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

(Continued)

Discussion and Analysis > Consolidated Operating Results

See pages 39–40 for a discussion of Cautionary Factors That May Affect Future Results.

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

The following events that occurred during 2005, 2004 and 2003 affected the comparability of statement of earnings amounts.

• Domestic Tobacco Headquarters Relocation Charges—PM USA has substantially completed the move of its corporate headquarters from New York City to Richmond, Virginia, for which pre-tax charges of $4 million, $31 million and $69 million were recorded in the operating companies income of the domestic tobacco segment for the years ended December 31, 2005, 2004 and 2003, respectively. At December 31, 2005, a liability of $6 million remains on the consolidated balance sheet.
• Domestic Tobacco Loss on U.S. Tobacco Pool—As further discussed in Note 19. Contingencies, in October 2004, FETRA was signed into law. Under the provisions of FETRA, PM USA was obligated to cover its share of potential losses that the government may incur on the disposition of pool tobacco stock accumulated under the previous tobacco price support program. In 2005, PM USA recorded a $138 million expense for its share of the loss.
• Domestic Tobacco Quota Buy-Out—The provisions of FETRA require PM USA, along with other manufacturers and importers of tobacco products, to make quarterly payments that will be used to compensate tobacco growers and quota holders affected by the legislation. Payments made by PM USA under FETRA will offset amounts due under the provisions of the NTGST, a trust formerly established to compensate tobacco growers and quota holders. Disputes arose as to the applicability of FETRA to 2004 NTGST payments. During the third quarter of 2005, a North Carolina Supreme Court ruling determined that FETRA enactment had not triggered the offset provisions during 2004 and that tobacco companies were required to make full payment to the NTGST for the full year of 2004. The ruling, along with FETRA billings from the USDA, established that FETRA was effective beginning in 2005. Accordingly during the third quarter of 2005, PM USA reversed a prior year accrual for FETRA payments in the amount of $115 million.
• Domestic Tobacco Legal Settlement—During 2003, PM USA and certain other defendants reached an agreement with a class of U.S. tobacco growers and quota holders to resolve a lawsuit related to tobacco leaf purchases. During 2003, PM USA recorded pre-tax charges of $202 million for its obligations under the agreement. The pre-tax charges are included in the operating companies income of the domestic tobacco segment.
• International Tobacco E.C. Agreement—In July 2004, PMI entered into an agreement with the E.C. and 10 member states of the European Union that provides for broad cooperation with European law enforcement agencies on anti-contraband and anti-counterfeit efforts. The agreement resolves all disputes between the parties relating to these issues. Under the terms of the agreement, PMI will make 13 payments over 12 years, including an initial payment of $250 million, which was recorded as a pre-tax charge against its earnings in 2004. The agreement calls for additional payments of approximately $150 million on the first anniversary of the agreement (this payment was made in July 2005), approximately $100 million on the second anniversary and approximately $75 million each year thereafter for 10 years, each of which is to be adjusted based on certain variables, including PMI’s market share in the European Union in the year preceding payment. Because future additional payments are subject to these variables, PMI records charges for them as an expense in cost of sales when product is shipped.
• Inventory Sale in Italy—During the first quarter of 2005, PMI made a one-time inventory sale of 4.0 billion units to its new distributor in Italy, resulting in a $96 million pre-tax operating companies income benefit for the international tobacco segment. During the second quarter of 2005, the new distributor reduced its inventories by approximately 1.0 billion units, resulting in lower shipments for PMI. The net impact of these actions was a benefit to PMI’s pre-tax operating companies income of approximately $70 million for the year ended December 31, 2005.