Domestic Tobacco

In our domestic tobacco business, PM USA’s net revenues increased 3.0% to $17.5 billion in 2004, and operating companies income grew 13.3% to $4.4 billion for the year, primarily driven by savings resulting from changes to trade programs in 2004 and charges related to the 2003 tobacco growers’ settlement, partially offset by increased costs including state settlement agreements.

While PM USA’s cigarette shipment volume was down slightly for the full year 2004 at 187.1 billion units, it achieved a retail share gain of more than a full share point, driven by Marlboro. Shipment volume and retail share performance since the fourth quarter of 2002 has been outstanding for Marlboro, due in part to PM USA’s integrated strategy that has kept Marlboro’s price gap with the lowest-priced brands at the mid-40% level on average.

Although PM USA has been increasingly successful in pursuing its societal alignment initiatives, regrettably, Congressional legislation providing for regulation of the tobacco industry by the U.S. Food and Drug Administration (FDA) was not passed in 2004. Although this was a significant disappointment, obtaining FDA regulation of the tobacco industry remains a key priority. The U.S. Congress did approve a buyout of the U.S. tobacco growers’ quota system, which may provide benefits to both PM USA and PMI over the long term.

Overall, I believe that despite a challenging environment, PM USA is on a solid footing and has returned to both stability and predictability.

International Tobacco

In our international tobacco business, PMI had a very solid year in the face of difficult circumstances. Its volume increased 3.5% to 761.4 billion units in 2004. PMI’s share of the international cigarette market (excluding the U.S. and worldwide duty-free) was an estimated 14.5% in 2004. Operating companies income rose 4.5% to $6.6 billion, aided by favorable currency of $540 million and other factors, partially offset by a $250 million pre-tax charge for the E.C. agreement and other items.

Changing consumption patterns, driven primarily by national tax policies, presented PMI with challenges in major Western European markets during 2004. PMI took aggressive action to address those challenges, and its situation has stabilized in France and Italy. However, significant challenges remain in Germany, where cigarette consumption is declining as consumers are trading down to lower-priced tobacco products, particularly tobacco portions, which are taxed at much lower rates than cigarettes under the current tax policy. The cigarette market in Germany was down 15.5% in 2004, while tobacco portions volume more than doubled for the year. The combined consumption of cigarettes and other tobacco products was down a more modest 7.0%.

PMI is participating vigorously in other tobacco product segments in Germany, and will do so until taxes are equalized. While PMI is progressively ramping up capacity, unfortunately, it may not be in a position to meet demand fully until the third quarter of 2005. Within this environment, Marlboro, with a market share of about 30%, has held its own in the German cigarette market. PMI’s share of the premium segment, at more than 70%, continues to exhibit strong growth.

Market strength and favorable currency have allowed PMI to invest in its brands. Although Marlboro’s international volume declined 1.3% for the year, it was up 2.6% excluding France and Germany, and market share gains were widespread for Marlboro, with solid increases achieved in many markets. PMI has also transformed L&M into the No. 3 cigarette brand worldwide, and its volume was up 6.7% for 2004. L&M has established significant shares in diverse markets throughout the world, and is the number one international brand in Poland, Romania, Russia and Turkey.

PMI has had success working with governments to secure fair excise tax structures in many of its key markets, with numerous countries adopting minimum excise taxes and several considering the adoption of minimum reference prices, following France’s lead. These tax structures, which are sensible from both a fiscal and health perspective, help ensure that price gaps are manageable in the face of fierce competitive price initiatives around the world.

On the business development front, 2004 was an active year for PMI, with an acquisition in Finland, an increase in its shareholding to a 40% stake in Pakistan and market entries in South Africa and Nigeria. PMI also announced an acquisition in Colombia that is expected to be completed in 2005.

With its powerful portfolio of brands and outstanding infrastructure in markets around the world, PMI is well positioned for growth in the years ahead.