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

(Continued)

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

2007 compared with 2006

The following discussion compares tobacco operating results for 2007 with 2006.

• U.S. tobacco: Net revenues, which include excise taxes billed to customers, increased $11 million (0.1%). Excluding excise taxes, net revenues increased $176 million (1.2%) to $15.0 billion, due primarily to lower wholesale promotional allowance rates ($1.1 billion), partially offset by lower volume ($906 million).
  
  Operating companies income decreased $294 million (6.1%), due primarily to lower volume ($608 million) and higher pre-tax charges in 2007 for asset impairment, exit and implementation costs related to the announced closing of the Cabarrus, North Carolina cigarette manufacturing facility ($361 million), partially offset by lower wholesale promotional allowance rates, net of higher ongoing resolution costs ($329 million) and lower marketing, administration and research costs ($311 million, net of a $26 million provision for the Scott case in Louisiana in 2007).
  
  Marketing, administration and research costs include PM USA’s cost of administering and litigating product liability claims. Litigation defense costs are influenced by a number of factors, as more fully discussed in Note 19. Principal among these factors are the number and types of cases filed, the number of cases tried annually, the results of trials and appeals, the development of the law controlling relevant legal issues, and litigation strategy and tactics. For the years ended December 31, 2007, 2006 and 2005, product liability defense costs were $200 million, $195 million and $258 million, respectively. The factors that have influenced past product liability defense costs are expected to continue to influence future costs. PM USA does not expect that product liability defense costs will increase significantly in the future.
  
  PM USA’s shipment volume was 175.1 billion units, a decrease of 4.6% or 8.3 billion units, but was estimated to be down approximately 3.6% when adjusted for changes in trade inventories and calendar differences. For the full year 2007, PM USA estimates a decline of about 4% in total cigarette industry volume. In the premium segment, PM USA’s shipment volume decreased 4.3%. Marlboro shipment volume decreased 5.9 billion units (3.9%) to 144.4 billion units. In the discount segment, PM USA’s shipment volume also decreased, with Basic shipment volume down 8.8% to 13.2 billion units. PM USA estimates that cigarette consumption in 2008 may decline by 2.5% to 3.0%.
  
  The following table summarizes PM USA’s cigarette volume performance by brand for 2007 and 2006:
  
  
                                                           
  
  The following table summarizes PM USA’s retail share performance, based on data from the IRI/Capstone Total Retail Panel, which is a tracking service that uses a sample of stores to project market share performance in retail stores selling cigarettes. This panel was not designed to capture sales through other channels, including Internet and direct mail:
  
  
                                                           
  
  Effective September 10, 2007, PM USA reduced its wholesale promotional allowances on Marlboro, Parliament and Basic by $0.50 per carton, from $4.00 to $3.50, and Virginia Slims by $2.00 per carton, from $4.00 to $2.00. In addition, PM USA raised the price on its other brands by $2.50 per thousand cigarettes or $0.50 per carton effective September 10, 2007 and by $9.95 per thousand cigarettes or $1.99 per carton effective February 12, 2007.
  
  Effective December 18, 2006, PM USA reduced its wholesale promotional allowance on its Focus on Four brands by $1.00 per carton, from $5.00 to $4.00, and increased the price of its other brands by $1.00 per carton.
  
  Effective December 19, 2005, PM USA reduced its wholesale promotional allowance on its Focus on Four brands by $0.50 per carton, from $5.50 to $5.00. In addition, effective December 27, 2005, PM USA increased the price of its other brands by $2.50 per thousand cigarettes or $0.50 per carton.
  
  PM USA anticipates that U.S. industry volume will decline by approximately 2.5% to 3.0% annually over the next few years. PM USA cannot predict the relative sizes of the premium and discount segments or its shipment or retail market share. PM USA believes that its results may be materially adversely affected by the items discussed under the caption Tobacco—Business Environment.
• European Union: Net revenues, which include excise taxes billed to customers, increased $2.9 billion (12.3%). Excluding excise taxes, net revenues increased $920 million (11.7%) to $8.8 billion, due primarily to favorable currency ($748 million) and price increases ($374 million), partially offset by lower volume/mix ($202 million).
  
  Operating companies income increased $657 million (18.7%), due primarily to favorable currency ($417 million), price increases, net of higher costs ($363 million), lower marketing, administration and research costs ($75 million) and the Italian antitrust charge in 2006 ($61 million), partially offset by lower volume/mix ($201 million), higher pre-tax charges for asset impairment and exit costs ($33 million) and higher fixed manufacturing costs ($23 million).
  
  In the European Union, PMI’s cigarette shipment volume decreased 0.7%, due primarily to declines in Germany and Poland, and unfavorable distributor inventory movements in France, partially offset by gains in Hungary, the Baltic States, and the impact of favorable inventory movements in Italy. PMI’s cigarette market share in the European Union was 39.3%, down 0.1 share point from 2006, due primarily to trade inventory distortions in the Czech Republic. Absent these distortions, market share in the European Union was flat.
  
  In France, PMI’s shipment volume decreased 4.8%, due primarily to a lower market due to higher pricing. PMI’s market share decreased 0.3 share points to 42.4%, due primarily to declines in Marlboro, reflecting the temporary adverse impact of crossing the €5.00 per pack threshold. In the mid-price segment, the Philip Morris brand grew market share.
  
  In Germany, PMI’s cigarette shipment volume declined 4.6%. The total cigarette market in Germany declined 4.0%, due mainly to the tax-driven price increase in October 2006. PMI’s cigarette market share declined 0.4 share points to 36.5%, due to lower Marlboro share, partially offset by share gains for L&M.
  
  In Italy, the total cigarette market was down 1.1%. PMI’s cigarette shipment volume increased 2.9%, due primarily to the favorable timing of shipments, and its market share in Italy increased 0.8 share points to 54.6%, driven by Chesterfield and Merit.
  
  In Poland, the total cigarette market declined 3.5%, due to consumer price sensitivity within the low-price segment following significant tax-driven price increases, as consumers switched to other tobacco products. PMI’s shipment volume was down 6.0% and market share decreased 1.0 share point to 39.0%, primarily reflecting share declines for PMI’s low-price and local 70mm brands. However, Marlboro market share rose 0.4 share points to 8.5%.
  
  In Spain, the total cigarette market declined 1.2%. PMI’s shipment volume increased 0.7%, due mainly to the favorable timing of shipments. PMI’s market share declined 0.2 share points to 32.1%, primarily reflecting declines in Marlboro, partially offset by gains for Chesterfield, L&M and the Philip Morris brand.