International Tobacco

2005 was a very good year for PMI in a challenging global environment. Its cigarette shipment volume increased by 5.7% to 804.5 billion units. Gains in many markets, particularly Egypt, France, Mexico, the Philippines, Russia, Thailand, Turkey and Ukraine, coupled with acquisitions in Indonesia and Colombia, were partially offset by lower shipments in the European Union. Excluding the impact of acquisitions, PMI’s cigarette shipment volume increased 0.7% versus 2004. PMI’s total tobacco volume, which included 7.1 billion cigarette equivalent units of other tobacco products (OTPs), grew 6.1% versus 2004, and 1.2% excluding acquisitions.

Operating companies income rose 19.2%, or $1.3 billion, to $7.8 billion, due primarily to higher pricing, as well as the impact of acquisitions, positive currency, higher income from the return of the Marlboro license in Japan, the impact of a one-time inventory sale in Italy and a favorable comparison with 2004 when PMI recorded a charge for the E.C. agreement. These were partially offset by unfavorable volume/mix, higher R&D, manufacturing, distribution, trade and selling expenses, and higher asset impairment and exit costs.

PMI continued to outperform its principal competitors in terms of both volume and income. Its share of the world market (excluding the U.S. and worldwide duty-free) reached an estimated 15%, up 0.5 share points versus 2004, driven by its superior brand portfolio and leadership in key growth segments such as premium and menthol.

Excise tax increases undoubtedly present PMI with a significant challenge. It is not just a question of tax incidence, but tax structure. Inappropriate structures distort markets by providing consumers with incentives to switch to substitute products or trade down to cheap and marginally profitable cigarette products.

PMI had considerable success in 2005 in advocating fair tax structures as several key countries adopted either absolute minimum reference price (MRP) or minimum excise tax (MET) levels. Most noteworthy was the adoption of an MRP in both Italy and Belgium, and the reform of taxes in Turkey. In Spain, an MET was introduced in February 2006, though it remains to be seen if its level is sufficient to achieve the government’s health and fiscal objectives.

In fact, 20 of PMI’s top 25 markets currently have in place either an MET, MRP or single-tier specific tax regime, up from 15 in 2004. In addition, some progress was achieved in securing equal tax treatment of all tobacco products, particularly in Germany, where tobacco portions will be taxed at the same rate as cigarettes for products manufactured as of April 1, 2006.

Less than 5% of PMI’s income today is derived from markets that account for combined cigarette consumption of 3.1 trillion cigarettes, or about 60% of the total international market of more than five trillion cigarettes. PMI has strategies in place that focus on expanding in those markets, either organically or through acquisitions.

The Sampoerna and Coltabaco acquisitions in 2005 are the most recent examples, offering PMI market share leadership in both Indonesia and Colombia, with aggregate consumption of 240 billion units.

Another example is PMI’s late-2005 announcement of a strategic alliance with the CNTC, which sets the stage for long-term growth in China through the licensed manufacture and sale of Marlboro in China and the formation of an international joint venture, equally owned by PMI and the CNTC. The joint venture will offer a portfolio of Chinese heritage brands globally and pursue other business development opportunities.

Looking ahead, I remain confident in PMI’s ability to generate strong results while successfully confronting the inevitable surprises, both good and bad, based on its unparalleled global infrastructure, outstanding brand portfolio and talented workforce.