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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2006 compared with 2005

The following discussion compares tobacco operating results for 2006 with 2005. 

• U.S. tobacco: Net revenues, which include excise taxes billed to customers, increased $340 million (1.9%). Excluding excise taxes, net revenues increased $382 million (2.6%) to $14.9 billion, due primarily to lower wholesale promotional allowance rates ($604 million), partially offset by lower volume ($239 million).
  
  Operating companies income increased $231 million (5.0%), due primarily to lower wholesale promotional allowance rates, net of higher ongoing resolution costs ($424 million) and several other items (aggregating $79 million), partially offset by lower volume ($170 million), higher fixed manufacturing costs ($47 million) and higher marketing, administration and research costs (including spending in 2006 for various excise tax ballot initiatives). The other items reflect a pre-tax provision in 2005 for the Boeken individual smoking case ($56 million) and the previously mentioned 2005 net charges related to tobacco quota buy-out legislation ($23 million).
  
  PM USA’s shipment volume was 183.4 billion units, a decrease of 1.1%, but was estimated to be down approximately 1.5% when adjusted for trade inventory changes and the timing of promotional shipments. In the premium segment, PM USA’s shipment volume decreased 0.7%. Marlboro shipment volume decreased 0.2 billion units (0.2%) to 150.3 billion units. In the discount segment, PM USA’s shipment volume decreased 6.2%, while Basic shipment volume was down 5.0% to 14.5 billion units.
  
  The following table summarizes PM USA’s cigarette volume performance by brand for 2006 and 2005:
  
  
                                                           
  
  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. The panel was not designed to capture sales through other channels, including Internet or direct mail:
  
  
                                                           
• European Union: Net revenues, which include excise taxes billed to customers, decreased $122 million (0.5%). Excluding excise taxes, net revenues decreased $609 million (7.2%) to $7.9 billion, due primarily to lower volume/ mix ($254 million), net price decreases ($203 million) and unfavorable currency ($152 million).
  
  Operating companies income decreased $418 million (10.6%), due primarily to lower volume/mix ($243 million), price decreases, net of cost savings ($179 million), the Italian antitrust charge ($61 million) and higher pre-tax charges for asset impairment and exit costs ($55 million), partially offset by lower marketing, administration and research costs ($90 million) and lower fixed manufacturing costs ($29 million).
  
  In the European Union, PMI’s cigarette shipment volume decreased 2.8%. Excluding the inventory sale in Italy, PMI’s volume decreased 1.7% in the European Union due largely to declines in Spain, Portugal, Germany and the Czech Republic, partially offset by gains in France, Hungary and Poland.
  
  In Spain, the total cigarette market was down 2.9%, due primarily to the impact of excise tax increases and a new tobacco law implemented on January 1, 2006. PMI’s shipment volume decreased 12.8%, reflecting increased consumer down-trading to the low-price segment. As a result of growing price gaps, PMI’s market share in Spain declined 2.3 share points to 32.3%. On January 21, 2006, the Spanish government raised excise taxes on cigarettes, which would have resulted in even larger price gaps if the tax increase had been passed on to consumers. Accordingly, PMI reduced its cigarette prices on January 26, 2006 to restore the competitiveness of its brands. In late February, the Spanish government again raised the level of excise taxes, but also established a minimum excise tax, following which PMI raised its prices back to prior levels. On November 10, 2006, the Spanish government announced an increase in the minimum excise tax to 70 euros per thousand cigarettes. Effective December 30, 2006, PMI raised prices on all its brands.
  
  In Portugal, the total cigarette market declined 8.2%, reflecting a tax-driven price increase that resulted in lower overall consumption and higher consumer cross-border purchases in Spain. PMI’s shipment volume decreased 13.0% and market share was down 5.0 share points to 82.0%, due to severe price competition, partially arising from competitors continuing to sell lower-priced product from inventory that was accumulated prior to the tax increase.
  
  In Germany, PMI’s total tobacco volume (which includes other tobacco products) increased 0.9%; however, PMI’s cigarette volume declined 2.8%. Total tobacco consumption in Germany was down 5.9% in 2006, reflecting the decline and ultimate exit of tobacco portions from the market. The total cigarette market decreased 4.0%, affected by the September 2005 tax-driven price increase as well as the sale of illicit cigarettes as reported by the German cigarette manufacturers’ association. PMI’s cigarette market share increased 0.2 share points to 36.9%, driven by the price repositioning of L&M in January 2006. During the fourth quarter of 2005, the European Court of Justice ruled that the German government’s favorable tax treatment of tobacco portions was against EU law. Accordingly, tobacco portions manufactured as of April 1, 2006 now incur the same excise tax as that levied on cigarettes, and as of October 2006, PMI’s shipments of tobacco portions ceased.
  
  In the Czech Republic, shipment volume was down 9.7% and market share was lower, reflecting intense price competition.
  
  In Italy, the total cigarette market rose 1.1% versus a low base in 2005, when it was adversely impacted by the compounding effects of the January 2005 legislation restricting smoking in public places and the December 2004 tax-driven price increase. PMI’s shipment volume in Italy decreased 3.9%, reflecting the one-time inventory sale in 2005. Adjusting for the onetime inventory sale, cigarette shipment volume in Italy increased 1.9%. Market share in Italy increased 1.3 share points to 53.8%, driven by Marlboro, Diana and Chesterfield.
  
  In Poland, shipment volume was up 6.3% and market share increased 2.8 share points to 40.0%, driven by L&M and Next.
  
  In France, shipment volume increased 7.0%, driven by price stability, moderate price gaps and favorable timing of shipments. Market share increased 1.0 share point to 42.7%, reflecting the strong performance of Marlboro and the Philip Morris brand.
• Eastern Europe, Middle East and Africa: Net revenues, which include excise taxes billed to customers, increased $1.1 billion (12.4%). Excluding excise taxes, net revenues increased $563 million (11.2%) to $5.6 billion, due primarily to price increases ($391 million) and higher volume/mix ($195 million), partially offset by unfavorable currency ($23 million).
  
  Operating companies income increased $430 million (26.3%), due primarily to price increases, net of higher costs ($381 million) and higher volume/mix ($130 million), partially offset by higher marketing, administration and research costs ($85 million).
  
  In Eastern Europe, Middle East and Africa, shipment volume increased 1.6%, driven by gains in Russia, Ukraine and Egypt, partially offset by declines in Romania and Turkey. In Russia, shipments were up 3.4%, driven by Marlboro, Muratti, Parliament, and Chesterfield, while market share was down 0.4 share points to 26.6%, due primarily to declines of low-price brands and L&M. Higher shipments in Ukraine mainly reflect higher market share, as well as up-trading to higher margin brands. In Romania, shipments declined 15.1% and market share was down 1.8 share points to 32.3%. In Turkey, shipments declined 3.5%, reflecting the continued decline of low-price Bond Street. However, PMI market share in Turkey rose 1.1 share points to 42.4%, as consumers traded up to its higher margin brands, Parliament and Muratti.
• Asia: Net revenues, which include excise taxes billed to customers, increased $1.5 billion (17.8%). Excluding excise taxes, net revenues increased $612 million (12.4%) to $5.5 billion, due primarily to the impact of acquisitions ($587 million) and price increases ($197 million), partially offset by unfavorable currency ($179 million).
  
  Operating companies income increased $76 million (4.2%), due primarily to the impact of acquisitions ($219 million) and price increases ($185 million), partially offset by unfavorable currency ($188 million), lower volume/mix ($81 million) and higher marketing, administration and research costs ($53 million).
  
  In Asia, shipment volume increased 12.3%, reflecting the acquisition of Sampoerna in Indonesia. Excluding this acquisition, volume in Asia was down 1.0%, due primarily to lower volume in Japan and Thailand. In Japan, the total market declined 4.4%, driven by the July 1, 2006 price increase. Market share in Japan decreased 0.1 share point to 24.7%. Market share in Indonesia grew 1.9 share points to 28.3%, led by A Hijau and A Mild. In Thailand, a lower total market reflected a December 2005 excise tax increase.
• Latin America: Net revenues, which include excise taxes billed to customers, increased $458 million (11.6%). Excluding excise taxes, net revenues increased $215 million (14.0%) to $1.8 billion, due primarily to higher volume/mix ($144 million), the impact of acquisitions ($50 million) and favorable currency ($14 million).
  
  Operating companies income increased $545 million (117.7%), due primarily to a pre-tax gain related to the exchange of PMI’s interest in a beer business in the Dominican Republic ($488 million), higher volume/mix ($37 million), price increases ($23 million) and the impact of acquisitions ($13 million), partially offset by higher marketing, administration and research costs ($24 million).
  
  In Latin America, shipment volume increased 10.8%, driven by strong gains in Argentina and Mexico, as well as higher volume in Colombia due to the 2005 acquisition of Coltabaco. Excluding this acquisition, volume was up 6.3% in Latin America. In Argentina, the total market advanced approximately 7.0%, while PMI shipments grew 15.9% and share was up 4.9 share points, due mainly to the Philip Morris brand. In Mexico, the total market was up approximately 2.0% and PMI shipments grew 6.0%. Market share rose 1.4 share points to 63.5%, reflecting the continued strong performance of Marlboro and Benson & Hedges.