ 41     $ 41     $ 49  

Interest cost

     130       120       121  

Amortization:

      

Net loss

     31       20       39  

Prior service credit

     (9 )     (8 )     (4 )

Other

     23       (2 )     3  
                        

Net postretirement health care costs

   $ 216     $ 171     $ 208  
                        

“Other” postretirement cost of $23 million during 2008 primarily reflects termination benefits and curtailment losses related to Altria Group, Inc.’s restructuring programs (see Note 3. Asset Impairment and Exit Costs). 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”, above. During 2006, Altria Group, Inc. instituted early retirement programs which resulted in special termination benefits and curtailment losses, which are included in “other”, above.

The amounts included in “other” in the table above for the years ended December 31, 2008 and 2007 were comprised of the following changes:

 

(in millions)

   2008     2007  

Accumulated postretirement health care costs

   $ 28     $ (29 )

Other comprehensive earnings/losses:

    

Net losses

       33  

Prior service credit

     (5 )     (6 )
                

Other

   $ 23     $ (2 )
                

For the postretirement benefit plans, the estimated net loss and prior service credit that are expected to be amortized from accumulated other comprehensive losses into net postretirement health care costs during 2009 are $40 million and $(8) million, respectively.

 

 

45


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

 

     2008     2007     2006  

Discount rate

   6.20 %   6.10 %   5.70 %

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 postretirement benefit obligation and net amount accrued at December 31, 2008 and 2007, were as follows:

 

(in millions)

   2008     2007  

Accumulated postretirement benefit obligation at January 1

   $ 2,033     $ 2,113  

Service cost

     41       41  

Interest cost

     130       120  

Benefits paid

     (105 )     (93 )

Curtailments

     28       (29 )

Plan amendments

       (23 )

Assumption changes

     117    

Actuarial losses (gains)

     161       (96 )

Divestitures

     (70 )  
                

Accrued postretirement health care costs at December 31

   $ 2,335     $ 2,033  
                

The current portion of Altria Group, Inc.’s accrued post-retirement health care costs of $127 million and $117 million at December 31, 2008 and 2007, respectively, is included in other accrued liabilities on the consolidated balance sheets.

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

 

     2008     2007  

Discount rate

   6.10 %   6.20 %

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

   2015     2011  

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, 2008:

 

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

Effect on total of service and interest cost

   12.9 %   (10.3 )%

Effect on postretirement benefit obligation

   11.1     (9.6 )

Altria Group, Inc.’s estimated future benefit payments for its postretirement health care plans at December 31, 2008, were as follows:

 

(in millions)

    

2009

   $ 127

2010

     136

2011

     147

2012

     154

2013

     159

2014 – 2018

     828

Postemployment Benefit Plans

Altria Group, Inc. sponsors 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, 2008, 2007 and 2006:

 

(in millions)

   2008    2007    2006

Service cost

   $ 2    $ 3    $ 4

Interest cost

     2      3      4

Amortization of net loss

     9      10      5

Other

     240      294      28
                    

Net postemployment costs

   $ 253    $ 310    $ 41
                    

“Other” postemployment cost primarily reflects incremental severance costs related to Altria Group, Inc.’s restructuring programs (see Note 3. Asset Impairment and Exit Costs).

For the postemployment benefit plans, the estimated net loss that is expected to be amortized from accumulated other comprehensive losses into net postemployment costs during 2009 is approximately $13 million.

Altria Group, Inc.’s postemployment plans are not funded. The changes in the benefit obligations of the plans at December 31, 2008 and 2007, were as follows:

 

(in millions)

   2008     2007  

Accrued postemployment costs at January 1

   $ 439     $ 174  

Service cost

     2       3  

Interest cost

     2       3  

Benefits paid

     (168 )     (36 )

Actuarial losses and assumption changes

     (40 )     1  

Other

     240       294  
                

Accrued postemployment costs at December 31

   $ 475     $ 439  
                

The accrued postemployment costs were determined using a weighted average discount rate of 5.2% and 5.8% in 2008 and 2007, respectively, an assumed ultimate annual turnover rate of 0.5% in 2008 and 2007, assumed compensation cost increases of 4.5% in 2008 and 2007, and assumed benefits as defined in the respective plans. Post-employment costs arising from actions that offer employees benefits in excess of those specified in the respective plans are charged to expense when incurred.

 

     
     

 

46


Note 17.

Additional Information:

The amounts shown below are for continuing operations.

 

(in millions)

For the Years Ended December 31,

   2008     2007     2006  

Research and development expense

   $ 232     $ 269     $ 282  
                        

Advertising expense

   $ 6     $ 5     $ 7  
                        

Interest and other debt expense, net:

      

Interest expense

   $ 237     $ 475     $ 629  

Interest income

     (70 )     (270 )     (404 )
                        
   $ 167     $ 205     $ 225  
                        

Interest expense of financial services operations included in cost of sales

   $ 38     $ 54     $ 81  
                        

Rent expense

   $ 59     $ 67     $ 100  
                        

Minimum rental commitments under non-cancelable operating leases in effect at December 31, 2008, were as follows:

 

(in millions)

    

2009

   $ 54

2010

     51

2011

     36

2012

     18

2013

     11

Thereafter

     83
      
   $ 253
      

Note 18.

Financial Instruments:

Derivative Financial Instruments: Derivative financial instruments are used by Altria Group, Inc., 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. During the years ended December 31, 2008, 2007 and 2006, ineffectiveness related to fair value hedges and cash flow hedges was not material.

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, 2008, 2007 and 2006, as follows (in millions):

 

(in millions)

   2008     2007     2006  

(Loss) gain as of January 1

   $ (5 )   $ 13     $ 24  

Derivative losses (gains) transferred to earnings

     93       (45 )     (35 )

Change in fair value

     (270 )     25       24  

Kraft spin-off

       2    

PMI spin-off

     182      
                        

(Loss) gain as of December 31

   $ —       $ (5 )   $ 13  
                        

See Note 19. Fair Value Measurements for disclosures related to fair value of derivative financial instruments.

Foreign exchange rates: During the first quarter of 2008, Altria Group, Inc. purchased forward foreign exchange contracts to mitigate its exposure to changes in exchange rates from its euro-denominated debt. While these forward exchange contracts were effective as economic hedges, they did not qualify for hedge accounting treatment and therefore $21 million of gains for the year ended December 31, 2008 relating to these contracts were reported in interest and other debt expense, net in Altria Group, Inc.’s consolidated statements of earnings. These contracts and the related debt matured in the second quarter of 2008. Subsequent to the maturities of these contracts, Altria Group, Inc. has had no derivative financial instruments remaining.

In addition, Altria Group, Inc. used foreign currency swaps to mitigate its exposure to changes in exchange rates related to foreign currency denominated debt. These swaps converted fixed-rate foreign currency denominated debt to fixed-rate debt denominated in the functional currency of the borrowing entity, and were accounted for as cash flow hedges. Subsequent to the PMI distribution, Altria Group, Inc. has had no such swap agreements remaining. At December 31, 2007, the notional amounts of foreign currency swap agreements aggregated $1.5 billion.

Altria Group, Inc. also designated certain foreign currency denominated debt and forwards as net investment hedges of foreign operations. During the years ended December 31, 2008, 2007 and 2006, these hedges of net investments resulted in losses, net of income taxes, of $85 million, $45 million and $164 million, respectively, and were reported as a component of accumulated other comprehensive earnings (losses) within currency translation adjustments. The accumulated losses recorded as net investment hedges of foreign operations were recognized and recorded in connection with the PMI distribution. Subsequent to the PMI distribution, Altria Group, Inc. has no such net investment hedges remaining.

 

47


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.

Note 19.

Fair Value Measurements:

On January 1, 2008, Altria Group, Inc. adopted SFAS 157, which establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

 

Level 1 —   Quoted prices in active markets for identical assets or liabilities.
Level 2 —   Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 —   Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Investments: The fair value of Altria Group, Inc.’s equity investment in SABMiller is based on readily available quoted market prices, which would meet the definition of a Level 1 input. For the fair value disclosure of the SABMiller investment, see Note 7. Investment in SABMiller.

Debt: The fair value of a substantial portion of Altria Group, Inc.’s outstanding debt can be determined by using readily available quoted market prices, which would meet the definition of a Level 1 input. For the remaining portion of Altria Group, Inc.’s debt where quoted market prices are not available, the fair value is determined by utilizing quotes and market interest rates currently available to Altria Group, Inc. for issuances of debt with similar terms and remaining maturities, which would meet the definition of a Level 2 input. For the fair value disclosure of the outstanding debt, see Note 10. Long-Term Debt.

Derivative Financial Instruments: Altria Group, Inc. assesses the fair value of its derivative financial instruments using internally developed models that use, as their basis, readily observable future amounts, such as cash flows, earnings, and the current market expectations of those future amounts. As discussed in Note 18. Financial Instruments, at December 31, 2008, Altria Group, Inc. had no derivative financial instruments remaining.

Pension Assets: The fair value of substantially all of Altria Group, Inc.’s pension assets are based on readily available quoted market prices as well as other observable inputs which would meet the definition of a Level 1 or Level 2 input. For the fair value disclosure of the pension plan assets, see Note 16. Benefit Plans.

In February 2008, the FASB issued Staff Position No. 157-2, “Effective Date of FASB Statement No. 157,” which delays the effective date of SFAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on at least an annual basis until 2009. Altria Group, Inc. adopted this Staff Position beginning January 1, 2008 and deferred the application of SFAS 157 to goodwill and other intangible assets, net, until January 1, 2009. The adoption of the deferred portion of SFAS 157 is not expected to have a material impact on Altria Group, Inc.’s consolidated financial statements.

Note 20.

Contingencies:

Legal proceedings covering a wide range of matters are pending or threatened in various United States and foreign jurisdictions against Altria Group, Inc. and its subsidiaries, including PM USA, as well as their 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 distributors.

Litigation is subject to uncertainty and it is possible that there could be adverse developments in pending or future cases. An unfavorable outcome or settlement of pending tobacco-related or other litigation could encourage the commencement of additional litigation. Damages claimed in some tobacco-related or other litigation are or can be significant and, in certain cases, range in 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.

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 43 states now limit the dollar amount of bonds or require no bond at all.

Altria Group, Inc. 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. At the present time, while it is reasonably possible that an unfavorable outcome in a case may occur, except as discussed

 

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elsewhere in this Note 20. Contingencies: (i) management has concluded that it is not 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. Legal defense costs are expensed as incurred.

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 in recent years. Altria Group, Inc., and each of its subsidiaries named as a defendant, believes and each has been so advised by counsel handling the respective cases, that it has valid defenses to the litigation pending against it, as well as valid bases for appeal of adverse verdicts. All such cases are, and will continue to be, vigorously defended. However, Altria Group, Inc. and its subsidiaries may enter into settlement discussions in particular cases if they believe it is in the best interests of Altria Group, Inc. to do so.

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 nongovernmental 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. 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.

The table below lists the number of certain tobacco-related cases pending in the United States against PM USA and, in some instances, Altria Group, Inc. as of December 31, 2008, December 31, 2007 and December 31, 2006.

 

Type of Case

   Number of Cases
Pending as of
December 31, 2008
   Number of Cases
Pending as of
December 31, 2007
   Number of Cases
Pending as of
December 31, 2006

Individual Smoking and Health Cases(1)

   99    105    196

Smoking and Health Class Actions and Aggregated Claims Litigation(2)

   9    10    10

Health Care Cost Recovery Actions

   3    3    5

“Lights/Ultra Lights” Class Actions

   18    17    20

Tobacco Price Cases

   2    2    2

 

(1) Does not include 2,620 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 3,170 individual smoking and health cases brought by or on behalf of approximately 9,151 plaintiffs in Florida following the decertification of the Engle case discussed below. It is possible that some of these cases are duplicates and additional cases have been filed but not yet recorded on the courts’ dockets.
(2) Includes as one case the 728 civil actions (of which 414 are actions against PM USA) that are proposed to be tried in a single proceeding in West Virginia. Middleton was named as a defendant in this action but it, along with other non-cigarette manufacturers, has been severed from this case. 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, which was denied on February 25, 2008. The case was stayed pending the United States Supreme Court’s decision in Good v. Altria Group, Inc. et al., discussed below.

• International Tobacco-Related Cases: As of December 31, 2008, PM USA is a named defendant in a “Lights” class action in Israel and a health care cost recovery action in Israel. PM USA is a named defendant in two health care cost recovery actions in Canada, one of which also names Altria Group, Inc. as a defendant.

• Pending and Upcoming Trials: As of December 31, 2008, 50 Engle-progeny cases against PM USA were scheduled for trial in 2009. In addition, there are currently 5 individual smoking and health cases scheduled for trial in 2009. Cases against other tobacco companies are also scheduled for trial through the end of 2009. Trial dates are subject to change.

 

     
     

 

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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). A motion for a new trial was granted in one of the cases in Florida.

Of the 17 cases in which verdicts were returned in favor of plaintiffs, eight have reached final resolution. A verdict against defendants in one 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 (Price) was reversed and the case was dismissed with prejudice in December 2006. In December 2008, the plaintiff in Price filed a motion with the state trial court to vacate the judgment dismissing this case in light of the United States Supreme Court’s decision in Good (see below for a discussion of developments in Good and Price). After exhausting all appeals, PM USA has paid judgments totaling $73.6 million and interest totaling $35.1 million.

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.

 

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 October 2007, in a limited retrial on the issue of punitive damages, 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 in January 2008. In March 2008, PM USA noticed an appeal to the California Court of Appeal, First Appellate District and in May 2008, posted a $2.2 million appeal bond.
August 2006    District of Columbia/ United States of America    Health Care Cost Recovery    Finding that defendants, including Altria Group, Inc. and PM USA, violated the civil provisions of the Racketeer Influenced and Corrupt Organizations Act (RICO). No monetary damages were assessed, but the court made specific findings and issued injunctions. See Federal Government’s Lawsuit below.    See Federal Government’s Lawsuit below.
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.    On April 10, 2008, an intermediate New York appellate court reversed the verdict and vacated the compensatory and punitive awards against PM USA. On December 16, 2008, the New York Court of Appeals affirmed the appellate court decision. On January 14, 2009, plaintiffs filed a petition with the New York Court of Appeals requesting that the court either vacate its earlier decision and reinstate the jury verdict or remand the case to the trial court for a new trial.
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.    See Scott Class Action below.

 

 

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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.    In December 2002, the trial court reduced the punitive damages award to $28 million. In April 2006, the California Court of Appeal affirmed the $28 million punitive damages award. In January 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. In April 2008, the California Supreme Court denied PM USA’s petition for review. 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 $24.8 million. PM USA’s share of the damages award is approximately $6 million. In January 2007, defendants petitioned the trial court to set aside the jury’s verdict and dismiss plaintiffs’ punitive damages claim. In August 2008, the trial court granted plaintiffs’ motion for entry of judgment and ordered compensatory damages of $24.8 million plus interest from the date of the verdict. In August 2008, PM USA filed a motion for reconsideration, which was denied. Final judgment was entered on November 12, 2008, awarding plaintiffs actual damages of $24.8 million, plus interest from the date of the verdict. Defendants filed a notice of appeal on December 1, 2008.

 

     
     

 

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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 Schwarz to the Oregon Supreme Court for proceedings consistent with its Williams 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.
July 2000    Florida/Engle    Smoking and Health Class Action    $145 billion in punitive damages against all defendants, including $74 billion against PM USA.    See Engle Class Action below.
March 1999    Oregon/Williams    Individual Smoking and Health    $800,000 in compensatory damages (capped statutorily at $500,000), $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 was 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. In January 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. In March 2008, plaintiffs and PM USA appealed to the California Supreme Court. In April 2008, the California Supreme Court denied both petitions for review. Following this decision, PM USA recorded a provision for compensatory damages of $850,000 plus costs and interest in the second quarter. The case has been remanded to the superior court for a new trial on the amount of punitive damages, if any. Trial is scheduled for June 2009. In July 2008, $43.3 million of escrow funds were returned to PM USA.
(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 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 decision, PM USA recorded an additional provision of approximately $25 million in interest charges. 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. In January 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. In March 2008, PM USA filed a petition for writ of certiorari with the United States Supreme Court, which was granted in June 2008. The United States Supreme Court heard oral argument on December 3, 2008.

 

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Security for Judgments: To obtain stays of judgments pending current appeals, as of December 31, 2008, PM USA has posted various forms of security totaling approximately $129 million, the majority of which has been collateralized with cash deposits that 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. 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 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 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 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 February 2008, PM USA paid a total of $2,964,685, which represents its share of compensatory damages and interest to the two individual plaintiffs identified in the Florida Supreme Court’s order.

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 r