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

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Discussion and Analysis > Operating Results by Business Segment >Tobacco > Operating Results

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2003 compared with 2002

The following discussion compares tobacco operating results for 2003 with 2002.

Domestic tobacco: PM USA’s net revenues, which include excise taxes billed to customers, decreased $1.9 billion (9.9%). Excluding excise taxes, net revenues decreased $1.8 billion (11.9%), due primarily to price promotions to narrow price gaps ($1.5 billion) and lower volume ($335 million).

Operating companies income decreased $1.1 billion (22.4%), due primarily to price promotions to narrow price gaps, net of lower costs under the State Settlement Agreements (aggregating $620 million), lower volume ($186 million), higher marketing, administration and research costs, and the 2003 pre-tax charges for a legal settlement ($202 million) and headquarters relocation ($69 million).

PM USA’s shipment volume was 187.2 billion units, a decrease of 2.3%. In the premium segment, PM USA’s shipment volume decreased 1.1%, while Marlboro shipment volume decreased 636 million units (0.4%) to 147.9 billion units. In the discount segment, PM USA’s shipment volume decreased 12.9%, while Basic shipment volume was down 11.6% to 15.8 billion units. While PM USA’s shipment volume comparisons to 2002 were affected by factors such as a weak economic environment and sharp increases in state excise taxes, PM USA’s sequential retail share improved.

Effective with the first quarter of 2003, PM USA began reporting retail share results based on a retail tracking service, with data beginning in the fourth quarter of 2002. This service, IRI/Capstone Total Retail Panel, was developed to measure market share in retail stores selling cigarettes, but was not designed to capture Internet or direct mail sales. The following table summarizes sequential retail share performance for PM USA’s key brands from the fourth quarter of 2002 through the fourth quarter of 2003, and the full year 2003, based on data from the IRI/Capstone Total Retail Panel:

International tobacco: International tobacco net revenues, which include excise taxes billed to customers, increased $4.7 billion (16.5%). Excluding excise taxes, net revenues increased $1.3 billion (8.7%), due primarily to favorable currency ($1.1 billion), price increases ($212 million), the impact of acquisitions in Serbia and Greece, and higher volume.

Operating companies income increased $620 million (10.9%), due primarily to favorable currency ($469 million), price increases ($212 million) and the pre-tax charges for asset impairment and exit costs in 2002 ($58 million), partially offset by higher marketing, administration and research costs, and unfavorable volume/mix, reflecting lower volume in the higher margin markets of France, Germany and Italy.

PMI’s volume of 735.8 billion units increased 12.7 billion units (1.8%). In Western Europe, volume declined, due primarily to decreases in France, Germany and Italy, partially offset by increases in Spain and Austria. Shipment volume decreased in France, although market share was higher, reflecting contraction of the entire market following tax-driven price increases in January 2002, January 2003 and October 2003. In Germany, volume declined, reflecting a lower total market and consumer down-trading to low-priced tobacco portions following tax-driven price increases. In Italy, volume decreased 14.3% and market share fell 7.1 share points to 54.1%, as PMI’s brands remain under pressure from low-priced competitive brands. In Central and Eastern Europe, Middle East and Africa, volume increased, due to gains in Russia, Ukraine, Romania and Turkey, and acquisitions in Greece and Serbia, partially offset by declines in Hungary and Poland, due to intense price competition, and declines in Lithuania and the Slovak Republic, due to lower markets as a result of tax-driven price increases. In Asia, volume declined slightly as decreases in the Philippines and Indonesia were partially offset by increases in Japan, Korea, Taiwan and Thailand. In Latin America, volume increased, driven by gains in Argentina and Mexico.

PMI achieved market share gains in a number of important markets, including Argentina, Austria, France, Germany, Greece, Japan, Poland, Russia, Singapore, the Slovak Republic, Spain, Turkey, Ukraine and the United Kingdom.

Volume for Marlboro declined 1.9%, due primarily to tax-driven price increases in France and Germany, intense price competition in Italy, consumer down-trading in Turkey and difficult economic conditions and price competition in Egypt and Indonesia, partially offset by higher volume in Argentina, Austria, Brazil, the Czech Republic, Japan, Romania, Russia, Serbia, the Slovak Republic, Spain and Ukraine.