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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2002 Compared with 2001

The following discussion compares tobacco operating results for 2002 with 2001.

Domestic tobacco: PM USA’s net revenues, which include excise taxes billed to customers, decreased $1.0 billion (5.2%). Excluding excise taxes, net revenues decreased $1.2 billion (7.6%), due primarily to lower volume ($1.6 billion), partially offset by higher pricing, net of higher promotional spending ($288 million).

Operating companies income decreased $253 million (4.8%), due primarily to lower volume ($998 million), partially offset by price increases and lower costs under the State Settlement Agreements, net of higher promotional spending (aggregating $283 million) and the 2001 Engle litigation related expense ($500 million).

PM USA’s shipment volume was 191.6 billion units, a decrease of 7.5%. In the premium segment, PM USA’s shipment volume decreased 6.5%, while Marlboro shipment volume decreased 9.2 billion units (5.8%) to 148.6 billion units. In the discount segment, PM USA’s shipment volume decreased 15.6% to 18.8 billion units, while Basic shipment volume decreased 12.8% to 17.8 billion units. PM USA’s volume comparisons for 2002 versus 2001 were affected by factors such as a weak economic environment, increases in state excise taxes, the growth of deep-discount cigarettes, increased competitive promotional activity, the increased incidence of counterfeit product and increased sales of some manufacturers, both domestic and foreign, that are not complying with either the MSA or related state legislation.

International tobacco: International tobacco net revenues, which include excise taxes billed to customers, increased $2.2 billion (8.1%). Excluding excise taxes, net revenues increased $949 million (6.9%), due primarily to higher volume/mix ($543 million) and price increases ($420 million), partially offset by unfavorable currency movements.

Operating companies income increased $260 million (4.8%), due primarily to price increases ($420 million) and higher volume/mix ($156 million), partially offset by unfavorable currency ($231 million) and the 2002 pre-tax charges for asset impairment and exit costs ($58 million).

PMI’s volume of 723.1 billion units increased 24.2 billion units (3.5%), due primarily to volume increases in most markets of Western, Central and Eastern Europe, as well as Asia and Latin America, partially offset by lower volume resulting from a decline in the total industry in France; increased competition in Italy, Hong Kong, Korea and Singapore; and economic weakness in Egypt, Lebanon and Venezuela. In addition, volume declined in Poland, due primarily to intense price competition. Volume advanced in a number of important markets, including Argentina, Austria, Brazil, Germany, Indonesia, Japan, Malaysia, Mexico, the Philippines, Romania, Russia, Spain, Taiwan, Thailand, Turkey and the Ukraine.

PMI recorded market share gains in most of its major markets.

Volume for Marlboro declined 0.6%, due primarily to consumer downtrading in Argentina, the Czech Republic, Egypt, Hungary, Lebanon, Poland, Russia, Saudi Arabia and Turkey, partially offset by higher volumes in Western Europe and Asia.