SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-8940
Philip Morris Companies Inc.
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(Exact name of registrant as specified in its charter)
Virginia 13-3260245
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
120 Park Avenue, New York, New York 10017
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (212) 880-5000
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Former name, former address and former fiscal year, if changed since last report
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
At July 31, 1997, there were 2,422,971,412 shares outstanding of the
registrant's common stock, par value $0.33 1/3 per share.
<PAGE>
PHILIP MORRIS COMPANIES INC.
TABLE OF CONTENTS
Page No.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited).
Condensed Consolidated Balance Sheets at
June 30, 1997 and December 31, 1996 3 - 4
Condensed Consolidated Statements of Earnings
For the Six Months Ended June 30, 1997 and 1996 5
For the Three Months Ended June 30, 1997 and 1996 6
Condensed Consolidated Statements of Stockholders'
Equity for the Year Ended December 31, 1996
and the Six Months Ended June 30, 1997 7
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1997 and 1996 8 - 9
Notes to Condensed Consolidated Financial Statements 10 - 25
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 26 - 49
PART II - OTHER INFORMATION
Item 1. Legal Proceedings. 50
Item 6. Exhibits and Reports on Form 8-K. 50
Signature 51
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<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(in millions of dollars)
(Unaudited)
June 30, December 31,
1997 1996
-------- ------------
ASSETS
Consumer products
Cash and cash equivalents $ 317 $ 240
Receivables, net 5,175 4,466
Inventories:
Leaf tobacco 3,868 4,143
Other raw materials 1,985 1,854
Finished product 3,007 3,005
------- -------
8,860 9,002
Other current assets 1,567 1,482
------- -------
Total current assets 15,919 15,190
Property, plant and equipment, at cost 19,929 19,972
Less accumulated depreciation 8,382 8,221
------- -------
11,547 11,751
Goodwill and other intangible assets
(less accumulated amortization of
$4,573 and $4,391) 18,137 18,998
Other assets 3,244 3,015
------- -------
Total consumer products assets 48,847 48,954
Financial services and real estate
Finance assets, net 5,541 5,345
Real estate held for development and sale 325 314
Other assets 259 258
------- -------
Total financial services and
real estate assets 6,125 5,917
------- -------
TOTAL ASSETS $54,972 $54,871
======= =======
See notes to condensed consolidated financial statements.
Continued
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<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Continued)
(in millions of dollars)
(Unaudited)
June 30, December 31,
1997 1996
-------- ------------
LIABILITIES
Consumer products
Short-term borrowings $ 190 $ 260
Current portion of long-term debt 1,727 1,846
Accounts payable 2,428 3,409
Accrued marketing 2,145 2,106
Accrued taxes, except income taxes 1,772 1,331
Other accrued liabilities 3,460 3,668
Income taxes 1,406 1,269
Dividends payable 972 978
-------- --------
Total current liabilities 14,100 14,867
Long-term debt 12,267 11,827
Deferred income taxes 889 731
Accrued postretirement health care costs 2,418 2,372
Other liabilities 5,624 5,773
-------- --------
Total consumer products liabilities 35,298 35,570
Financial services and real estate
Short-term borrowings 425 173
Long-term debt 868 1,134
Deferred income taxes 3,685 3,636
Other liabilities 248 140
-------- --------
Total financial services and
real estate liabilities 5,226 5,083
-------- --------
Total liabilities 40,524 40,653
Contingencies (Note 3)
STOCKHOLDERS' EQUITY
Common stock, par value $0.33 1/3 per share
(2,805,961,317 shares issued) 935 935
Earnings reinvested in the business 24,073 22,478
Currency translation adjustments (657) 192
-------- --------
24,351 23,605
Less cost of repurchased stock
(383,882,002 and 374,615,043 shares) 9,903 9,387
-------- --------
Total stockholders' equity 14,448 14,218
-------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 54,972 $ 54,871
======== ========
See notes to condensed consolidated financial statements.
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<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(in millions, except per share data)
(Unaudited)
For the Six Months Ended
June 30,
------------------------
1997 1996
------- -------
Operating revenues $36,630 $35,000
Cost of sales 13,407 13,405
Excise taxes on products 8,247 7,506
------- -------
Gross profit 14,976 14,089
Marketing, administration and research costs 8,050 7,853
Amortization of goodwill 296 293
------- -------
Operating income 6,630 5,943
Interest and other debt expense, net 566 543
------- -------
Earnings before income taxes 6,064 5,400
Provision for income taxes 2,455 2,214
------- -------
Net earnings $ 3,609 $ 3,186
======= =======
Weighted average number of shares 2,426 2,480
======= =======
Per share data:
Net earnings $ 1.49 $ 1.29
======= =======
Dividends declared $ 0.80 $ 0.67
======= =======
See notes to condensed consolidated financial statements.
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<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(in millions, except per share data)
(Unaudited)
For the Three Months Ended
June 30,
--------------------------
1997 1996
------- -------
Operating revenues $18,413 $17,509
Cost of sales 6,690 6,660
Excise taxes on products 4,123 3,749
------- -------
Gross profit 7,600 7,100
Marketing, administration and research costs 4,089 3,940
Amortization of goodwill 147 146
------- -------
Operating income 3,364 3,014
Interest and other debt expense, net 279 266
------- -------
Earnings before income taxes 3,085 2,748
Provision for income taxes 1,249 1,127
------- -------
Net earnings $ 1,836 $ 1,621
======= =======
Weighted average number of shares 2,423 2,470
======= =======
Per share data:
Net earnings $ 0.76 $ 0.66
======= =======
Dividends declared $ 0.40 $ 0.33
======= =======
See notes to condensed consolidated financial statements.
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<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Stockholders' Equity
for the Year Ended December 31, 1996 and
the Six Months Ended June 30, 1997
(in millions of dollars, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Earnings Total
Reinvested Currency Cost of Stock-
Common in the Translation Repurchased holders'
Stock Business Adjustments Stock Equity
-------- ---------- ----------- ----------- --------
<S> <C> <C> <C> <C> <C>
Balances, January 1, 1996 $ 935 $ 19,779 $ 467 $ (7,196) $ 13,985
Net earnings 6,303 6,303
Exercise of stock options
and issuance of other stock
awards (28) 609 581
Cash dividends declared
($1.47 per share) (3,606) (3,606)
Currency translation adjustments (275) (275)
Stock repurchased (2,800) (2,800)
Net unrealized appreciation
on securities 30 30
-------- -------- -------- -------- --------
Balances, December 31, 1996 935 22,478 192 (9,387) 14,218
Net earnings 3,609 3,609
Exercise of stock options
and issuance of other stock
awards (75) 227 152
Cash dividends declared
($0.80 per share) (1,940) (1,940)
Currency translation adjustments (849) (849)
Stock repurchased (743) (743)
Net unrealized appreciation
on securities 1 1
-------- -------- -------- -------- --------
Balances, June 30, 1997 $ 935 $ 24,073 $ (657) $ (9,903) $ 14,448
======== ======== ======== ======== ========
</TABLE>
See notes to condensed consolidated financial statements.
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<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(in millions of dollars)
(Unaudited)
For the Six Months Ended
June 30,
------------------------
1997 1996
------- -------
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net earnings - Consumer products $ 3,541 $ 3,128
- Financial services and real estate 68 58
------- -------
Net earnings 3,609 3,186
Adjustments to reconcile net earnings to
operating cash flows:
Consumer products
Depreciation and amortization 855 833
Deferred income tax provision 93 160
Gain on sale of businesses (23)
Cash effects of changes, net of the effects
from acquired and divested companies:
Receivables, net (973) (683)
Inventories (147) (211)
Accounts payable (864) (1,035)
Income taxes 324 106
Other working capital items 455 209
Other 151 145
Financial services and real estate
Deferred income tax provision 48 43
Decrease in real estate receivables 25 16
(Increase) decrease in real estate held for
development and sale (11) 13
Other 38 52
------- -------
Operating cash flow before income taxes on
sales of businesses 3,580 2,834
Income taxes on sales of businesses (123) (39)
------- -------
Net cash provided by operating activities 3,457 2,795
------- -------
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
Consumer products
Capital expenditures (745) (688)
Purchases of businesses, net of acquired cash (223) (534)
Proceeds from sales of businesses 164 23
Other (5) 27
Financial services and real estate
Investments in finance assets (328) (191)
Proceeds from finance assets 181 96
------- -------
Net cash used in investing activities (956) (1,267)
------- -------
See notes to condensed consolidated financial statements.
Continued
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<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Continued)
(in millions of dollars)
(Unaudited)
For the Six Months Ended
June 30,
------------------------
1997 1996
------- -------
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
Consumer products
Net (repayment) issuance of short-term borrowings $ (149) $ 1,137
Long-term debt proceeds 1,786 934
Long-term debt repaid (1,277) (625)
Financial services and real estate
Net issuance (repayment) of short-term borrowings 252 (233)
Long-term debt proceeds 174 170
Long-term debt repaid (387)
Repurchase of outstanding stock (805) (1,361)
Dividends paid (1,946) (1,661)
Issuance of shares 58 192
Other (77) (11)
------- -------
Net cash used in financing activities (2,371) (1,458)
Effect of exchange rate changes on cash and
cash equivalents (53) (43)
------- -------
Cash and cash equivalents:
Increase 77 27
Balance at beginning of period 240 1,138
------- -------
Balance at end of period $ 317 $ 1,165
======= =======
See notes to condensed consolidated financial statements.
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<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 1. Accounting Policies:
The interim condensed consolidated financial statements of Philip Morris
Companies Inc. (the "Company") are unaudited. It is the opinion of the Company's
management that all adjustments necessary for a fair statement of the interim
results presented have been reflected therein. All such adjustments were of a
normal recurring nature. Operating revenues and net earnings for any interim
period are not necessarily indicative of results that may be expected for the
entire year.
These statements should be read in conjunction with the consolidated financial
statements and related notes which appear in the Company's annual report to
stockholders and which are incorporated by reference into the Company's Annual
Report on Form 10-K for the year ended December 31, 1996.
Balance sheet accounts are segregated by two broad types of business. Consumer
products assets and liabilities are classified as either current or non-current,
whereas financial services and real estate assets and liabilities are
unclassified, in accordance with respective industry practices.
Note 2. Capital Stock:
On February 26, 1997, the Company's Board of Directors declared a three-for-one
split of the Company's common stock, effected by a distribution on April 10,
1997, of two shares for each share held of record at the close of business on
March 17, 1997. In addition, the par value of the Company's common stock was
changed from $1.00 to $0.33 1/3 per share and authorized shares of common stock
were increased from 4 billion to 12 billion shares. All share and per share data
have been restated to reflect this stock split for all periods presented.
Note 3. Contingencies:
Legal proceedings covering a wide range of matters are pending in various U.S.
and foreign jurisdictions against the Company and its subsidiaries, including
Philip Morris Incorporated ("PM Inc."), the Company's domestic tobacco
subsidiary. Various types of claims are raised in these proceedings, including
products liability, consumer protection, antitrust, securities law, tax, patent
infringement and employment matters.
Pending claims related to tobacco products generally fall within three
categories: (i) smoking and health cases alleging personal injury brought on
behalf of individual smokers, (ii) smoking and health cases alleging personal
injury and purporting to be brought on behalf of a class of plaintiffs, and
(iii) health care cost recovery actions brought by state and local governments,
unions and others seeking reimbursement for Medicaid and other health care
expenditures allegedly caused by cigarette smoking.
In the individual and class action smoking and health cases pending against PM
Inc. and, in some cases, the Company and/or certain of its other subsidiaries,
plaintiffs allege "addiction" to cigarette smoking, personal injury resulting
from cigarette smoking and/or exposure to environmental tobacco smoke ("ETS")
and seek various forms of relief, including compensatory damages, creation of a
medical monitoring fund, disgorgement of profits, various injunctive and
equitable relief, and, in some cases, punitive damages in amounts ranging into
the billions of dollars. Recently, there has been a substantial increase in the
number of such smoking and health cases in the United States, with many of the
new cases having been filed in Florida on behalf of individual plaintiffs. As of
August 1, 1997, there were approximately 305 smoking and health cases filed and
served on behalf of individual plaintiffs in the United States against PM Inc.
and, in some cases, the Company (excluding approximately 25 cases in Texas that
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<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
were recently voluntarily dismissed but which may be refiled under certain
conditions), compared to approximately 190 such cases as of March 31, 1997, and
approximately 150 such cases as of March 31, 1996. Approximately 150 of the
cases filed and served as of August 1, 1997, were filed on behalf of individual
plaintiffs in the State of Florida. Seventeen of the individual cases involve
allegations of various personal injuries allegedly related to exposure to ETS.
In addition to the foregoing individual smoking and health cases, as of August
1, 1997, there were approximately 40 purported smoking and health class actions
pending in the United States against PM Inc. and, in some cases, the Company (as
compared to 25 on March 31, 1997), including three that involve allegations of
various personal injuries related to exposure to ETS. Most of these actions
purport to constitute statewide class actions and were filed after the Fifth
Circuit Court of Appeals, in the Castano case, reversed a federal district
court's certification of a purported nationwide class action on behalf of
persons who were allegedly "addicted" to tobacco products. One purported smoking
and health class action is pending in Canada (against an entity in which the
Company, through subsidiaries, owns a 40% interest) and another in Brazil
against affiliates of the Company.
As of August 1, 1997, approximately 75 health care cost recovery actions were
pending compared to approximately 30 on March 31, 1997. In California,
individuals and local governments and other organizations purportedly acting as
"private attorneys general" have filed suits seeking, among other things,
injunctive relief, restitution and disgorgement of profits for alleged
violations of California's consumer protection statutes.
In August 1996, a Florida jury awarded a former smoker and his spouse $750,000
in a smoking and health case against another United States cigarette
manufacturer (Carter v. American Tobacco Co., et al.), and that manufacturer was
subsequently ordered to pay approximately $1.8 million in attorneys fees and
costs. Neither PM Inc. nor the Company was a party to that litigation. Defendant
in that action has appealed the verdict. Later that month, a jury returned a
verdict for defendants in a smoking and health case in Indiana against United
States cigarette manufacturers, including PM Inc. (Rogers v. R.J. Reynolds
Tobacco Company, et al.). Plaintiff has appealed the verdict. In May 1997, a
Florida jury returned a verdict for defendants in a smoking and health case
involving another United States cigarette manufacturer (Connor v. R.J. Reynolds
Tobacco Company).
A number of smoking and health cases and health care cost recovery actions
pending against PM Inc. and, in some cases, the Company, are scheduled for trial
in 1997, although trial dates are subject to change. The first phase of a class
action suit on behalf of flight attendants alleging injury caused by exposure to
ETS aboard aircraft is currently being tried in Florida state court (Broin, et
al. v. Philip Morris Incorporated, et al.). This initial phase tries certain
"common issues" other than liability and compensatory damages. A class action on
behalf of Florida residents who allege injuries from alleged nicotine
"addiction," originally set for trial in September 1997, has been postponed
pending the conclusion of the first phase of the Broin trial (Engle, et al. v.
R.J. Reynolds Tobacco Company, et al.). A lawsuit on behalf of certain
Pennsylvania residents alleging "addiction" and seeking medical monitoring is
set for trial in October 1997 (Barnes (formerly Arch), et al. v. The American
Tobacco Company Inc., et al.). Jury selection in Florida's health care cost
recovery action began on August 1, 1997, and the trial of the Texas health care
recovery suit is scheduled to begin in September of this year. In addition, two
cases brought on behalf of individual smokers in which PM Inc. is a defendant
are currently scheduled for trial in September and December 1997.
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<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Recently, PM Inc. and other companies in the domestic tobacco industry entered
into Memoranda of Understanding to settle Mississippi's health care cost
recovery action and to support the adoption of federal legislation that, if
enacted, would resolve many of the regulatory and litigation issues affecting
the domestic tobacco industry. These developments are more fully discussed below
under the headings "Health Care Cost Recovery Litigation -- Mississippi" and
"Proposed Resolution of Certain Regulatory and Litigation Issues."
A description of certain recent developments in smoking and health class
actions, health care cost recovery litigation and certain other actions pending
against the Company and/or its subsidiaries and affiliates follows.
SMOKING AND HEALTH LITIGATION
Plaintiffs' allegations of liability in smoking and health cases are based on
various theories of recovery, including negligence, gross negligence, strict
liability, fraud, misrepresentation, design defect, failure to warn, breach of
express and implied warranties, conspiracy, concert of action, violations of
deceptive trade practice laws and consumer protection statutes, and claims under
the federal Racketeer Influenced and Corrupt Organization Act ("RICO") and state
RICO statutes. Defenses raised by defendants in these cases include lack of
proximate cause, assumption of the risk, comparative fault and/or contributory
negligence, statutes of limitations or repose, and preemption by the Federal
Cigarette Labeling and Advertising Act, as amended (the "Labeling Act"). In June
1992, the United States Supreme Court held that the Labeling Act, as enacted in
1965, does not preempt common law damage claims but that the Labeling Act, as
amended in 1969, preempts claims arising after July 1969 against cigarette
manufacturers "based on failure to warn and the neutralization of federally
mandated warnings to the extent that those claims rely on omissions or
inclusions in advertising or promotions." The Court also held that the 1969
Labeling Act does not preempt claims based on express warranty, fraudulent
misrepresentation or conspiracy. The Court also held that claims for fraudulent
concealment were preempted except "insofar as those claims relied on a duty to
disclose...facts through channels of communication other than advertising or
promotion." (The Court did not consider whether such common law damage claims
were valid under state law.) The Court's decision was announced by a plurality
opinion. The effect of the decision on pending and future cases will be the
subject of further proceedings in the lower federal and state courts. Additional
similar litigation could be encouraged if legislation to eliminate the federal
preemption defense, proposed in Congress in recent years, were enacted. It is
not possible to predict whether any such legislation will be enacted.
Recently Filed Smoking and Health Class Actions
Since March 31, 1997 through August 1, 1997, the following smoking and health
class actions have been filed against PM Inc. and, in some cases, the Company:
Insolia, et al. v. Philip Morris Incorporated, et al., United States District
Court, Western District of Wisconsin, filed April 21, 1997.
Geiger, et al. v. The American Tobacco Company, et al., Supreme Court of the
State of New York, County of Queens, filed April 30, 1997.
Cole, et al. v. The Tobacco Institute, Inc., et al., United States District
Court, Eastern District of Texas, filed May 5, 1997.
Clay, et al. v. The American Tobacco Company, Inc., et al., United States
District Court, Southern District of Illinois, filed May 22, 1997.
Anderson, et al. v. The American Tobacco Company, Inc., et al., United States
District Court, Eastern District of Tennessee, filed May 23, 1997.
Taylor, et al. v. The American Tobacco Company, Inc., et al., United States
District Court, Eastern District of Michigan, filed May 23, 1997.
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<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Lyons, et al. v. Brown & Williamson Tobacco Corporation, et al., United States
District Court, Northern District of Georgia, filed May 27, 1997.
Cosentino, et al. v. Philip Morris Incorporated, et al., Superior Court of New
Jersey, Law Division: Middlesex County, filed May 28, 1997.
Enright, et al. v. American Tobacco Company, Inc., et al., Superior Court of New
Jersey, Law Division: Camden County, filed May 28, 1997.
Tepper, et al. v. Philip Morris Incorporated, et al., Superior Court of New
Jersey, Law Division: Bergen County, filed May 28, 1997.
Langdeau, et al. v. The American Tobacco Company, et al., Tribal Court, Lower
Brule Sioux Tribe, Lower Brule, South Dakota, filed June 4, 1997.
Thomas v. American Tobacco Company, Inc., et al., United States District Court,
Eastern District of Michigan, filed June 6, 1997.
Brown, et al. v. The American Tobacco Company, Inc., et al., Superior Court, San
Diego County, California, filed June 10, 1997.
Lippincott, et al. v. American Tobacco, et al., Superior Court of New Jersey,
Law Division: Camden County, filed June 13, 1997.
Brammer, et al. v. R.J. Reynolds Tobacco Company, et al., United States District
Court, Southern District of Iowa, filed June 20, 1997.
Knowles, et al. v. The American Tobacco Company, et al., United States District
Court, Eastern District of Louisiana, filed June 30, 1997.
Daley, et al. v. American Brands, Inc., et al., Circuit Court, Cook County,
Illinois, filed July 7, 1997.
Certain Developments in Smoking and Health Class Actions
In addition to the recently filed smoking and health class actions listed above,
since March 31, 1997, there have been certain developments in the smoking and
health class actions.
Broin -- The first phase of this class action trial, which involves certain
"common issues" other than liability and compensatory damages, began in June
1997 and is continuing. If plaintiffs prevail in the first phase of the trial,
subsequent phases will address issues relating to the resolution of "individual"
issues, including liability and causation, and the amount of punitive damages,
if any. The class, as certified by the court, consists of "all non-smoking
flight attendants who are or have been employed by airlines based in the United
States" and who are allegedly suffering various injuries claimed to be caused by
exposure to ETS aboard aircraft. In May 1997, the court denied defendants'
motion for class decertification, denied a motion for summary judgment as to
plaintiffs' fraud and conspiracy claims and denied defendants' challenge to
plaintiffs' punitive damages claim. Defendants have petitioned the Florida
Supreme Court to review the trial court's punitive damages ruling. Broin, et al.
v. Philip Morris Incorporated, et al., Circuit Court, Dade County, Florida,
filed October 31, 1991.
Engle -- The trial of this class action, originally scheduled to begin in
September 1997, has been postponed pending the conclusion of the first phase of
the Broin trial. The class, as certified by the court, consists of all Florida
citizens and residents and their survivors who have suffered injury "caused by
their addiction to cigarettes that contain nicotine." In May 1997, the court
agreed to reconsider its earlier order granting partial summary judgment on the
grounds that certain of plaintiffs' claims were preempted by the Labeling Act.
Plaintiffs' claim for medical monitoring was dismissed by the court in July
1997. Engle, et al. v. R.J. Reynolds Tobacco Company, et al., Circuit Court,
Dade County, Florida, filed May 5, 1994.
Barnes (formerly Arch) -- The trial in this case is scheduled to begin in
October 1997. In June 1997, the court denied plaintiffs' motion to certify a
class on behalf of Pennsylvania residents seeking medical monitoring and other
damages for
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<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
"addiction." Plaintiffs have filed a renewed motion for certification of a
medical monitoring class. Barnes, et al. v. The American Tobacco Company Inc.
et al., United States District Court, Eastern District of Pennsylvania, filed
August 8, 1996.
Scott -- In April 1997, the state court judge certified a class consisting of
certain Louisiana residents who are or were smokers and who desire to
participate in smoking cessation and/or medical monitoring programs. Defendants
subsequently removed this case to federal court and filed a motion for
reconsideration of the class certification, which is pending. Scott, et al. v.
The American Tobacco Company, Inc., et al., United States District Court,
Eastern District of Louisiana, filed May 24, 1996.
Frosina -- It is anticipated that the trial of this purported class action,
originally scheduled to begin in November 1997, will commence during the first
quarter of 1998. Frosina, et al. v. Philip Morris, Inc., et al., Supreme Court
of the State of New York, County of New York, filed June 19, 1996.
Geiger -- In July 1997, the court entered an order granting interim
certification of a class consisting of residents of the State of New York who
have been diagnosed with lung cancer and throat cancer and denied defendants'
motion to dismiss. Geiger, et al. v. The American Tobacco Company, et al.,
Supreme Court of the State of New York, County of Queens, filed May 1, 1997.
HEALTH CARE COST RECOVERY LITIGATION
In certain of the pending proceedings, foreign, state and local government
entities, unions, taxpayers, Native American tribes and others seek
reimbursement for Medicaid and/or other health care expenditures allegedly
caused by tobacco products. In one purported class action, Blue Cross/Blue
Shield subscribers in the United States are seeking reimbursement of allegedly
increased medical insurance premiums caused by tobacco products. In the Native
American cases claims are also asserted for alleged lost productivity of tribal
government employees. Other relief sought by some but not all plaintiffs
includes punitive damages, treble damages for alleged antitrust law violations,
injunctions prohibiting alleged marketing and sales to minors, disclosure of
research, disgorgement of profits, funding of anti-smoking programs, disclosure
of nicotine yields and payment of attorney and expert witness fees.
The claims asserted in these health care cost recovery actions vary. In most of
these cases plaintiffs assert the equitable claim that the tobacco industry was
"unjustly enriched" by plaintiffs' payment of health care costs allegedly
attributable to smoking and seek reimbursement of those costs. Other claims made
by some but not all plaintiffs include the equitable claim of indemnity, common
law claims of negligence, strict liability, breach of express and implied
warranty, violation of a voluntary undertaking or special duty, fraud, negligent
misrepresentation, conspiracy, public nuisance, claims under federal and state
statutes governing consumer fraud, antitrust, deceptive trade practices and
false advertising, and claims under federal and state RICO statutes.
Defenses raised by defendants include failure to state a valid claim, lack of
benefit, adequate remedy at law, "unclean hands" (namely, that plaintiffs cannot
recover because they participated in, and benefited from, the sale of
cigarettes), lack of antitrust injury, federal preemption, lack of proximate
cause and statute of limitations. In addition, defendants argue that they should
be entitled to "set-off" any alleged damages to the extent the plaintiff
benefits economically from the sale of cigarettes through the receipt of excise
taxes or otherwise. Defendants also argue that these cases are improper because
plaintiffs must proceed under principles of subrogation and assignment. Under
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<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
traditional theories of recovery, a payor of medical costs (such as an insurer
or a state) can seek recovery of health care costs from a third party solely by
"standing in the shoes" of the injured party. Defendants argue that plaintiffs
should be required to bring an action on behalf of each individual health care
recipient and should be subject to all defenses available against the injured
party. In certain of these cases, defendants have also challenged the ability of
the plaintiffs to use contingency fee counsel to prosecute these actions.
Further, certain cigarette companies, including PM Inc., have filed declaratory
judgment actions in Massachusetts, Texas, Maryland, Connecticut, Utah, New
Jersey, Alaska and Hawaii seeking to block the health care cost recovery actions
in those states and/or to prevent the state from hiring contingency fee counsel.
The Maryland, New Jersey and Connecticut actions have been dismissed. The
plaintiff tobacco companies are appealing these dismissals.
Recently Filed Health Care Cost Recovery Actions
Since March 31, 1997 through August 1, 1997, the following health care cost
recovery actions have been filed against PM Inc. and, in some cases, the
Company.
State of Alaska v. Philip Morris, Incorporated, et al., Superior Court for the
State of Alaska, First Judicial District at Juneau, filed April 14, 1997.
County of Cook v. Philip Morris Inc., et al., United States District Court,
Northern District of Illinois, filed April 18, 1997.
White, et al. v. Philip Morris Inc., et al., United States District Court,
Southern District of Mississippi, filed April 18, 1997.
Commonwealth of Pennsylvania v. Philip Morris Inc., et al., Court of Common
Pleas, Philadelphia County, Pennsylvania, filed April 23, 1997.
Stationary Engineers Local 39 Health and Welfare Trust, et al. v. Philip Morris,
Inc., et al., United States District Court, Northern District of
California, filed April 25, 1997.
State of Arkansas v. The American Tobacco Company, Inc., et al., Chancery Court,
Sixth Division, Pulaski County, Arkansas, filed May 5, 1997.
State of Montana v. Philip Morris Incorporated, et al., District Court, Lewis
and Clark County, Montana, filed May 5, 1997.
Beckom, et al. v. The American Tobacco Company, Inc., et al., United States
District Court, Eastern District of Tennessee, May 8, 1997.
State of Ohio v. Philip Morris Incorporated, et al., Court of Common Pleas,
Franklin County, Ohio, filed May 8, 1997.
State of Missouri v. American Tobacco Company, Inc., et al., Circuit Court of
the City of St. Louis, Missouri, filed May 12, 1997.
State of South Carolina v. Brown & Williamson Tobacco Corporation, et al., Court
of Common Pleas, Richland County, South Carolina, filed May 12, 1997.
Iron Workers Local Union No. 17 Insurance Fund, et al. v. Philip Morris Inc.,
et al., United States District Court, Northern District of Ohio, filed May
20, 1997.
State of Nevada v. Philip Morris Incorporated, et al., Second Judicial District,
Washoe County, Nevada, filed May 21, 1997.
Northwest Laborers-Employers Health and Security Trust Fund, et al. v. Philip
Morris Inc., et al., United States District Court, Western District of
Washington, filed May 21, 1997.
University of South Alabama v. The American Tobacco Company, et al., United
States District Court, Southern District of Alabama, filed May 23, 1997.
City of Birmingham, Alabama, and The Green County Racing Commission v. The
American Tobacco Company, et al., United States District Court, Northern
District of Alabama, filed May 28, 1997.
State of New Mexico v. The American Tobacco Company, et al., First Judicial
District Court, County of Santa Fe, New Mexico, filed May 27, 1997.
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
The Lower Brule Sioux Tribe, et al. v. The American Tobacco Company, et al.,
Tribal Court, Lower Brule Sioux Tribe, Lower Brule, South Dakota, filed
May 28, 1997.
State of Vermont v. Philip Morris Incorporated, et al., Chittenden County,
Superior Court, Vermont, filed May 29, 1997.
Unpingco, et al. v. The American Tobacco Company, et al., United States District
Court, Territory of Guam, filed May 29, 1997.
Central Illinois Carpenters Health & Welfare Trust Fund, et al. v. Philip Morris
Inc., et al., United States District Court, Southern District of Illinois,
filed May 30, 1997.
Massachusetts Laborers' Health & Welfare Fund, et al. v. Philip Morris Inc., et
al., Commonwealth of Massachusetts Superior Court, County of Suffolk,
filed June 2, 1997.
State of New Hampshire v. R.J. Reynolds Tobacco Company, et al., New Hampshire
Superior Court, County of Merrimack, filed June 4, 1997.
State of Colorado v. R.J. Reynolds Tobacco Co., et al., District Court, City and
County of Denver, Colorado, filed June 5, 1997.
State of Idaho v. Philip Morris Inc., et al., District Court, 4th Judicial
District of the State of Idaho, County of Ada, filed June 9, 1997.
State of Oregon v. The American Tobacco Company, et al., Oregon Circuit Court,
Multnomah County, Oregon, filed June 9, 1997.
The Crow Tribe v. The American Tobacco Company, Inc., et al., Tribal Court,
Montana, filed June 10, 1997.
People of the State of California, et al. v. Philip Morris, Inc., et al.,
Superior Court, Sacramento County, California, filed June 12, 1997.
Hawaii Health & Welfare Trust Fund for Operating Engineers, et al. v. Philip
Morris Inc., et al., United States District Court, District of Hawaii,
filed June 13, 1997.
Rossello, et al. v. Brown & Williamson Tobacco Corporation, et al., United
States District Court, Puerto Rico, filed June 17, 1997.
State of Maine, et al. v. Philip Morris Incorporated, et al., State of Maine
Superior Court, County of Kennebec, filed June 17, 1997.
State of Rhode Island v. American Tobacco Company, Inc., et al., Superior Court,
Providence County, Rhode Island, filed June 17, 1997.
The Citizens of the Republic of the Marshall Islands v. The American Tobacco
Company, et al., United States District Court, Hawaii, filed June 18,
1997.
Oregon Labor-Employers Health & Welfare Trust Fund, et al. v. Philip Morris
Inc., et al., United States District Court, District of Oregon, filed June
18, 1997.
Laborers Local 17 Health and Benefit Fund, et al. v. Philip Morris Inc., et al.,
United States District Court, Southern District of New York, filed June
19, 1997.
The Ark-La-Miss Laborers Welfare Fund, et al. v. Philip Morris, Inc., et al.,
United States District Court, Eastern District of Louisiana, filed June
20, 1997.
The Iowa Laborers District Council Health & Welfare Fund, et al. v. Philip
Morris, Inc., et al., United States District Court, Central District of
Iowa, filed June 20, 1997.
Kentucky Laborers District Council Health & Welfare Trust Fund, et al. v. Hill &
Knowlton, Inc., et al., United States District Court, Western District of
Kentucky, filed June 20, 1997.
The Muscogee Creek Nation, et al. v. The American Tobacco Company, et al.,
Muscogee Creek Nation Tribal Court, Okmulgee District, filed June 20,
1997.
The Chehalis Tribe, et al. v. The American Tobacco Company, et al., Chehalis
Tribal Court, Oakville, Washington, filed June 23, 1997.
United Federation of Teachers Welfare Fund, et al. v. Philip Morris Inc., et
al., United States District Court, Southern District of New York, filed
June 25, 1997.
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Connecticut Pipe Trades Health Fund, et al. v. Philip Morris Inc., et al.,
United States District Court, District of Connecticut, filed July 1, 1997.
Seafarers Welfare Plan, et al. v. Philip Morris Inc., et al., United States
District Court, District of Maryland, filed July 2, 1997.
Laborers' and Operating Engineers' Utility Agreement Health and Welfare Trust
Fund for Arizona, et al. v. Philip Morris, Inc., et al., United States
District Court, District of Arizona, filed July 7, 1997.
Woods v. The American Tobacco Company, et al., Superior Court, Wake County,
North Carolina, filed July 10, 1997.
West Virginia Laborers Pension Fund, et al. v. Philip Morris Inc., et al.,
United States District Court, Southern District of West Virginia, filed
July 11, 1997.
Rhode Island Laborers Health & Welfare Funds v. Philip Morris Incorporated,
Superior Court, Providence County, Rhode Island, filed July 20, 1997.
In addition to these actions, other foreign, state and local government entities
and others, including unions, have announced they are considering filing health
care cost recovery actions.
Certain Developments in Health Care Cost Recovery Actions
In addition to the recently filed health care cost recovery actions listed
above, since March 31, 1997, there have been certain developments in the health
care cost recovery actions.
Florida -- Jury selection in Florida's health care cost recovery action began on
August 1, 1997. That case was filed under Florida's Medicaid recovery statute
("MRS"), which was enacted in May 1994, and which purports, among other things,
to abolish affirmative defenses normally available in Medicaid recovery actions.
In June 1996, the Florida Supreme Court ruled that the provisions of the MRS
that permitted the state to pursue its action without identifying individual
Medicaid recipients violated defendants' due process rights under the Florida
constitution and that defendants may rebut the state's claims of causation and
damages on a recipient-by-recipient basis. The court held constitutional on its
face the statutory provision abolishing affirmative defenses normally available
to a third party, including assumption of the risk, but stated that this
provision could be challenged as unconstitutional as applied in the state's
case. The court also held that the state's independent cause of action created
by the MRS could apply only to Medicaid costs paid after the amendment became
effective in July 1994, that, if liable, each defendant's share of the total
damages would be based on its market share, that the state could use statistical
evidence to present its case, and that the agency charged with enforcing the
statute was constitutionally established. In March 1997, the United States
Supreme Court denied a petition for a writ of certiorari filed by PM Inc. and
others challenging the MRS as violating due process. Associated Industries of
Florida, Inc., et al. v. State of Florida Agency for Health Care Administration,
et al., Circuit Court, Leon County, Florida, filed June 30, 1994.
In September 1996, the trial court in Florida's health care cost recovery action
dismissed all of the state's claims except for its negligence and strict
liability counts arising from Medicaid payments made after July 1, 1994, and its
count for injunctive relief. The court also ordered the state to disclose the
identity of the Medicaid recipients. Thereafter, the state filed a coded listing
(without names) for all Medicaid recipients with alleged smoking-related
illnesses. The trial court accepted the coded listing and, in January 1997, the
Florida Supreme Court determined not to hear and denied defendants' challenge to
the sufficiency of the state's purported identification of Medicaid recipients.
In November 1996, plaintiffs amended their complaint to add claims for
violations of Florida's RICO and consumer protection statutes. In December 1996,
the court
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
granted defendants' motion to dismiss various claims brought under state
statutes and denied the motion to dismiss claims based on Florida's RICO statute
and on a state false advertising statute. In January 1997, defendants waived
their rights to a pretrial determination of whether plaintiffs can amend their
complaint to include a punitive damages claim. Defendants have reserved their
rights to challenge the punitive damages claim on factual or legal bases. In
February 1997, the court granted plaintiffs' motion to strike all of defendants'
affirmative defenses to the counts brought under the MRS. In response to
defendants' motion for reconsideration, the court permitted certain of the
affirmative defenses to be asserted. The court granted defendants leave to file
a new set of affirmative defenses. Plaintiffs moved to strike all of the
defenses. That motion was granted in part and denied in part. The court also
ruled that defendants are entitled to the names of the individual Medicaid
recipients whose medical expenses form the basis of the state's damages and that
defendants may depose and obtain the medical records of twenty-five recipients
of defendants' choice. In March 1997, the court granted defendants' motion to
file a third-party complaint against the state on the ground that the state
manufactured and sold cigarettes and, in May 1997, the court denied plaintiffs'
motion to dismiss the third-party complaint. In May 1997, the court denied
defendants' motion to limit the initial trial to the medical expenditures made
to treat the twenty-five Medicaid recipients deposed by defendants. In June and
July 1997, the court issued a number of rulings, including (i) that plaintiffs
could not recover for future damages under the MRS, (ii) that plaintiffs could
not proceed under the MRS on a claim that cigarettes are inherently defective,
(iii) that plaintiffs' claims under the MRS are limited to allegations of
misrepresentation, failure to warn and failure to design a "safer" cigarette,
(iv) that plaintiffs could not seek punitive damages under the MRS, but may
pursue such damages only in connection with their misleading advertising claim,
and (v) that the statute of repose barred claims under Florida's false
advertising statute based on conduct before July 1, 1982. The court also (i)
granted defendants' motion for partial summary judgment for lack of proximate
cause with respect to plaintiffs' claim of "regulatory fraud" (fraud on
governmental entities or officials), but denied the motion as to plaintiffs'
proof of causation and damages and as to claims of negligence and strict
liability based on the product liability statute of repose, (ii) denied
defendants' motion for summary judgment with respect to plaintiffs' claim for
compensatory damages under Florida's false advertising and racketeering statutes
for the federal government's share of Medicaid expenses in Florida, (iii) denied
defendants' motion for summary judgment challenging plaintiffs' statistical
models to be used in establishing their damages claims, and (iv) denied
defendants' motion for summary judgment based on federal preemption, except to
the extent that plaintiffs specifically attack any "actual advertising" or
"promotion" or attack the adequacy of the federal warning labels. The court also
granted plaintiffs' motions to (i) preclude evidence of the state's awareness
and the public's awareness of the risks of smoking in response to claims under
the MRS, (ii) exclude evidence of the state's manufacture of cigarettes and
evidence of benefits derived by the state from the sale of cigarettes, including
excise taxes, (iii) preclude the use of the depositions of Medicaid recipients
unless defendants first make a specific showing of relevance to the court, and
(iv) strike defendants' due process defense to the false advertising and
racketeering act counts. In other rulings the court denied plaintiffs' motion
for summary judgment on racketeering act claims (but held that plaintiffs could
seek disgorgement and equitable relief pursuant to the racketeering act) and
held that the equitable defenses of "unclean hands" and laches could only be
raised in post-trial proceedings with respect to the equitable count. The State
of Florida, et al. v. The American Tobacco Company, et al., Circuit Court, Palm
Beach County, Florida, filed February 21, 1995.
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Mississippi -- In July 1997, together with other companies in the United States
tobacco industry, PM Inc. entered into a Memorandum of Understanding (the "MOU")
with the State of Mississippi setting forth the principal terms and conditions
of an agreement in principle to settle and resolve with finality all present and
future claims relating to the subject matter of Mississippi's health care cost
recovery action pending against PM Inc. and others. Moore v. The American
Tobacco Company, et al., Chancery Court of Jackson County, Mississippi, filed
May 23, 1994.
Under the MOU, the parties have petitioned the Chancery Court of Jackson County,
Mississippi to adjourn all further proceedings in contemplation of their final
resolution and termination pursuant to the MOU and the Settlement Agreement
contemplated thereby. In addition, the settling defendants have deposited in an
escrow account (the "Escrow") $170 million, representing the state's estimate of
its share of the $10 billion initial payment under the Resolution discussed
below under the heading "Proposed Resolution of Certain Regulatory and
Litigation Issues," and have paid an additional $15 million (subject to later
adjustment) to reimburse the state and its attorneys for legal expenses. PM
Inc.'s share of these payments was approximately $122 million. Under the MOU the
parties agree that the Settlement Agreement will include the terms summarized
below.
Beginning December 31, 1998, the settling defendants will pay into the Escrow
1.7% of that portion of the annual industry payments under the Resolution which
is contemplated to be paid to the states. These payments, which are not offset
by potential credits for civil tort liability and which would be adjusted as
provided in the Resolution, could result in payments to the State of Mississippi
of $68 million with respect to 1998 and $76.6 million with respect to 1999.
These amounts would increase to $136 million with respect to 2003 and would
continue at that level thereafter. The settling defendants will also be
responsible for the attorneys' fees of counsel for Mississippi (which will be
set by a panel of arbitrators). Each of these payments would be allocated among
the settling defendants in accordance with their relative volume of domestic
cigarette sales.
If legislation implementing the proposed resolution described below under the
heading "Proposed Resolution of Certain Regulatory and Litigation Issues" or its
substantial equivalent is enacted, the Settlement Agreement will remain in
place, but the terms of the federal legislation will supersede the Settlement
Agreement and the foregoing payment amounts will be adjusted so that the state
would receive the same payment as it would receive under the proposed
resolution. Similar provision is made in the event of multiple settlements of
non-federal governmental health care cost recovery actions, provided that
Mississippi is entitled to treatment at least as relatively favorable as such
other non-federal governmental entities.
Maryland -- In May 1997, the court dismissed all of plaintiff's claims other
than those based on antitrust and consumer protection theories and held that
plaintiff is limited to its statutory remedy of subrogation. Trial is scheduled
for January 1999. State of Maryland v. Philip Morris Incorporated, et al.,
Circuit Court for Baltimore County, Maryland, filed May 1, 1996.
Washington -- In November 1996, the court dismissed plaintiff's claims based on
special duty, unjust enrichment and restitution to the state, but did not
dismiss claims brought under Washington's antitrust laws. The State of
Washington then filed an amended complaint in an attempt to cure the
deficiencies found by the court to exist in the special duty and unjust
enrichment claims and to expand the state's claims for relief to include
disgorgement of profits under Washington's consumer protection statute. In June
1997, the court dismissed claims of special
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
duty and unjust enrichment and the expanded claim of disgorgement of profits and
plaintiff is appealing that ruling. Trial is scheduled for September 1998. State
of Washington v. American Tobacco Co., Inc., et al., Superior Court of
Washington, King County, filed June 5, 1996.
Los Angeles County -- In April 1997, the court dismissed plaintiffs' fraud
claims without leave to amend, but denied defendants' motion to dismiss
plaintiffs' claim for breach of express warranty. County of Los Angeles v. R.J.
Reynolds Tobacco Company, et al., Superior Court of California, San Diego
County, filed August 5, 1996.
Michigan -- In May 1997, the court granted plaintiff's motion, which contended
that statutory subrogation is not the exclusive remedy to be pursued by the
state (although the court appeared to hold that statutory and common law
subrogation were the only theories available to the state to recover damages).
In addition, the court dismissed certain of defendants' affirmative defenses
under Michigan's consumer protection statute, dismissed plaintiff's antitrust
claim, dismissed, with leave to amend, plaintiff's claims of breach of special
duty and injunctive relief, and dismissed plaintiff's claims for punitive
damages. Frank J. Kelley, Attorney General, ex rel. State of Michigan v. Philip
Morris, Incorporated, et al., Circuit Court for the 30th Judicial Circuit,
Ingham County, Michigan, filed August 21, 1996.
Arizona -- After being instructed by the Governor of Arizona to dismiss the
case, the attorney general filed an amended complaint that abandons claims for
Medicaid payments, but seeks recovery of other health care costs as well as
other damages and forms of relief. In May 1997, the court granted defendants'
motion to dismiss plaintiffs' claims of breach of assumed duty and performance
of another's duty to the public, negligence per se, public nuisance, and unjust
enrichment and restitution and denied defendants' dismissal motion with respect
to plaintiff's claims for antitrust violations, fraud and violations of a
deceptive trade practices statute. In July 1997, the court granted defendants'
motion to dismiss plaintiffs' RICO claim without prejudice. Trial is scheduled
for October 1998. State of Arizona, et al. v. American Tobacco Co., Inc., et
al., Superior Court, Maricopa County, Arizona, filed August 20, 1996.
University of South Alabama -- In June 1997, the attorney general filed a notice
of dismissal contending that plaintiff, as an instrumentality of the state, does
not have authority to bring this action on its own behalf. This action was
dismissed by the court on August 12, 1997. University of South Alabama v. The
American Tobacco Company, et al., United States District Court, Southern
District of Alabama, filed May 19, 1997.
CERTAIN OTHER ACTIONS
In April 1994, the Company, PM Inc. and certain officers and directors were
named as defendants in several purported class actions that were consolidated in
the United States District Court in the Southern District of New York. Kurzweil,
et al. v. Philip Morris Companies Inc., et al., United States District Court for
the Southern District of New York, filed April 4, 1994 and State Board of
Administration of Florida, et al. v. Philip Morris Companies Inc., et al.,
United States District Court for the Southern District of New York, filed
September 7, 1994. In those cases, plaintiffs asserted that defendants violated
federal securities laws by, among other things, making allegedly false and
misleading statements regarding the allegedly "addictive" qualities of
cigarettes. In each case, plaintiffs claimed to have been misled by defendants'
knowing and intentional failure to disclose material information. In September
1995, the court granted defendants' motion to dismiss the two complaints in
their entirety. The court granted plaintiff in the State Board action leave to
replead one of its
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
claims. In April 1996, the court entered an order stipulating the dismissal of
the State Board claims. In August 1996, the court entered judgment dismissing
the claims in Kurzweil. In April 1997, the district court granted a motion filed
by the Kurzweil plaintiffs to vacate the judgment and for leave to amend their
complaint. Defendants' appeal of this ruling was dismissed by the Court of
Appeals on August 5, 1997, for lack of appellate jurisdiction.
Since April 1996, five purported class action suits have been filed in
Wisconsin, alleging that Kraft Foods, Inc. ("Kraft") and others engaged in a
conspiracy to fix and depress the prices of bulk cheese and milk through their
trading activity on the National Cheese Exchange. Plaintiffs seek injunctive and
equitable relief and treble damages. Stuart, et al. v. Kraft Foods, Inc., et
al., United States District Court, Eastern District of Wisconsin, filed April 4,
1996; Sheeks, et al. v. Kraft Foods, Inc., et al., United States District Court,
Eastern District of Wisconsin, filed September 24, 1996; Servais, et al. v.
Kraft Foods, Inc. and the National Cheese Exchange, Inc., Circuit Court of Dane
County, Wisconsin, filed May 5, 1997; Dodson, et al. v. Kraft Foods, Inc., et
al., United States District Court, Western District of Wisconsin, filed July 1,
1997; Noll, et al. v. Kraft Foods, Inc., et al., United States District Court,
Western District of Wisconsin, filed July 11, 1997. In December 1996,
plaintiffs' motion for class certification in Stuart was denied, and in May
1997, the court granted the Sheeks plaintiffs' motion for voluntary dismissal
without prejudice. Each of the three remaining cases seek certification of a
class consisting of all milk producers in the U.S.
During 1996 and the first four months of 1997, tax assessments alleging the
underpayment of Italian value added taxes for the years 1988 to 1995 and income
taxes for the years 1987 to 1995 were asserted against certain affiliates of the
Company. The aggregate amount of taxes claimed to be assessed to date is the
Italian lire equivalent of $2.5 billion. In addition there have been claimed
assessments of the Italian lire equivalent of $5.9 billion in interest and
penalties. The Company anticipates that additional value added and income tax
assessments may be claimed for 1996. With respect to these assessments, the
Company and its affiliates believe they have complied with applicable Italian
tax laws and are vigorously contesting the assessments. A hearing concerning one
of the assessments for value added taxes was held in the Italian tax court on
July 1, 1997.
It is not possible to predict the outcome of the litigation pending against the
Company and its subsidiaries. Litigation is subject to many uncertainties, and
it is possible that some of these actions could be decided unfavorably. An
unfavorable outcome of a pending smoking and health case, such as the Carter
case discussed above, could encourage the commencement of additional similar
litigation. There have also been a number of adverse legislative, regulatory,
political and other developments concerning cigarette smoking and the tobacco
industry that have received widespread media attention, including the recent
Liggett settlements of certain health care cost recovery actions and a purported
nationwide smoking and health class action, and a decision by a federal district
court on a motion for summary judgment not to preclude the United States Food
and Drug Administration (the "FDA") from asserting jurisdiction over cigarettes
as "drugs" or "medical devices." These developments, as well as the widespread
media attention given to the proposed resolution, discussed below under the
heading "Proposed Resolution of Certain Regulatory and Litigation Issues," may
negatively affect the perception of potential triers of fact with respect to the
tobacco industry, possibly to the detriment of certain pending litigation, and
may prompt the commencement of additional similar litigation.
Management is unable to make a meaningful estimate of the amount or range of
loss that could result from an unfavorable outcome of all pending litigation. It
is
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
possible that the Company's results of operations or cash flows in a particular
quarterly or annual period or its financial position could be materially
affected by an unfavorable outcome of certain pending litigation or by the
proposed resolution discussed below or by settlement, if any, of certain state
health care cost recovery actions. However, implementation of the proposed
resolution would resolve the most significant tobacco litigation against the
Company and its subsidiaries. Furthermore, the Company and each of its
subsidiaries named as a defendant believe, and each has been so advised by
counsel handling the respective cases, that it has a number of valid defenses to
all litigation pending against it. Except as described below under the heading
"Proposed Resolution of Certain Regulatory and Litigation Issues -- Effects on
Litigation," all such cases are, and will continue to be, vigorously defended.
PROPOSED RESOLUTION OF CERTAIN REGULATORY AND LITIGATION ISSUES
On June 20, 1997, together with other companies in the United States tobacco
industry, PM Inc. entered into a Memorandum of Understanding to support the
adoption of federal legislation and any necessary ancillary undertakings,
incorporating the features described in the proposed resolution attached to the
Memorandum of Understanding (together, the "Resolution"). The Resolution can be
implemented only by federal legislation and is subject to approval of the boards
of directors of the participating companies. (The Company's Board of Directors
approved the Resolution on June 25, 1997.) If enacted into law, the legislation
would resolve many of the regulatory and litigation issues affecting the United
States tobacco industry and, thereby, reduce uncertainties facing the industry
and increase stability in business and capital markets.
The Resolution is currently under review by the White House, Congress, the
public health community and other interested parties. The White House and
certain members of the public health community have expressed concern with
certain aspects of the Resolution and certain members of Congress have indicated
that they may offer alternative legislation. There can be no assurance that
federal legislation in the form of the Resolution will be enacted or that it
will be enacted without modification that is materially adverse to the Company
or that any modification would be acceptable to the Company or that, if enacted,
the legislation would not face legal challenges. In any event, implementation of
the Resolution would materially adversely affect the financial position of the
Company in the year of implementation and would likely materially adversely
affect the volume, operating revenues, cash flows and/or operating income of the
Company in future years. The degree of the adverse impact would depend, among
other things, on the final form of implementing federal legislation, the rates
of decline in United States cigarette sales in the premium and discount
segments, PM Inc.'s share of the domestic premium and discount cigarette
segments, interest rates and the timing of principal payments on debt incurred
to finance the initial payment due under the Resolution, and the effect of the
Resolution on cigarette consumption and the regulatory and litigation
environment outside the United States. In addition, the Company currently
anticipates that implementation of the Resolution would require a charge to
comply with the advertising and marketing restrictions of the Resolution.
Moreover, the negotiation and signing of the Resolution could affect other
federal, state and local regulation of the United States tobacco industry and
regulation of the international tobacco industry.
The Resolution includes provisions relating to advertising and marketing
restrictions, product warnings and labeling, access restrictions, licensing of
tobacco retailers, the adoption and enforcement of "no sales to minors" laws by
states, surcharges against the industry for failure to achieve underage smoking
reduction goals (discussed below), regulation of tobacco products by the FDA,
public disclosure of industry documents and research, smoking cessation
programs, compliance programs by the industry, public smoking and smoking in the
workplace, enforcement of the Resolution, industry payments (discussed below)
and litigation (discussed below).
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Surcharge for Failure to Achieve Underage Smoking Reduction Goals
The Resolution would impose surcharges on the industry if required reductions in
underage smoking are not achieved. A "look back" provision would require the
following reductions in the incidence of underage smoking from estimated levels
over the past decade: 30% in the fifth and sixth years after enactment of
implementing federal legislation, 50% in the seventh, eighth and ninth years,
and 60% in the tenth year, with incidence remaining at such reduced levels
thereafter.
For any year in which these required reductions are not met, the FDA must impose
a mandatory surcharge on the participating members of the cigarette industry
based upon an approximation of the present value of the profit the companies
would earn over the lives of the number of underage consumers in excess of the
required reduction. The annual surcharge would be $80 million (as adjusted for
changes in population and cigarette profitability) for each percentage point by
which the reduction in underage smoking falls short of the required reductions
(as adjusted to prevent double counting of persons whose smoking has already
resulted in the imposition of a surcharge in previous years). The annual
surcharge would be subject to a $2 billion annual cap (as adjusted for
inflation). The surcharge would be the joint and several obligation of
participating manufacturers allocated among participating manufacturers based on
their market share of the United States cigarette industry and would be payable
on or before July 1 of the year in which it is assessed. Manufacturers could
receive a partial refund of this surcharge (up to 75%) only after paying the
assessed amount and only if they could thereafter prove to the FDA that they had
fully complied with the Resolution, had taken all reasonably available measures
to reduce youth tobacco usage and had not acted to undermine the achievement of
the reduction goals.
Industry Payments
The Resolution would require participating manufacturers to make substantial
payments in the year of implementation and thereafter ("Industry Payments").
Participating manufacturers would be required to make an aggregate $10 billion
initial Industry Payment on the date federal legislation implementing the terms
of the Resolution is signed. This Industry Payment would be based on relative
market capitalizations and the Company currently estimates that its share of the
initial Industry Payment would be approximately $6.5 billion. Thereafter, the
companies would be required to make specified annual Industry Payments
determined and allocated among the companies based on volume of domestic sales
as long as the companies continue to sell tobacco products in the United States.
These Industry Payments, which would begin on December 31 of the first full year
after implementing federal legislation is signed, would be in the following
amounts (at 1996 volume levels): year 1: $8.5 billion; year 2: $9.5 billion;
year 3: $11.5 billion; year 4: $14 billion; and each year thereafter: $15
billion. These Industry Payments would be increased by the greater of 3% or the
previous year's inflation rate determined with reference to the Consumer Price
Index. The Industry Payments would increase or decrease in proportion to changes
from 1996 domestic sales volume levels. Volume declines would be measured based
on adult sales volume figures; volume increases would be measured by total sales
volume. If sales volume declines but the industry's domestic net operating
profit exceeds base year inflation-adjusted levels, the reduction in the annual
Industry Payment due to volume decline, if any, would be offset to the extent of
25% of the increased profit. At current levels of sales and prior to any
adjustment for inflation, the Resolution would require total Industry Payments
of $368.5 billion over the first 25 years (subject to credits described below in
connection with potential civil tort liability).
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
The Industry Payments would be separate from any surcharges required under the
"look back" provision discussed above under the heading "Surcharge for Failure
to Achieve Underage Smoking Reduction Goals." The Industry Payments would
receive priority and would not be dischargeable in any bankruptcy or
reorganization proceeding and would be the obligation only of entities selling
tobacco products in the United States (and not their affiliated companies). The
Resolution provides that all payments by the industry would be ordinary and
necessary business expenses in the year of payment, and no part thereof would be
either in settlement of an actual or potential liability for a fine or penalty
(civil or criminal) or the cost of a tangible or intangible asset. The
Resolution would provide for the pass-through to consumers of the annual
Industry Payments in order to promote the maximum reduction in underage use.
Effects on Litigation
If enacted, the federal legislation provided for in the Resolution would settle
present attorney general health care cost recovery actions (or similar actions
brought by or on behalf of any governmental entity), parens patriae and smoking
and health class actions and all "addiction"/dependence claims and would bar
similar actions from being maintained in the future. However, the Resolution
provides that no stay applications will be made in pending governmental actions
without the mutual consent of the parties. As discussed above under the heading
"Health Care Cost Recovery Litigation--Mississippi" in July 1997, together with
other companies in the United States tobacco industry, PM Inc. entered into a
Memorandum of Understanding with the State of Mississippi with respect to that
state's health care cost recovery action. The Company may enter into discussions
with certain other states with health care cost recovery actions scheduled to be
tried this year with regard to the postponement or settlement of such actions
pending the enactment of the legislation contemplated by the Resolution. No
assurance can be given whether a postponement or settlement will be achieved,
or, if achieved, as to the terms thereof. The Resolution would not affect any
smoking and health class action or any health care cost recovery action that is
reduced to final judgment before implementing federal legislation is effective.
Under the Resolution, the rights of individuals to sue the tobacco industry
would be preserved, as would existing legal doctrine regarding the types of tort
claims that can be brought under applicable statutory and case law except as
expressly changed by implementing federal legislation. Claims, however, could
not be maintained on a class or other aggregated basis and could be maintained
only against tobacco manufacturing companies (and not their retailers,
distributors or affiliated companies). In addition, all punitive damage claims
based on past conduct would be resolved as part of the Resolution and future
claimants could seek punitive damages only with respect to claims predicated
upon conduct taking place after the effective date of implementing federal
legislation. Finally, except with respect to actions pending as of June 9, 1997,
third-party payor (and similar) claims could be maintained only based on
subrogation of individual claims. Under subrogation principles, a payor of
medical costs can seek recovery from a third party only by "standing in the
shoes" of the injured party and being subject to all defenses available against
the injured party.
The Resolution contemplates that participating tobacco manufacturers would enter
into a joint sharing agreement for civil liabilities relating to past conduct.
Judgments and settlements arising from tort actions would be paid as follows.
The Resolution would set an annual aggregate cap equal to 33% of the annual base
Industry Payment (including any reductions for volume declines). Any judgments
or settlements exceeding the cap in a year would roll over into the next year.
While judgments and settlements would run against the defendant, they would give
rise to an 80-cents-on-the-dollar credit against the annual Industry Payment.
Finally,
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
any individual judgments in excess of $1 million would be paid at the rate of $1
million per year unless every other judgment and settlement could first be
satisfied within the annual aggregate cap. In all circumstances, however, the
companies would remain fully responsible for costs of defense and certain costs
associated with the fees of attorneys representing certain plaintiffs in the
litigation that would be settled by the Resolution.
Note 4. New Accounting Standards:
In 1996, the American Institute of Certified Public Accountants' Accounting
Standards Executive Committee issued Statement of Position ("SOP") No. 96-1,
"Environmental Remediation Liabilities," which, as required, was adopted by the
Company as of January 1, 1997. The adoption and application of SOP No. 96-1 had
no material effect on the Company's 1997 results of operations or financial
position for the three or six month periods ended June 30, 1997.
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share," which is
effective for the year ending December 31, 1997. SFAS No. 128 establishes
standards for computing and presenting earnings per share ("EPS") and requires
the presentation of both basic and diluted EPS. Based upon the Company's current
capitalization structure, the basic and diluted EPS amounts calculated in
accordance with SFAS No. 128 are expected to approximate the Company's EPS
amounts computed in accordance with Accounting Principles Board Opinion No. 15,
"Earnings Per Share."
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
- --------------------------------------------------------------------------------
Consolidated Operating Results
For the Six Months Ended June 30,
Operating Revenues
-----------------------------------
(in millions)
1997 1996
---- ----
Tobacco $20,073 $18,340
Food 14,164 14,178
Beer 2,193 2,300
Financial services and real estate 200 182
------- -------
Operating revenues $36,630 $35,000
======= =======
Operating Income
-----------------------------------
(in millions)
1997 1996
---- ----
Tobacco $ 4,672 $ 4,130
Food 2,118 1,968
Beer 285 275
Financial services and real estate 106 90
------- -------
Operating companies income 7,181 6,463
Amortization of goodwill (296) (293)
Unallocated corporate expenses (222) (210)
Minority interest in earnings of
consolidated subsidiaries (33) (17)
------- -------
Operating income $ 6,630 $ 5,943
======= =======
For the Three Months Ended June 30,
Operating Revenues
-----------------------------------
(in millions)
1997 1996
---- ----
Tobacco $10,153 $ 9,194
Food 6,953 7,034
Beer 1,207 1,200
Financial services and real estate 100 81
------- -------
Operating revenues $18,413 $17,509
======= =======
Operating Income
-----------------------------------
(in millions)
1997 1996
---- ----
Tobacco $ 2,318 $ 2,046
Food 1,102 1,020
Beer 166 159
Financial services and real estate 58 49
------- -------
Operating companies income 3,644 3,274
Amortization of goodwill (147) (146)
Unallocated corporate expenses (113) (105)
Minority interest in earnings of
consolidated subsidiaries (20) (9)
------- -------
Operating income $ 3,364 $ 3,014
======= =======
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Operating revenues and operating income for the first six months of 1997
increased $1.6 billion (4.7%) and $687 million (11.6%), respectively, over the
comparable 1996 period. Operating revenues and operating income for the second
quarter of 1997 increased $904 million (5.2%) and $350 million (11.6%),
respectively, over the comparable 1996 period. Operating revenues were higher
due primarily to increases in domestic and international tobacco and North
American food operations. The growth in operating income reflects increases in
all operations.
Currency movements, primarily the strengthening of the U.S. dollar versus key
European currencies and the Japanese yen, decreased operating income by $180
million and $96 million in the first six months and second quarter of 1997,
respectively, versus the comparable 1996 periods. Although the Company cannot
predict future movements in currency rates, it anticipates that the strength of
the U.S. dollar will continue to have an unfavorable impact on operating income
for the remainder of 1997.
On February 26, 1997, the Company's Board of Directors declared a three-for-one
split of the Company's common stock, effected by a distribution on April 10,
1997, of two shares for each share held of record at the close of business on
March 17, 1997. All share and per share data have been restated to reflect this
stock split for all periods presented.
Earnings per share of $1.49 in the first six months of 1997 increased by 15.5%
over the comparable 1996 period, due to higher net earnings and fewer shares
outstanding. Similarly, net earnings per share of $0.76 in the second quarter of
1997 increased 15.2% as compared to the prior year. As a result of the Company's
share repurchase program, the weighted average number of shares outstanding
decreased 2.2% to 2,426 million shares in the first six months of 1997 and
decreased 1.9% to 2,423 million shares in the second quarter of 1997 from the
comparable 1996 periods.
Operating Results by Business Segment
Tobacco
Business Environment
As discussed below, the tobacco industry, including PM Inc., the Company's
domestic tobacco subsidiary, and Philip Morris International Inc. ("PMI"), the
Company's international tobacco subsidiary, have faced, and continue to face, a
number of issues which may adversely affect volume, operating revenues, cash
flows, operating income and financial position.
In the United States, these issues include proposed federal regulatory controls
(including, as discussed below, the issuance of final regulations by the United
States Food and Drug Administration (the "FDA") which regulate cigarettes as
"drugs" or "medical devices"); actual and proposed excise tax increases; new and
proposed federal, state and local governmental and private restrictions on
smoking (including proposals to ban or restrict smoking in workplaces and in
buildings permitting public access); new and proposed restrictions on tobacco
manufacturing, marketing, advertising (including decisions by certain companies
to limit or not accept tobacco advertising) and sales; new and proposed
legislation and regulations to require substantial additional health warnings on
cigarette packages and in advertising, and to eliminate the tax deductibility of
tobacco advertising and promotional costs; actual and proposed requirements
regarding disclosure of cigarette ingredients and other proprietary information;
increased assertions of adverse health effects associated with both smoking and
exposure to environmental tobacco smoke ("ETS"); legislation or other
governmental action seeking to ascribe to the industry responsibility and
liability for the purported adverse health effects associated with both smoking
and exposure to ETS; the diminishing social acceptance of smoking; increased
pressure from anti-smoking groups; unfavorable press reports; governmental and
grand jury investigations; increased smoking and health litigation, including
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private plaintiff class action litigation and health care cost recovery actions
brought by state and local governments, unions and others seeking reimbursement
for Medicaid and other health care expenditures allegedly caused by cigarette
smoking; and the proposed legislative resolution of certain regulatory and
litigation issues affecting the United States tobacco industry discussed below.
Cigarettes are subject to substantial excise taxes in the United States and to
similar taxes in most foreign markets. The United States federal excise tax on
cigarettes is currently $12 per 1,000 cigarettes ($0.24 per pack of 20
cigarettes). In August 1997, legislation was enacted that will raise the federal
excise tax to $17 per 1,000 cigarettes ($0.34 per pack of 20 cigarettes)
starting in the year 2000 and then to $19.50 per 1,000 cigarettes ($0.39 per
pack of 20 cigarettes) in 2002. In general, excise taxes, sales taxes and other
cigarette-related taxes levied by various states, counties and municipalities
have been increasing, and additional increases have been proposed in a number of
states. These taxes vary considerably and, when combined with the current
federal excise tax, may be as high as $1.28 per pack.
In the opinion of PM Inc. and PMI, past increases in excise and similar taxes
have had an adverse impact on sales of cigarettes. Any future increases, the
extent of which cannot be predicted, could result in volume declines for the
cigarette industry, including PM Inc. and PMI, and might cause sales to shift
from the premium segment to the discount segment.
In August 1996, the FDA issued final regulations pursuant to which it asserts
jurisdiction over cigarettes as "drugs" or "medical devices" under the
provisions of the Food, Drug and Cosmetic Act. The final regulations include
severe restrictions on the distribution, marketing and advertising of
cigarettes, and would require the industry to comply with a wide range of
labeling, reporting, recordkeeping, manufacturing, and other requirements
applicable to medical devices and their manufacturers. For the most part, the
regulations are scheduled to become effective on August 28, 1997. The FDA's
exercise of jurisdiction, if not reversed by judicial or legislative action,
could lead to more expansive FDA-imposed restrictions on cigarette operations
than those set forth in the final regulations, and could materially adversely
affect the volume, operating revenues and operating income of PM Inc. PM Inc.
and other domestic cigarette manufacturers and an advertising firm sued the FDA,
seeking a judicial declaration that the FDA has no authority to regulate
cigarettes and asking the court to permanently enjoin the FDA from enforcing its
regulations. Similar suits have been filed against the FDA by manufacturers of
smokeless tobacco products, by a trade association of cigarette retailers and by
advertising agency associations. In April 1997, a U.S. district court ruled that
Congress has not precluded the FDA from regulating cigarettes as "drugs" or
"medical devices" and that the FDA may so regulate cigarettes if the facts
asserted in support of the FDA's assertion of jurisdiction are proven to be
correct. The court also ruled, however, that the section of the Food, Drug and
Cosmetic Act relied upon by the agency does not give the FDA authority to
implement its regulations restricting cigarette advertising and promotions. The
court stayed implementation of the FDA's regulations scheduled for August 28,
1997. The court left in effect the specific regulations that took effect in
February 1997 establishing a federal minimum age of 18 for the sale of tobacco
products and requiring proof of age for anyone under age 27. The tobacco company
plaintiffs, including PM Inc., are appealing that portion of the district
court's order relating to the FDA's assertion of jurisdiction. The FDA is
appealing the portion of the order enjoining the advertising and promotion
restrictions. The outcome of the litigation challenging the FDA regulations
cannot be predicted.
In August 1996, the Commonwealth of Massachusetts enacted legislation that would
require cigarette manufacturers to disclose the flavorings and other ingredients
used in each brand of cigarettes sold in the Commonwealth, and to provide
"nicotine-yield ratings" for their products based on standards to be established
by the Massachusetts Department of Public Health ("DPH"). PM Inc. believes that
enforcement of the statute, which is scheduled to take effect on November 1,
1997, could require the disclosure of valuable proprietary
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information concerning its brands. PM Inc. and three other domestic cigarette
manufacturers have filed suit in federal district court in Boston challenging
the legislation as being preempted by the Federal Cigarette Labeling and
Advertising Act, as amended (the "Labeling Act") and as violating the commerce,
full faith and credit, due process and takings clauses of the U.S. Constitution.
In February 1997, the court ruled on summary judgment motions that the Labeling
Act does not preempt the requirement that ingredient information be provided to
the Commonwealth. The plaintiffs have appealed that decision. In addition, the
plaintiffs will continue to assert their other constitutional claims. The
ultimate outcome of this lawsuit cannot be predicted. The enactment of this
legislation has encouraged, and continues to encourage, the enactment of, and
efforts to enact, comparable legislation in other states. The DPH has proposed
regulations to implement the Massachusetts legislation, and has invited public
comment on the proposed regulations. PM Inc. and three other domestic cigarette
manufacturers filed comments on the proposed regulations. Final regulations have
not been issued.
In June 1995, PM Inc. announced that it had voluntarily undertaken a program to
limit minors' access to cigarettes. Elements of the program include
discontinuing free cigarette sampling to consumers in the United States,
discontinuing the distribution of cigarettes by mail to consumers in the United
States, placing a notice on cigarette cartons and packs for sale in the United
States stating "Underage Sale Prohibited," working with others in support of
state legislation to prevent youth access to tobacco products, taking measures
to encourage retailer compliance with minimum-age laws, and independent auditing
of the program.
Some foreign countries have also taken steps to restrict or prohibit cigarette
advertising and promotion, to require ingredient disclosure, to impose maximum
constituent levels, to increase taxes on cigarettes, to control prices, to
restrict imports, to ban or severely restrict smoking in workplaces and public
places, and otherwise to discourage cigarette smoking. It is not possible to
predict what, if any, other foreign governmental legislation or regulations will
be adopted relating to the manufacturing, advertising, sale or use of cigarettes
or to the tobacco industry generally.
PM Inc. has received requests for information (including grand jury subpoenas)
in connection with governmental investigations of the tobacco industry, and is
cooperating with respect to such requests. Certain present and former employees
of PM Inc. have testified or have been asked to testify in connection with
certain of these matters. The investigations are as follows:
PM Inc. has been informed that an investigation by the United States Attorney
for the Southern District of New York, which had been initiated following the
publication of an article in The New York Times that made allegations about PM
Inc. documents and supposedly secret research relating to nicotine, has been
consolidated with the United States Department of Justice investigation
discussed immediately below.
PM Inc. has been informed of an investigation by the United States Attorney for
the Eastern District of New York relating to The Council for Tobacco
Research-U.S.A., Inc., a research organization of which PM Inc. is a sponsor;
and an investigation by the United States Department of Justice relating to
issues raised in testimony provided by tobacco industry executives before
Congress and other related matters.
PM Inc. has been advised that the Federal Trade Commission has commenced an
investigation to determine whether PM Inc. unfairly restricts the distribution
of competing manufacturers' cigarette brands through its merchandising practices
at the wholesale and retail levels.
While the outcomes of these investigations cannot be predicted, PM Inc. believes
it has acted lawfully.
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During 1996 and the first four months of 1997, tax assessments alleging the
underpayment of Italian value added taxes for the years 1988 to 1995 and income
taxes for the years 1987 to 1995 were asserted against certain affiliates of the
Company. The aggregate amount of taxes claimed to be assessed to date is the
Italian lire equivalent of $2.5 billion. In addition there have been claimed
assessments of the Italian lire equivalent of $5.9 billion in interest and
penalties. The Company anticipates that additional value added and income tax
assessments may be claimed for 1996. With respect to these assessments, the
Company and its affiliates believe they have complied with applicable Italian
tax laws and are vigorously contesting the assessments. A hearing concerning one
of the assessments for value added taxes was held in the Italian tax court on
July 1, 1997.
In March 1997, Liggett Group Inc. ("Liggett"), a United States cigarette
manufacturer with approximately 2% of the domestic cigarette market, announced
agreements with the attorneys general of twenty-two states to settle the health
care cost recovery actions pending against Liggett in those states. Liggett also
entered into an agreement to settle a purported nationwide class action suit
which, subject to court approval, provides, during its 25-year term, for (i) the
mandatory settlement of all present and future claims by Liggett smokers and
their estates and families, as well as claims by individuals who allege injury
from exposure to ETS, and (ii) the settlement of all present and future claims
against Liggett by individuals or entities alleging economic loss as a result of
payments for the treatment of diseases or medical conditions allegedly caused by
cigarette smoking or exposure to ETS. As a part of the settlements, Liggett
agreed, among other things, (i) to pay 25% of its "Pre-tax Income," if any, for
the next 25 years into a settlement fund, subject to certain conditions and
offsets, (ii) to comply with certain aspects of the FDA regulations discussed
above, (iii) to acknowledge that cigarettes cause health problems and that
nicotine is "addictive," (iv) to add a warning to each package of its cigarettes
and its advertising stating that "Smoking is Addictive," (v) to acknowledge that
cigarette companies have targeted marketing programs toward minors, and (vi) to
cooperate with otherwise adverse parties in certain investigations and lawsuits
and, in furtherance thereof, to waive the attorney-client privilege and other
protections with respect to certain of its documents and information and to
assist in obtaining court adjudication with respect to documents ("protected
documents") in its possession that are subject to joint defense or other
privileges and protections held by other members of the tobacco industry. The
issue of Liggett's proposed disclosure of these protected documents is being
litigated in state courts. In Florida's health care cost recovery action certain
of these protected documents were publicly disclosed pursuant to court order.
The settlement agreements contain certain provisions that would apply to any
other member of the tobacco industry having a share of the domestic cigarette
market of less than 30% that acquires, or is acquired by, Liggett. Each
settlement can be terminated by Liggett upon the occurrence of specified events.
Liggett has sought to have the purported nationwide class action certified, and
the related settlement agreement approved, in actions brought in Alabama state
court and in federal court in West Virginia. In March 1997, the Alabama state
court conditionally certified the nationwide class and preliminarily approved
the related settlement agreement, subject to final approval after a fairness
hearing. In August 1997, the federal court in the West Virginia case withdrew
its earlier preliminary approval of the settlement and the settlement class and
denied plaintiffs' motion to certify the class.
As further discussed in Note 3 to the Condensed Consolidated Financial
Statements ("Note 3"), there is litigation pending in various jurisdictions
related to tobacco products. These cases generally fall within three categories:
(i) smoking and health cases alleging personal injury brought on behalf of
individual smokers, (ii) smoking and health cases alleging personal injury and
purporting to be brought on behalf of a class of plaintiffs, and (iii) health
care cost recovery actions.
In the individual and class action smoking and health cases pending against PM
Inc. and, in some cases, the Company and/or certain of its other subsidiaries,
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plaintiffs allege "addiction" to cigarette smoking, personal injury resulting
from cigarette smoking and/or exposure to ETS and seek various forms of relief,
including compensatory damages, creation of a medical monitoring fund,
disgorgement of profits, various injunctive and equitable relief, and, in some
cases, punitive damages in amounts ranging into the billions of dollars.
Recently, there has been a substantial increase in the number of such smoking
and health cases in the United States, with many of the new cases having been
filed in Florida on behalf of individual plaintiffs. As of August 1, 1997, there
were approximately 305 smoking and health cases filed and served on behalf of
individual plaintiffs in the United States against PM Inc. and, in some cases,
the Company (excluding approximately 25 cases in Texas that were recently
voluntarily dismissed but which may be refiled under certain conditions),
compared to approximately 190 such cases as of March 31, 1997, and approximately
150 such cases as of March 31, 1996. Approximately 150 of the cases filed and
served as of August 1, 1997, were filed on behalf of individual plaintiffs in
the State of Florida. Seventeen of the individual cases involve allegations of
various personal injuries allegedly related to exposure to ETS.
In addition to the foregoing individual smoking and health cases, as of August
1, 1997, there were approximately 40 purported smoking and health class actions
pending in the United States against PM Inc. and, in some cases, the Company (as
compared to 25 on March 31, 1997), including three that involve allegations of
various personal injuries related to exposure to ETS. Most of these actions
purport to constitute statewide class actions and were filed after the Fifth
Circuit Court of Appeals, in the Castano case, reversed a federal district
court's certification of a purported nationwide class action on behalf of
persons who were allegedly "addicted" to tobacco products. One purported smoking
and health class action is pending in Canada and another in Brazil against
affiliates of the Company.
As of August 1, 1997, approximately 75 health care cost recovery actions were
pending compared to approximately 30 on March 31, 1997. In California,
individuals and local governments and other organizations purportedly acting as
"private attorneys general" have filed suits seeking, among other things,
injunctive relief, restitution and disgorgement of profits for alleged
violations of California's consumer protection statutes.
Other foreign, state, and local government entities and others, including
unions, have announced that they are considering filing health care cost
recovery actions.
It is not possible to predict the outcome of the litigation pending against the
Company and its subsidiaries. Litigation is subject to many uncertainties, and
it is possible that some of these actions could be decided unfavorably. An
unfavorable outcome of a pending smoking and health case, such as the Carter
case discussed in Note 3, could encourage the commencement of additional similar
litigation. There have also been a number of adverse legislative, regulatory,
political and other developments concerning cigarette smoking and the tobacco
industry that have received widespread media attention, including the recent
Liggett settlements of certain health care cost recovery actions and a purported
nationwide smoking and health class action, and a decision by a federal district
court on a motion for summary judgment not to preclude the FDA from asserting
jurisdiction over cigarettes as "drugs" or "medical devices." These
developments, as well as the widespread media attention given to the proposed
resolution, discussed below under the heading "Proposed Resolution of Certain
Regulatory and Litigation Issues," may negatively affect the perception of
potential triers of fact with respect to the tobacco industry, possibly to the
detriment of certain pending litigation, and may prompt the commencement of
additional similar litigation.
Management is unable to make a meaningful estimate of the amount or range of
loss that could result from an unfavorable outcome of all pending litigation. It
is possible that the Company's results of operations or cash flows in a
particular quarterly or annual period or its financial position could be
materially affected
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by an unfavorable outcome of certain pending litigation or by the proposed
resolution discussed below or by settlement, if any, of certain state health
care cost recovery actions. However, implementation of the proposed resolution
would resolve the most significant tobacco litigation against the Company and
its subsidiaries. Furthermore, the Company and each of its subsidiaries named as
a defendant believe, and each has been so advised by counsel handling the
respective cases, that it has a number of valid defenses to all litigation
pending against it. Except as described below under the heading "Proposed
Resolution of Certain Regulatory and Litigation Issues -- Effects on
Litigation," all such cases are, and will continue to be, vigorously defended.
PROPOSED RESOLUTION OF CERTAIN REGULATORY AND LITIGATION ISSUES
On June 20, 1997, together with other companies in the United States tobacco
industry, PM Inc. entered into a Memorandum of Understanding to support the
adoption of federal legislation and any necessary ancillary undertakings,
incorporating the features described in the proposed resolution attached to the
Memorandum of Understanding.
The Memorandum of Understanding and the proposed resolution (together, the
"Resolution") resulted from negotiations with state attorneys general,
representatives of the public health community and attorneys representing
plaintiffs in certain smoking and health litigation. The Resolution contains
certain regulatory and legislative provisions with which the industry does not
necessarily agree, but which the industry has agreed to accept in the interest
of achieving the Resolution. The Resolution can be implemented only by federal
legislation and is subject to approval of the boards of directors of the
participating companies. (The Company's Board of Directors approved the
Resolution on June 25, 1997.) If enacted into law, the legislation would resolve
many of the regulatory and litigation issues affecting the United States tobacco
industry and, thereby, reduce uncertainties facing the industry and increase
stability in business and capital markets.
The Resolution is currently under review by the White House, Congress, the
public health community and other interested parties. The White House and
certain members of the public health community have expressed concern with
certain aspects of the Resolution and certain members of Congress have indicated
that they may offer alternative legislation. There can be no assurance that
federal legislation in the form of the Resolution will be enacted or that it
will be enacted without modification that is materially adverse to the Company
or that any modification would be acceptable to the Company or that, if enacted,
the legislation would not face legal challenges. In any event, implementation of
the Resolution would materially adversely affect the financial position of the
Company in the year of implementation and would likely materially adversely
affect the volume, operating revenues, cash flows and/or operating income of the
Company in future years. Moreover, the negotiation and signing of the Resolution
could affect other federal, state and local regulation of the United States
tobacco industry and regulation of the international tobacco industry.
The following summary of the Resolution is qualified by reference to the
complete text, which has been filed with the Securities and Exchange Commission
as Exhibit 10 to the Company's Current Report on Form 8-K dated June 20, 1997,
and which is incorporated herein by reference. Certain terms of the Resolution
would apply to all tobacco products sold in the United States; certain terms
would apply only to tobacco manufacturers that consent to participate in the
Resolution; other terms would apply only to non-consenting manufacturers.
Advertising and Marketing Restrictions
The Resolution would incorporate certain regulations previously promulgated by
the FDA and add additional restrictions to curtail tobacco product advertising
and marketing. Among other things, it would:
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Prohibit the use of human images and cartoon characters, such as Joe Camel
and the Marlboro man, in all tobacco-product advertising.
Ban all outdoor tobacco-product advertising, including advertising in
enclosed stadia and advertising inside a retail establishment that is
directed outside.
Except for advertising in adult-only facilities or adult publications,
limit tobacco-product advertising to black text on a white background.
Ban sponsorships (including concerts and sporting events) in the name,
logo or selling message of a tobacco brand.
Ban all non-tobacco merchandise (such as caps, jackets and bags) bearing
the name, logo or selling message of a tobacco brand.
Ban offers of non-tobacco items or gifts based on proof of purchase of
tobacco products.
Ban direct or indirect payments for tobacco product placement in movies,
television programs and video games.
Prohibit direct and indirect payments to "glamorize" tobacco use in media
appealing to minors, including live and recorded music performances.
Prohibit tobacco-product advertising on the Internet unless designed to be
inaccessible in or from the United States.
In addition, the Resolution would require that use of currently employed product
descriptors such as "low tar" and "light" be accompanied by a mandatory health
disclaimer in advertisements, and would prohibit the use of any new descriptors
embodying express or implied health claims unless approved by the FDA. The FDA
would also have the corresponding power, but not the obligation, to modify
advertising restrictions with respect to tobacco products that it concludes
present sufficiently reduced health risks. Exemplars of all new advertising and
tobacco product labeling would be submitted to the FDA for its ongoing review.
Warnings and Labeling
The Resolution would mandate a new set of rotating warnings to be placed on
packages of tobacco products with greater prominence than previous warnings (25%
of the front of cigarette packs at the top of the pack). The new rotating
warnings would also appear in all advertisements and would occupy 20% of press
advertisements. Cigarette packs would also carry the FDA mandated statement of
intended use ("Nicotine Delivery Device").
Access Restrictions
The Resolution would restrict access to tobacco products by minors. Without
preventing state and local governments from imposing stricter measures, the
Resolution would incorporate regulations previously promulgated by the FDA that
restrict access to tobacco products and would also add additional restrictions.
Taken together, these access restrictions would include the following:
Setting a minimum age of 18 to purchase tobacco products.
Requiring retailers to check photo identification of anyone under 27 years
of age.
Establishing a requirement of face-to-face transactions for all sales of
tobacco products.
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Banning the sale of tobacco products from opened packages, requiring a
minimum package size of 20 cigarettes, and banning the sampling of tobacco
products.
Banning the distribution of tobacco products through the mail except for
sales subject to proof of age (with subsequent FDA review to determine if
minors are obtaining tobacco products through the mail).
Imposing retailer compliance obligations to ensure that all displays,
advertising, labeling, and other items conform with all applicable
requirements.
Banning all sales of tobacco products through vending machines.
Banning self-service displays of tobacco products except in adult-only
facilities.
Licensing of Tobacco Retailers
The Resolution would require that any entity that sells tobacco products
directly to consumers obtain a license. Sellers would be subject to monetary
penalties and suspension or loss of their licenses if they do not comply with
the access restrictions. The federal government and state and local authorities
would enforce these access and licensing provisions through funding provided by
Industry Payments, as defined below under the heading "Industry Payments."
State Enforcement
The Resolution would require states to adopt "no sales to minors" laws and would
contain economic incentives for the states to enforce such laws. If a state does
not meet "no sales to minors" performance targets, the FDA may refuse to pay
that state certain funds otherwise payable under the Resolution. To comply with
the "no sales to minors" law, the state must achieve compliance rate results of
75% by the fifth year after enactment of federal legislation, 85% by the seventh
year and 90% by the tenth year and each year thereafter. Compliance would be
measured as a percentage of random, unannounced compliance checks in which the
retailer refused to sell tobacco products to minors. Funds withheld from states
for failure to achieve the performance targets would, in turn, be reallocated to
those states that demonstrated superior "no sales to minors" enforcement
records.
Surcharge for Failure to Achieve Underage Smoking Reduction Goals
The Resolution would impose surcharges on the industry if required reductions in
underage smoking are not achieved. A "look back" provision would require the
following reductions in the incidence of underage smoking from estimated levels
over the past decade: 30% in the fifth and sixth years after enactment of
implementing federal legislation, 50% in the seventh, eighth and ninth years,
and 60% in the tenth year, with incidence remaining at such reduced levels
thereafter.
For any year in which these required reductions are not met, the FDA must impose
a mandatory surcharge on the participating members of the cigarette industry
based upon an approximation of the present value of the profit the companies
would earn over the lives of the number of underage consumers in excess of the
required reduction. The annual surcharge would be $80 million (as adjusted for
changes in population and cigarette profitability) for each percentage point by
which the reduction in underage smoking falls short of the required reductions
(as adjusted to prevent double counting of persons whose smoking has already
resulted in the imposition of a surcharge in previous years). The annual
surcharge would be subject to a $2 billion annual cap (as adjusted for
inflation). The surcharge would be the joint and several obligation of
participating manufacturers allocated among participating manufacturers based on
their market share of the United States cigarette industry and would be payable
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on or before July 1 of the year in which it is assessed. Manufacturers could
receive a partial refund of this surcharge (up to 75%) only after paying the
assessed amount and only if they could thereafter prove to the FDA that they had
fully complied with the Resolution, had taken all reasonably available measures
to reduce youth tobacco usage and had not acted to undermine the achievement of
the reduction goals. The FDA would use the surcharges to fund its administrative
costs and to fund grants to states for additional efforts to reduce underage
smoking.
Regulation
Under the Resolution, the FDA would oversee the development, manufacturing,
marketing and sale of tobacco products in the United States, including FDA
approval of ingredients and imposition of standards for reducing or eliminating
the level of certain constituents, including nicotine.
Under the Resolution, tobacco would continue to be categorized as a "drug" and a
"device" under the Food, Drug and Cosmetic Act. The FDA's authority to regulate
tobacco products as "restricted medical devices" would be explicitly recognized
and tobacco products would be classified as a new subcategory of Class II
devices.
For a period of at least twelve years after implementing legislation is
effective, the FDA would be permitted, subject to certain procedures and
judicial review, to adopt performance standards that require the modification of
existing tobacco products, including the gradual reduction, but not the
elimination, of nicotine yields, and the possible elimination of other
constituents or components of the tobacco product, based upon a finding that the
modification: (i) will result in a significant reduction of the health risks
associated with such products to consumers thereof; (ii) is technologically
feasible; and (iii) will not result in the creation of a significant demand for
contraband or other tobacco products that do not meet the performance standards.
The Resolution would also require, effective three years after implementing
legislation is effective, that no cigarette sold in the United States can exceed
a 12 mg. "tar" yield, using the Federal Trade Commission's presently existing
methodology to determine "tar" yields.
Beginning twelve years after implementing legislation becomes effective, the FDA
would be permitted to set performance standards that exceed those discussed
above, including the elimination of nicotine and the elimination of other
constituents or other demonstrated harmful components of tobacco products, based
upon a finding that: (i) the safety standard will result in a significant
overall reduction of the health risks to tobacco consumers as a group; (ii) the
modification is technologically feasible; and (iii) the modification will not
result in the creation of a significant demand for contraband or other tobacco
products that do not meet the performance standards. An FDA determination to
eliminate nicotine would have to be based upon a preponderance of the evidence
and be subject to judicial review and a two-year phase-in to permit
Congressional review.
The Resolution would require disclosure of non-tobacco ingredients to the FDA,
require manufacturers to submit within five years a safety assessment for
non-tobacco ingredients currently used, and require manufacturers to obtain the
FDA's preapproval for any new non-tobacco ingredients. The FDA would have
authority to disapprove an ingredient's safety. The Resolution also outlines
legislation that would require companies to notify the FDA of technology they
develop or acquire that reduces the risk from tobacco products and that would
mandate cross-licensing of technology that the FDA determines reduces the risk
from tobacco products and that would authorize the FDA to mandate the
introduction of "less hazardous tobacco products" that are technologically
feasible.
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The Resolution would subject the tobacco industry to "good manufacturing
practice" standards, including requirements regarding quality control systems,
FDA inspections and record-keeping and reporting.
Public Disclosure
The Resolution would require the tobacco industry to disclose to the public
previously confidential internal laboratory research as well as certain other
documents relating to smoking and health, "addiction" or nicotine dependency,
"safer or less hazardous" cigarettes and underage tobacco use and marketing. The
Resolution would also require the industry to disclose all such internal
laboratory research generated in the future. The Resolution would provide
protection for proprietary information and applicable privileges, and would
establish a streamlined process by which interested persons could contest claims
of privilege.
Cessation Programs
The Resolution would authorize the Secretary of Health and Human Services to
accredit smoking cessation programs and techniques that the agency determines to
be potentially effective.
Compliance Programs
Participating tobacco manufacturers would be required to create, and to update
each year, plans to ensure compliance with all applicable laws and regulations,
to identify ways to reduce underage use of tobacco products, and to provide
internal incentives for reducing underage use and for developing products with
"reduced risk."
Participating manufacturers would also be required to implement compliance
programs setting compliance standards and procedures for employees and agents
that are reasonably capable of reducing violations. These programs must assign
to specific high-level personnel the overall responsibility for overseeing
compliance, forbid delegation of substantial discretionary authority to
individuals who have shown a propensity to disregard corporate policies,
establish training or equivalent means of educating employees and agents, and
institute appropriate disciplinary measures and steps to respond to violations
and prevent similar ones from recurring.
Participating manufacturers would be required to promulgate corporate principles
that express and explain the company's commitment to compliance, reduction of
underage tobacco use, and development of "reduced risk" tobacco products. They
would be required to work with retail organizations on compliance, including
retailer compliance checks and financial incentives for compliance, and disband
certain industry associations and only form new ones subject to regulatory
oversight.
Participating manufacturers would be subject to fines and penalties for
breaching any of these obligations. Companies would be required to direct their
employees to report known or alleged violations to the company compliance
officer, who in turn would be required to provide reports to the FDA. Finally,
companies would be prohibited from taking adverse action against
"whistleblowers" who report violations to the government.
Public Smoking
The Resolution would mandate minimum federal standards governing smoking in
public places or at work (with states and localities retaining power to impose
stricter requirements). These restrictions, which would be enforced by the
Occupational Safety and Health Administration, would:
Restrict indoor smoking in "public facilities" to ventilated areas with
systems that exhaust the air directly to the outside, maintain the smoking
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area at "negative pressure" compared with adjoining areas and do not
recirculate the air inside the public facility.
Ensure that no employee may be required to enter a designated smoking area
while smoking is occurring.
Exempt restaurants (other than fast food restaurants) and bars, private
clubs, hotel guest rooms, casinos, bingo parlors, tobacco merchants and
prisons.
Enforcement
Violations of the Resolution's terms would carry civil and criminal penalties
based upon the penalty provisions of the Food, Drug and Cosmetic Act and, where
applicable, the provisions of the United States criminal code. Special enhanced
civil penalties of up to ten times the penalties applicable to similar
violations by drug companies would attach to violations of the obligations to
disclose research about health effects and information about the toxicity of
non-tobacco ingredients.
Terms of the Resolution would be embodied in state consent decrees, giving the
states concurrent enforcement powers. State enforcement could not impose
obligations or requirements beyond those imposed by the Resolution (except where
the Resolution specifically does not preempt additional state-law obligations)
and would be limited to the penalties specified in the Resolution and by
prohibition of duplicative penalties.
Industry Payments
The Resolution would require participating manufacturers to make substantial
payments in the year of implementation and thereafter ("Industry Payments").
Participating manufacturers would be required to make an aggregate $10 billion
initial Industry Payment on the date federal legislation implementing the terms
of the Resolution is signed. This Industry Payment would be based on relative
market capitalizations and the Company currently estimates that its share of the
initial Industry Payment would be approximately $6.5 billion. Thereafter, the
companies would be required to make specified annual Industry Payments
determined and allocated among the companies based on volume of domestic sales
as long as the companies continue to sell tobacco products in the United States.
These Industry Payments, which would begin on December 31 of the first full year
after implementing federal legislation is signed, would be in the following
amounts (at 1996 volume levels): year 1: $8.5 billion; year 2: $9.5 billion;
year 3: $11.5 billion; year 4: $14 billion; and each year thereafter: $15
billion. These Industry Payments would be increased by the greater of 3% or the
previous year's inflation rate determined with reference to the Consumer Price
Index. The Industry Payments would increase or decrease in proportion to changes
from 1996 domestic sales volume levels. Volume declines would be measured based
on adult sales volume figures; volume increases would be measured by total sales
volume. If sales volume declines but the industry's domestic net operating
profit exceeds base year inflation-adjusted levels, the reduction in the annual
Industry Payment due to volume decline, if any, would be offset to the extent of
25% of the increased profit. At current levels of sales and prior to any
adjustment for inflation, the Resolution would require total Industry Payments
of $368.5 billion over the first 25 years (subject to credits described below in
connection with potential civil tort liability).
The Industry Payments would be separate from any surcharges required under the
"look back" provision discussed above under the heading "Surcharge for Failure
to Achieve Underage Smoking Reduction Goals." The Industry Payments would
receive priority and would not be dischargeable in any bankruptcy or
reorganization proceeding and would be the obligation only of entities selling
tobacco products in the United States (and not their affiliated companies). The
Resolution provides that all payments by the industry would be ordinary and
necessary business expenses in the year of payment, and no part thereof would be
either in settlement of an actual or potential liability for a fine or penalty
(civil or criminal) or the cost of a tangible or intangible asset. The
Resolution would provide for the pass-through
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to consumers of the annual Industry Payments in order to promote the maximum
reduction in underage use.
The Industry Payments would be made to a central federal authority and then
allocated among various programs and entities to provide funds for federal and
state enforcement efforts; federal, state and local governments' health benefit
programs; public benefits to resolve past punitive damages claims that might be
asserted in private litigation; and the expenses related to the administration
of federal legislation enacted pursuant to the Resolution. A portion of these
expenditures would be to fund a variety of public and private non-profit efforts
to discourage minors from beginning to use tobacco products and to assist
current tobacco consumers to quit. Those programs include research, public
education campaigns, individual cessation programs, and impact grants.
Effects on Litigation
If enacted, the federal legislation provided for in the Resolution would settle
present attorney general health care cost recovery actions (or similar actions
brought by or on behalf of any governmental entity), parens patriae and smoking
and health class actions and all "addiction"/dependence claims and would bar
similar actions from being maintained in the future. However, the Resolution
provides that no stay applications will be made in pending governmental actions
without the mutual consent of the parties. In July 1997, together with other
companies in the United States tobacco industry, PM Inc. entered into a
Memorandum of Understanding with the State of Mississippi with respect to that
state's health care cost recovery action. See Note 3 "Health Care Cost Recovery
Litigation--Mississippi." The Company may enter into discussions with certain
other states with health care cost recovery actions scheduled to be tried this
year with regard to the postponement or settlement of such actions pending the
enactment of the legislation contemplated by the Resolution. No assurance can be
given whether a postponement or settlement will be achieved, or, if achieved, as
to the terms thereof. The Resolution would not affect any smoking and health
class action or any health care cost recovery action that is reduced to final
judgment before implementing federal legislation is effective.
Under the Resolution, the rights of individuals to sue the tobacco industry
would be preserved, as would existing legal doctrine regarding the types of tort
claims that can be brought under applicable statutory and case law except as
expressly changed by implementing federal legislation. Claims, however, could
not be maintained on a class or other aggregated basis and could be maintained
only against tobacco manufacturing companies (and not their retailers,
distributors or affiliated companies). In addition, all punitive damage claims
based on past conduct would be resolved as part of the Resolution and future
claimants could seek punitive damages only with respect to claims predicated
upon conduct taking place after the effective date of implementing federal
legislation. Finally, except with respect to actions pending as of June 9, 1997,
third-party payor (and similar) claims could be maintained only based on
subrogation of individual claims. Under subrogation principles, a payor of
medical costs can seek recovery from a third party only by "standing in the
shoes" of the injured party and being subject to all defenses available against
the injured party.
The Resolution contemplates that participating tobacco manufacturers would enter
into a joint sharing agreement for civil liabilities relating to past conduct.
Judgments and settlements arising from tort actions would be paid as follows.
The Resolution would set an annual aggregate cap equal to 33% of the annual base
Industry Payment (including any reductions for volume declines). Any judgments
or settlements exceeding the cap in a year would roll over into the next year.
While judgments and settlements would run against the defendant, they would give
rise to an 80-cents-on-the-dollar credit against the annual Industry Payment.
Finally, any individual judgments in excess of $1 million would be paid at the
rate of $1 million per year unless every other judgment and settlement could
first be satisfied within the annual aggregate cap. In all circumstances,
however, the companies would remain fully responsible for costs of defense and
certain costs
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associated with the fees of attorneys representing certain plaintiffs in the
litigation that would be settled by the Resolution.
Non-participating Manufacturers
The Resolution would contain certain measures to ensure that non-participating
manufacturers are not free to undercut the Resolution by selling tobacco
products at lower prices because they were not making the Industry Payments.
Financial Effects
The Company anticipates that its share of the industry's $10 billion initial
payment, which it currently estimates would be approximately $6.5 billion, would
be funded from a combination of available cash, commercial paper issuances, bank
borrowings and long-term debt issuances in the global markets. This payment
would have a material adverse effect on the Company's financial position.
The Company currently anticipates that implementation of the Resolution would
require a charge to comply with the advertising and marketing restrictions of
the Resolution.
The Company believes that implementation of the Resolution would likely
materially adversely affect the volume, operating revenues, cash flows and/or
operating income of the Company in future years. The degree of the adverse
impact would depend, among other things, on the rates of decline in United
States cigarette sales in the premium and discount segments, PM Inc.'s share of
the domestic premium and discount cigarette segments, interest rates and the
timing of principal payments on debt incurred to finance the initial payment due
under the Resolution, and the effect of the Resolution on cigarette consumption
and the regulatory and litigation environment outside the United States. In view
of the foregoing, the Company may reevaluate its share repurchase and dividend
policies.
Operating Results
For the Six Months Ended June 30,
------------------------------------------
Operating Revenues Operating Income
------------------ ----------------
(in millions)
1997 1996 1997 1996
---- ---- ---- ----
Domestic tobacco $ 6,369 $ 5,967 $ 2,259 $ 2,033
International tobacco 13,704 12,373 2,413 2,097
------- ------- ------- -------
Total $20,073 $18,340 $ 4,672 $ 4,130
======= ======= ======= =======
Domestic tobacco. During the first six months of 1997, PM Inc.'s operating
revenues increased 6.7% over the comparable 1996 period, due to pricing ($249
million), higher volume ($126 million) and improved product mix ($27 million).
Operating income for the first six months of 1997 increased 11.1% over the
comparable 1996 period, due to price increases, net of product cost increases
($246 million), higher volume ($80 million) and improved product mix ($25
million), partially offset by higher marketing, administration and research
costs ($98 million, primarily higher marketing expense) and higher fixed
manufacturing expense ($27 million).
PM Inc.'s shipment volume for the first six months of 1997 was 114.2 billion
units, an increase of 2.1% from the first six months of 1996 on higher Marlboro
volume. Marlboro shipment volume increased 4.3 billion units (5.7%) to 79.3
billion units for a 34.1% share of the total industry, an increase of 2.4 share
points from the first six months of 1996. Domestic tobacco industry volume
declined 1.5%, in line with historical trends as discussed below. While PM Inc.
cannot predict future growth rates, it believes that, over the long term,
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industry shipments will continue to decline in line with their historical
average decline of 1% to 2% per annum, subject to the effects, if implemented,
of the proposed Resolution discussed under "Tobacco--Business Environment"
above.
PM Inc.'s shipment market share was 49.1%, an increase of 1.8 share points from
the comparable 1996 period. Based on shipments, the premium and discount
segments accounted for approximately 72.2% and 27.8%, respectively, of domestic
cigarette industry volume in the first six months of 1997, versus approximately
71.3% and 28.7%, respectively, in the comparable 1996 period. This reflects a
continued shift to the higher-margin premium segment, which began in the second
half of 1993.
In the premium segment, PM Inc.'s volume increased 3.7%, compared with a 0.3%
decrease for the industry, resulting in a premium segment share of 58.0%, an
increase of 2.2 share points from the first six months of 1996, reflecting the
timing of promotions.
In the discount segment, PM Inc.'s shipments decreased 6.0%, to 16.9 billion
units in the first six months of 1997 compared with an industry decline of 4.7%,
resulting in a discount segment share of 26.1%, a decrease of 0.4 share points
from the first six months of 1996. Basic shipment volume increased 120 million
units to 11.5 billion units, and its shipment share of the discount segment
during the first six months of 1997 increased 1.0 share points over the
comparable 1996 period, to 17.8%.
Retail sales data (compiled by the A.C. Nielsen Company) indicate PM Inc. and
Marlboro market shares of 50.7% and 34.8%, respectively, during the first six
months of 1997, compared with 49.2% and 32.9%, respectively, in the comparable
1996 period.
PM Inc. cannot predict future change or rates of change in the relative sizes of
the premium and discount segments or in PM Inc.'s shipments, shipment market
share or retail market share; however, it believes that implementation of the
proposed Resolution discussed above would likely materially adversely affect PM
Inc.'s shipments.
In March 1997, PM Inc. announced a price increase of $2.50 per thousand
cigarettes on its domestic premium and discount brands. PM Inc. previously
increased the price of its domestic premium and discount brands by $2.00 per
thousand cigarettes in the second quarter of 1996.
As discussed in Note 3, "Contingencies," of the Notes to the Condensed
Consolidated Financial Statements, in July 1997, PM Inc. and other companies in
the United States tobacco industry entered into an agreement in principle to
settle Mississippi's health care cost recovery action. Pursuant to the
agreement, in the third quarter, PM Inc. deposited approximately $115 million in
an escrow account and paid approximately $7 million (subject to later
adjustment) to reimburse the State of Mississippi and its attorneys for legal
expenses.
International tobacco. During the first six months of 1997, tobacco operating
revenues of PMI increased 10.8% over the comparable 1996 period, due to higher
foreign excise taxes ($726 million, principally for the consolidation of
previously unconsolidated and newly acquired subsidiaries), price increases
($385 million), favorable volume/mix ($340 million) and the consolidation of
previously unconsolidated and newly acquired subsidiaries ($292 million),
partially offset by unfavorable currency movements ($412 million). Operating
income for the first six months of 1997 increased 15.1% over the comparable 1996
period, due primarily to price increases, net of cost increases ($299 million),
favorable volume/mix ($226 million) and the consolidation of previously
unconsolidated and newly acquired subsidiaries ($39 million), partially offset
by unfavorable currency movements ($164 million) and higher marketing,
administration and research costs ($76 million).
PMI's volume grew 27.3 billion units (8.0%) in the first six months of 1997 over
the comparable 1996 period to 368.0 billion units, including local brands
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manufactured by Tabaqueira, Portugal's leading tobacco company, and ZPT-Krakow,
Poland's largest cigarette manufacturer. PMI acquired a controlling interest in
these companies during the first quarters of 1997 and 1996, respectively. Volume
advanced in most markets, including Germany, Italy, the Benelux countries,
Spain, Central and Eastern Europe, Turkey, the Middle East and the Asia/Pacific
region. Volume was down in France and Australia. Volume continued to grow for
PMI's portfolio of international brands, including Marlboro, PMI's largest
brand. PMI recorded market share gains in virtually all major markets.
For the Three Months Ended June 30,
------------------------------------------
Operating Revenues Operating Income
------------------ ----------------
(in millions)
1997 1996 1997 1996
---- ---- ---- ----
Domestic tobacco $ 3,457 $ 3,133 $ 1,185 $ 1,062
International tobacco 6,696 6,061 1,133 984
------- ------- ------- -------
Total $10,153 $ 9,194 $ 2,318 $ 2,046
======= ======= ======= =======
Domestic tobacco. During the second quarter of 1997, PM Inc.'s operating
revenues increased 10.3% over the comparable 1996 period, due to pricing ($155
million), higher volume ($152 million) and improved product mix ($17 million).
Operating income for the 1997 second quarter increased 11.6% over the comparable
1996 period, due to price increases, net of product cost increases ($152
million), higher volume ($96 million) and improved product mix ($16 million),
partially offset by higher marketing, administration and research costs ($118
million, primarily higher marketing expense) and higher fixed manufacturing
expense ($23 million).
PM Inc.'s shipment volume for the second quarter of 1997 was 60.8 billion units,
an increase of 5.0% from the second quarter of 1996, compared with an industry
decrease of 0.3%. The increase in PM Inc.'s shipments was due largely to the
timing of Marlboro promotional activity and increased buying by wholesalers in
the second quarter of 1997. For the second quarter of 1997, Marlboro shipment
volume increased 3.8 billion units (9.7%) to 42.6 billion units for a 34.6%
share of the total industry, an increase of 3.2 share points from the second
quarter of 1996. While PM Inc. cannot predict future growth rates, it believes
that, over the long term, industry shipments will continue to decline in line
with their historical average decline of 1% to 2% per annum, subject to the
effects, if implemented, of the proposed Resolution discussed under
"Tobacco--Business Environment" above.
PM Inc.'s 1997 second quarter shipment market share was 49.5%, an increase of
2.5 share points from the comparable 1996 period. Based on shipments, the
premium and discount segments accounted for approximately 72.6% and 27.4%,
respectively, of domestic cigarette industry volume in the second quarter of
1997, versus approximately 71.3% and 28.7%, respectively, in the comparable 1996
period. This reflects a continued shift to the higher-margin premium segment,
which began in the second half of 1993.
In the premium segment, PM Inc.'s volume increased 6.9%, compared with a 1.5%
increase for the industry, resulting in a premium segment share of 58.4%, an
increase of 3.0 share points from the second quarter of 1996, due largely to the
timing of Marlboro promotions.
In the discount segment, PM Inc.'s shipments decreased 5.0%, to 8.7 billion
units in the second quarter of 1997 compared with an industry decline of 4.8%,
resulting in a discount segment share of 25.7%, flat compared to the second
quarter of 1996. Basic shipment volume increased 231 million units to 6.0
billion units as its shipment share of the discount segment during the second
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quarter of 1997 increased 1.5 share points over the comparable 1996 period, to
17.8%.
Retail sales data (compiled by the A.C. Nielsen Company) indicate PM Inc. and
Marlboro market shares of 51.1% and 35.2%, respectively, during the second
quarter of 1997, compared with 49.6% and 33.4%, respectively, in the comparable
1996 period.
PM Inc. cannot predict future change or rates of change in the relative sizes of
the premium and discount segments or in PM Inc.'s shipments, shipment market
share or retail market share; however, it believes that implementation of the
proposed Resolution discussed above would likely materially adversely affect PM
Inc.'s shipments.
International tobacco. During the second quarter of 1997, tobacco operating
revenues of PMI increased 10.5% over the comparable 1996 period, due to higher
foreign excise taxes ($336 million, principally for the consolidation of
previously unconsolidated and newly acquired subsidiaries), price increases
($215 million), favorable volume/mix ($144 million) and the consolidation of
previously unconsolidated and newly acquired subsidiaries ($199 million),
partially offset by unfavorable currency movements ($259 million). Operating
income for the 1997 second quarter increased 15.1% over the comparable 1996
period, due primarily to price increases, net of cost increases ($146 million),
favorable volume/mix ($100 million) and the consolidation of previously
unconsolidated and newly acquired subsidiaries ($20 million), partially offset
by unfavorable currency movements ($84 million) and higher marketing,
administration and research costs ($26 million).
PMI's volume grew 12.3 billion units (7.5%) in the second quarter of 1997 over
the comparable 1996 period to 177.1 billion units, including local brands
manufactured by Tabaqueira, Portugal's leading tobacco company, in which PMI
acquired a controlling interest in January 1997. Volume advanced in most
markets, including Germany, the Benelux countries, Spain, Central and Eastern
Europe, Turkey, the Middle East, Mexico and the Asia/Pacific region, where gains
in most of this region's markets were partially offset by lower volume in Japan
due to first quarter buying in advance of a tax-driven retail price increase.
Volume continued to grow for PMI's portfolio of international brands, including
Marlboro, PMI's largest brand. PMI recorded market share gains in virtually all
major markets.
Food
Business Environment
Kraft Foods, Inc. ("Kraft"), the largest processor and marketer of retail
packaged food in the United States, and its subsidiary Kraft Foods
International, Inc. ("KFI"), which markets coffee, confectionery and grocery
products in Europe and the Asia/Pacific region, are subject to fluctuating
commodity costs and competitive challenges in various product categories and
markets. Certain subsidiaries and affiliates of PMI that manufacture and sell
food products in Latin America are also subject to competitive challenges in
various product categories and markets. In addition, the results of KFI, as well
as PMI's food operations in Latin America, are subject to fluctuations of local
currencies against the U.S. dollar.
Steps have been, and will continue to be, taken to build the value of premium
brands, reduce costs and improve the Company's food business portfolio. The
North American food business has been reorganized to streamline operations and
improve effectiveness and customer response. The realignment included the
creation of a unified sales force in the United States. KFI has been realigned
to capitalize on future growth opportunities and reorganized into separate
regional units.
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From 1995 through the second quarter of 1997, Kraft and KFI realigned their
portfolios of businesses to focus on higher-margin premium products. During
1995, Kraft sold its bakery, North American margarine, specialty oils,
marshmallows, caramels and Kraft Foodservice distribution businesses. During
1996, Kraft sold its bagel business and KFI sold its margarine businesses in the
U.K. and Italy. In the first six months of 1997, KFI sold a Scandinavian sugar
confectionery business. Kraft and KFI have also sold several smaller
non-strategic businesses. In July 1997, Kraft sold certain of its maple-flavored
syrup businesses, including the Log Cabin and Country Kitchen brands. The sale
is expected to result in a gain in the third quarter of 1997. In addition, Kraft
and KFI initiated cost saving programs that primarily included downsizing
facilities and workforce reductions. The cost of these actions substantially
offset the gains from businesses sold.
Kraft also acquired the Taco Bell grocery and Del Monte shelf-stable pudding
businesses during 1996 and 1995, respectively. In Latin America, PMI acquired
nearly all of the remaining voting shares of Industrias de Chocolate Lacta S.A.
("Lacta"), a Brazilian chocolate confectionery company, in the second quarter of
1996.
The North American and international food businesses are affected by fluctuating
commodity costs, particularly coffee bean prices, which can influence consumer
and trade buying patterns, affect retail price volatility and lead to price
competition in some markets. During the first quarter of 1997, coffee prices
rose dramatically due primarily to speculation concerning 1997's South American
crop and unusually low world stocks. Coffee bean prices reached a twenty-year
high in late May and led to price increases by Kraft, KFI and their competitors.
Kraft and KFI estimate that coffee consumption may be sluggish for the remainder
of 1997, as a result of higher than average 1997 coffee bean prices. Kraft was
also affected by record high cheese commodity costs in 1996, as well as other
higher dairy commodity costs, arising from low U.S. milk production. Cheese and
dairy commodity costs moderated in the first quarter of 1997 and have remained
stable.
Kraft's cereal business continues to be affected by intense price competition,
particularly from value brands. In response, Kraft implemented a price rollback
and simplified couponing of its cereal products in the second quarter of 1996.
Several competitors followed with similar pricing strategies. The reduction of
cereal prices in 1996 lowered operating revenues and operating income in 1996
and the first quarter of 1997 in relation to prior period results.
Operating Results
For the Six Months Ended June 30,
--------------------------------------------
Operating Revenues Operating Income
------------------ ----------------
(in millions)
1997 1996 1997 1996
---- ---- ---- ----
North American food $ 8,731 $ 8,447 $ 1,558 $ 1,420
International food 5,433 5,731 560 548
------- ------- ------- -------
Total $14,164 $14,178 $ 2,118 $ 1,968
======= ======= ======= =======
North American food. During the first six months of 1997, operating revenues
increased 3.4% over the comparable 1996 period, due to volume increases in
ongoing operations ($322 million), pricing ($135 million) and the impact of
acquisitions ($38 million), partially offset by the impact of divestitures ($148
million), unfavorable product mix ($58 million) and unfavorable currency
movements ($5 million). Operating income for the first six months of 1997
increased 9.7% over the comparable 1996 period, due primarily to volume
increases in ongoing operations ($199 million), price increases, net of cost
increases ($124 million), partially offset by the impact of divestitures ($20
million) and
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higher marketing, administration and research costs ($154 million, due in large
part to higher marketing expense).
Excluding operating results of the divested North American businesses discussed
above, operating revenues and operating income increased 5.2% and 11.3%,
respectively, in the first six months of 1997 over the comparable 1996 period.
Strong volume gains were achieved in frozen pizza, driven by new product
introductions and geographic market expansion; beverages, on the strength of
ready-to-drink and powdered soft drink products; meals, due to strength in
macaroni and cheese dinners and the acquisition of Taco Bell grocery products in
1996; cereals, due primarily to product introductions and the implementation of
a price rollback and simplified couponing as discussed previously; and desserts,
due to new product introductions and growth in refrigerated ready-to-eat and dry
packaged desserts. Volume gains were also realized in processed meats, driven by
continued growth of lunch combinations, as well as volume gains in cold cuts and
hot dogs. Cheese volume also increased slightly in the first six months due to
strong first quarter volume. Coffee volume increased, aided by sales of
premium-priced products and heavy first quarter volume in advance of
commodity-driven price increases.
International food. Operating revenues for the first six months of 1997
decreased 5.2% from the comparable 1996 period, due to unfavorable currency
movements ($344 million), lower volume/mix ($128 million) and the impact of
divestitures ($116 million), partially offset by the impact of newly acquired
and previously unconsolidated subsidiaries ($198 million) and pricing ($92
million). Operating income for the first six months of 1997 increased 2.2% over
the first six months of 1996, due to price increases, net of cost increases ($20
million), the impact of newly acquired and previously unconsolidated
subsidiaries ($35 million) and lower marketing, administration and research
costs ($39 million), partially offset by lower volume ($55 million), the impact
of divestitures ($18 million) and unfavorable currency movements ($17 million).
KFI recorded a net gain of $22 million from the sale of a Scandinavian sugar
confectionery business in the first quarter of 1997. In addition, KFI recorded
charges primarily for product discontinuance. These charges partially offset the
gain from the business sold.
Excluding operating results of the divested international food businesses
discussed above, operating revenues decreased 3.2% and operating income
increased 5.7% in the first six months of 1997 over the comparable 1996 period.
Lower ongoing volume for KFI was due primarily to one less selling week during
the first quarter of 1997 compared to the first quarter of 1996. KFI's coffee
volume increased slightly during the first six months of 1997, particularly in
Germany and France, its largest coffee markets, on heavy first quarter volume in
advance of announced commodity-driven price increases. KFI also recorded market
share gains in many of its key coffee markets. KFI's confectionery volume
declined, due primarily to strong competition in Northern Europe and lower
volume in Romania and Bulgaria, reflecting poor economic environments. KFI's
cheese and grocery volumes decreased due primarily to the impact of one less
selling week during the first quarter of 1997. Excluding the acquisition of
Lacta, PMI's food volume in Latin America for the first six months of 1997 was
lower than the comparable 1996 period, due primarily to lower volume in ice
cream, partially offset by higher volume in beverages.
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<PAGE>
For the Three Months Ended June 30,
------------------------------------------
Operating Revenues Operating Income
------------------ ----------------
(in millions)
1997 1996 1997 1996
---- ---- ---- ----
North American food $4,331 $4,258 $ 815 $ 735
International food 2,622 2,776 287 285
------ ------ ------ ------
Total $6,953 $7,034 $1,102 $1,020
====== ====== ====== ======
North American food. During the second quarter of 1997, operating revenues
increased 1.7% over the comparable 1996 period, due primarily to pricing ($148
million), the impact of acquisitions ($23 million) and volume increases in
ongoing operations ($9 million), partially offset by the impact of divestitures
($72 million) and unfavorable product mix ($31 million). Operating income for
the second quarter of 1997 increased 10.9% over the comparable 1996 period, due
primarily to pricing ($149 million) and volume increases in ongoing operations
($16 million), partially offset by unfavorable product mix ($12 million), the
impact of divestitures ($10 million) and higher marketing, administration and
research costs ($68 million).
Excluding operating results of the divested North American businesses discussed
above, operating revenues and operating income increased 3.5% and 12.4%,
respectively, in the second quarter of 1997 over the comparable 1996 period.
Strong ongoing volume gains were achieved in frozen pizza, driven by new product
introductions and geographic market expansion; beverages, on the strength of
ready-to-drink and powdered soft drink products; meals, due to strength in
macaroni and cheese dinners and the acquisition of Taco Bell grocery products in
1996; and processed meats, driven by continued growth of lunch combinations and
growth in hot dogs and cold cuts. Volume gains were realized in desserts, due to
new product introductions and strength in refrigerated ready-to-eat and dry
packaged desserts, and enhancers, where volume growth in barbecue sauce and
pourable dressings more than offset a volume decline in spoonable dressings.
Cereals volume was lower than in the second quarter of 1996 when sales surged
after the implementation of a price rollback and simplified couponing as
discussed previously. Cheese and coffee volume comparisons were affected by
commodity prices as discussed above. Coffee volume declined during the quarter
due to heavy first quarter buying in advance of commodity-driven price increases
and cheese volume was lower than the second quarter of 1996, when sales
accelerated in advance of a commodity-driven price increase.
International food. Operating revenues for the second quarter of 1997 decreased
5.5% from the second quarter of 1996, due to unfavorable currency movements
($223 million), lower volume/mix ($114 million) and the impact of divestitures
($55 million), partially offset by the impact of newly acquired and previously
unconsolidated subsidiaries ($128 million) and pricing ($110 million). Operating
income for the second quarter of 1997 increased 0.7% over the second quarter of
1996, due primarily to the impact of newly acquired and previously
unconsolidated subsidiaries ($30 million), lower marketing, administration and
research costs ($40 million) and price increases, net of cost increases ($4
million), partially offset by lower volume ($49 million), unfavorable currency
movements ($14 million) and the impact of divestitures ($9 million).
Excluding operating results of the divested international food businesses
discussed above, operating revenues decreased 3.6% and operating income
increased 4.0% in the second quarter of 1997 over the comparable 1996 period.
Lower second quarter ongoing food volume for KFI reflects a decline in coffee
volume during the second quarter of 1997 as a result of first quarter trade
purchases made in advance of announced commodity-driven price increases and
lower
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<PAGE>
confectionery volume. KFI's confectionery volume decreased, due primarily to
volume declines in Romania and Bulgaria, reflecting poor economic environments;
and an unfavorable comparison to last year in Germany, KFI's largest
confectionery market, since the trade purchased abnormally high volumes during
1996 in advance of a price increase. KFI's cheese and grocery volumes increased
due to volume gains in the Asia/Pacific region. Excluding the acquisition of
Lacta, PMI's food volume in Latin America for the second quarter of 1997 was
lower than in the comparable 1996 period, due primarily to lower volume in ice
cream, partially offset by higher volume in beverages.
Beer
Six Months ended June 30
Operating revenues of the Miller Brewing Company ("Miller") for the first six
months of 1997 decreased $107 million (4.7%) from the comparable 1996 period,
due to lower volume ($61 million) and unfavorable price/mix ($46 million).
Operating income for the first six months of 1997 increased $10 million (3.6%)
from the comparable 1996 period, due primarily to lower marketing,
administration and research costs ($50 million) and lower fixed manufacturing
expense ($12 million), partially offset by unfavorable price/mix ($29 million)
and lower volume ($25 million). Revenues, manufacturing costs and lower
marketing, administration and research costs were impacted by actions taken by
Miller in the fourth quarter of 1996 to restore growth, streamline its
organization and reduce costs.
Miller's 1997 shipment volume of 22.5 million barrels for the first six months
of 1997 decreased 2.7% from the comparable 1996 period, reflecting lower
shipments of premium-priced brands. Lower shipment volume was due largely to a
decision to reduce wholesaler inventories in 1997 and an unfavorable comparison
to last year, which was favorably affected by the launch of Miller Beer.
However, wholesalers' sales to retailers in the first six months of 1997
increased slightly from the comparable 1996 period, reflecting higher sales of
Miller Lite, as Miller's new advertising and promotional campaigns renewed focus
on core brands.
Quarter ended June 30
Operating revenues for Miller for the second quarter of 1997 increased $7
million (0.6%) from the comparable 1996 period due to higher volume ($38
million), partially offset by unfavorable price/mix ($31 million). Operating
income for the second quarter of 1997 increased $7 million (4.4%) from the
comparable 1996 period, due primarily to higher volume ($16 million), lower
fixed manufacturing expense ($7 million) and lower marketing, administration and
research costs ($4 million), partially offset by unfavorable price/mix ($21
million).
Miller's 1997 second quarter shipment volume of 12.4 million barrels increased
3.2% from the comparable 1996 period, reflecting higher shipments of
premium-priced and budget-priced brands. Shipments of Miller Lite rose, driven
by new advertising and promotional activity. Shipment volume increases were
recorded for Miller High Life, Red Dog, Milwaukee's Best, Icehouse and Foster's.
Shipments of Miller Genuine Draft declined slightly. Wholesalers' sales to
retailers in the second quarter increased slightly.
Financial Services and Real Estate
During the first six months and second quarter of 1997, Philip Morris Capital
Corporation's ("PMCC") operating revenues increased $18 million (9.9%) and $19
million (23.5%), respectively, while operating income increased $16 million
(17.8%) and $9 million (18.4%), respectively, from the comparable 1996 periods.
Financial services operating revenues and operating income from PMCC advanced
due to the continued growth and profitability of its leasing and structured
finance portfolio. Operating revenues from the real estate operations of Mission
Viejo Company ("MVC") increased during the first six months and second quarter
of 1997 from the comparable 1996 periods, due primarily to increased land sales,
as operating income declined slightly. On August 1, 1997, PMCC announced that it
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<PAGE>
agreed to sell MVC. The sale is expected to be completed during the third
quarter of 1997. PMCC estimates that the sale will result in a gain.
Financial Review
Net Cash Provided by Operating Activities
During the first six months of 1997, cash provided by operating activities was
$3.6 billion, $746 million higher than in the first six months of 1996, due
primarily to higher net earnings and lower cash requirements for working capital
items. Including payments of income taxes on sales of businesses, cash provided
by operating activities in the first six months of 1997 was $3.5 billion, $662
million higher than the first six months of 1996.
Net Cash Used in Investing Activities
During the first six months of 1997, cash used in investing activities was $956
million, compared with $1.3 billion used during the comparable 1996 period. The
change was due primarily to cash provided by the sale of a Scandinavian sugar
confectionery company in 1997 and less cash used for acquisitions.
In June, 1997, PMI reached agreement to increase its equity interest in a
Mexican cigarette business from 28.8% to 50.0% in exchange for a payment of
approximately $400 million.
Net Cash Used in Financing Activities
During the first six months of 1997, the Company's net cash used in financing
activities increased to $2.4 billion, compared to $1.5 billion used in the first
six months of 1996, due primarily to lower net proceeds from borrowings and an
increase in dividends paid, partially offset by lower stock repurchases.
Debt
The Company's total debt and consumer products debt at June 30, 1997 were $15.5
billion and $14.2 billion, respectively, approximately the same as debt levels
at December 31, 1996. At both June 30, 1997 and December 31, 1996, the Company's
ratio of consumer products debt to total equity was 0.98 and ratio of total debt
to total equity was 1.07.
The Company has revolving bank credit agreements totaling $12.0 billion. These
facilities are used to support the Company's commercial paper borrowings and are
available for acquisitions and other corporate purposes. An agreement for $4.0
billion expires in October 1997. An agreement for $8.0 billion expires in 2000,
enabling the Company to refinance short-term debt on a long-term basis, based
upon its intent and ability to refinance such debt. At June 30, 1997, $1.3
billion of consumer products commercial paper was reclassified as long-term
debt. The Company subsequently issued $1.0 billion of consumer products
long-term debt in July 1997, the proceeds of which were used to repay commercial
paper borrowings. The Company expects to continue to refinance long-term and
short-term debt from time to time. The nature and amount of the Company's
long-term and short-term debt and the proportionate amount of each can be
expected to vary as a result of future business requirements, market conditions
and other factors.
As discussed above in "Tobacco--Business Environment," PM Inc. estimates that
the proposed Resolution in its current form, would result in an initial payment
by PM Inc. of approximately $6.5 billion upon enactment. The Company anticipates
that the payment would be funded from a combination of available cash,
commercial paper issuances, bank borrowings and long-term debt issuances in
global markets. The Company further anticipates that the payment will result in
significant increases in its consumer products debt to total equity ratio, total
debt to total equity ratio and total debt outstanding.
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<PAGE>
The Company operates internationally, with manufacturing and sales facilities in
various locations around the world. The Company continually evaluates its
foreign currency net asset exposure (primarily the Swiss franc, German mark,
Swedish krona, Netherlands guilder and Canadian dollar) based on current market
conditions and business strategies, and it acts to manage such exposure, when
deemed prudent, through various hedging transactions. The Company has entered
into currency and related interest rate swap agreements to manage exposure to
currency movements. The U.S. dollar value of aggregate notional principal
amounts for these agreements outstanding was equivalent to $1.4 billion and $2.2
billion at June 30, 1997 and December 31, 1996, respectively. Of these amounts,
$737 million and $1.5 billion related to consumer products debt at June 30, 1997
and December 31, 1996, respectively.
The Company enters into forward exchange and option contracts, for purposes
other than trading, to reduce the effects of fluctuating foreign currency on
foreign currency denominated current assets, liabilities, commitments and
short-term intercompany transactions. At June 30, 1997 and December 31, 1996,
the Company had entered into contracts, with maturities of less than one year
and notional U.S. dollar equivalents of $3.0 billion (including $1.5 billion in
option contracts) and $1.7 billion, respectively.
The Company's credit ratings by Moody's at June 30, 1997 and December 31, 1996
were "P-1" in the commercial paper market and "A2" for long-term debt
obligations. The Company's credit ratings by Standard & Poor's ("S&P") at June
30, 1997 and December 31, 1996 were "A-1" in the commercial paper market and "A"
for long-term debt obligations. In April 1997, S&P placed the debt ratings of
the Company on its CreditWatch list with the intent of monitoring tobacco
litigation developments.
Equity and Dividends
On February 26, 1997, the Company's Board of Directors declared a three-for-one
split of the Company's common stock, effected by a distribution on April 10,
1997, of two shares for each share held of record at the close of business on
March 17, 1997. All share and per share data have been restated to reflect this
stock split for all periods presented.
During the first six months of 1997, the Company repurchased 18.2 million shares
of its common stock at an aggregate cost of $743 million. Of these purchases,
16.9 million shares ($692 million) were made pursuant to the Company's
repurchase program, announced in 1994, to purchase up to $6.0 billion of its
common stock in the open market, and the remainder were made under an $8.0
billion share repurchase program approved by the Board of Directors in the first
quarter of 1997. These 1997 repurchases, net of 8.9 million shares issued under
the Philip Morris 1992 Incentive Compensation and Stock Option Plan during 1997,
resulted in lower weighted average shares outstanding for the first six months
and second quarter of 1997 as compared to the first six months and second
quarter of 1996.
Dividends paid in 1997 were 17.2% higher than in 1996, reflecting an increase in
the dividend rate, partially offset by fewer shares outstanding. In August 1996,
the Board of Directors increased the Company's quarterly dividend rate to $0.40
per share, a 20.0% increase, resulting in an annualized dividend rate of $1.60
per share.
As discussed above in the last paragraph of "Tobacco-Business
Environment-Proposed Resolution of Certain Regulatory and Litigation Issues,"
the Company may reevaluate its share repurchase and dividend policies.
During the first six months of 1997, currency translation adjustments reduced
equity by $849 million due to the strengthening of the U.S. dollar versus
European currencies, primarily the Swiss franc, German mark, Netherlands guilder
and Swedish krona.
New Accounting Standards
In 1996, the American Institute of Certified Public Accountants' Accounting
Standards Executive Committee issued Statement of Position ("SOP") No. 96-1,
"Environmental Remediation Liabilities," which, as required, was adopted by the
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Company as of January 1, 1997. The adoption and application of SOP No. 96-1 had
no material effect on the Company's 1997 results of operations or financial
position for the three or six month periods ended June 30, 1997.
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share," which is
effective for the year ending December 31, 1997. SFAS No. 128 establishes
standards for computing and presenting earnings per share ("EPS") and requires
the presentation of both basic and diluted EPS. Based upon the Company's current
capitalization structure, the basic and diluted EPS amounts calculated in
accordance with SFAS No. 128 are expected to approximate the Company's EPS
amounts computed in accordance with Accounting Principles Board Opinion No. 15,
"Earnings Per Share."
Contingencies
See Note 3 to the Condensed Consolidated Financial Statements for a discussion
of contingencies.
Forward-Looking and Cautionary Statements
Reference is made to Item 1 (c) "Other Matters--Forward-Looking and Cautionary
Statements" in the Company's Form 10-K regarding important factors that could
cause actual results to differ materially from those contained in any
forward-looking statement made by or on behalf of the Company, including
forward-looking statements contained in this report. Reference is also made to
the section herein under the heading "Tobacco--Business Environment."
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<PAGE>
Part II - OTHER INFORMATION
Item 1. Legal Proceedings.
Reference is made to Note 3, "Contingencies," of the Notes to the
Condensed Consolidated Financial Statements included in Part I, Item 1 of this
report, and to "Tobacco--Business Environment," of the Management's Discussion
and Analysis of Financial Condition and Results of Operations included in Part
I, Item 2 of this report.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
10 1992 Compensation Plan for Non-Employee Directors, as amended.
12 Statement regarding computation of ratios of earnings to fixed
charges.
27 Financial Data Schedule.
(b) Reports on Form 8-K. Since the beginning of the quarter for which
this report is filed, the Registrant filed Current Reports on Form
8-K, dated June 20, 1997 and June 25, 1997, concerning the proposed
Resolution. The Registrant has also filed a Current Report on Form
8-K dated July 2, 1997, concerning the proposed Resolution and other
recent developments, including an agreement in principle to settle
Mississippi's health care cost recovery action.
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<PAGE>
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHILIP MORRIS COMPANIES INC.
/s/ LOUIS C. CAMILLERI
Louis C. Camilleri, Senior Vice President and
Chief Financial Officer
August 13, 1997
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EXHIBIT 10
Philip Morris Companies Inc.
1992 Compensation Plan For Non-Employee Directors
(as amended, and in effect, June 25, 1997)
SECTION 1. Purposes; Definitions.
The purposes of the Plan are (i) to assist the Company in promoting a greater
identity of interest between the Company's non-employee directors and its
shareholders; and (ii) to assist the Company in attracting and retaining
non-employee directors by affording Participants an opportunity to share in the
future successes of the Company. In addition, in accordance with Revenue Ruling
71-419, 1971-2 C.B. 220, the Plan is intended to afford any or all non-employee
directors of the Company the option to defer the receipt of all or part of their
Compensation until such future date as they may elect pursuant to the terms and
conditions of the Plan.
For purposes of the Plan, the following terms are defined as set forth below:
a. "Account" means an unfunded deferred compensation account established by
the Company pursuant to the Deferred Fee Program, consisting of one or
more Subaccounts established in accordance with Section 3.2.2.
b. "Allocation Date" means any date on which an amount representing all or a
part of a Participant's Compensation is to be credited to his or her
Account pursuant to an effective deferral election. The Allocation Date
for the Retainer Fee shall be the first day of each calendar quarter and
for Meeting Fees shall be the first day of the month following the
meeting.
c. "Beneficiary" means any person or entity designated as such in a current
Election Form. If there is no valid designation or if no designated
Beneficiary survives the Participant, the Beneficiary is the Participant's
estate.
d. "Board" means the Board of Directors of the Company.
e. "Code" means the Internal Revenue Code of 1986, as amended from time to
time.
f. "Common Stock" means the common stock, $0.331/3 par value, of the Company.
g. "Company" means Philip Morris Companies Inc., a corporation organized
under the laws of the Commonwealth of Virginia, or any successor
corporation.
h. "Compensation" means the sum of the Retainer Fee and the Meeting Fees
payable by the Company to each Participant but
<PAGE>
EXHIBIT 10
shall not include any additional amount paid to a chairman of a committee
for additional services.
i. "Date of Grant" means May 1 of each year (beginning May 1, 1992 and ending
May 1, 2001) on which dates shares of Common Stock will be awarded in
accordance with Section 4.
j. "Deferred Amount" means the amount (determined as a percentage of the
Retainer Fee and the Meeting Fees) subject to a current deferral election.
k. "Deferred Fee Program" means the provisions of the Plan that permit
Participants to defer all or part of their Compensation.
l. "Disability" means permanent and total disability as determined under
procedures established by the Board for purposes of the Plan.
m. "Distribution Date" means the date designated by a Participant in
accordance with Sections 3.4.1 and 3.4.2 for the commencement of payment
of amounts credited to his or her Account.
n. "Election Date" means the date an Election Form is received by the
Secretary of the Company.
o. "Election Form" means a valid Deferred Fee Program Initial Election Form
or Modified Election Form properly completed and signed.
p. "ERISA" means the Employee Retirement Income Security Act of 1974, as
amended from time to time, and the rules and regulations thereunder.
q. "Exchange Act" means the Securities Exchange Act of 1934, as from time to
time amended.
r. "Extraordinary Distribution Request Date" means the date an Extraordinary
Distribution Request Form is received by the Secretary of the Company.
s. "Extraordinary Distribution Request Form" means the Deferred Fee Program
Extraordinary Distribution Request Form properly completed and executed by
a Participant or Beneficiary who wishes to request an extraordinary
distribution of amounts credited to his or her Account in accordance with
Section 3.4.3.
t. "Fair Market Value" means, as of any given date, the mean of the highest
and lowest reported sales prices of the Common Stock as reported in the
principal consolidated transaction reporting system with respect to
securities listed or admitted to trading on The New York Stock Exchange.
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<PAGE>
EXHIBIT 10
u. "Fund" means any one of the investment vehicles in which the trust fund
established under the trust agreement, as amended from time to time,
entered into by the Company in connection with the Profit-Sharing Plan, is
invested.
v. "Meeting Fees" means the portion of a Participant's Compensation that is
based upon his or her attendance at Board meetings and meetings of
committees of the Board.
w. "Participant" means a member of the Board who satisfies the requirements
of Section 2 and a Director Emeritus. For purposes of the Deferred Fee
Program only, a Participant shall also include a person who was, but is no
longer, a member of the Board as long as an Account is being maintained
for his or her benefit.
aa. "Plan" means the Philip Morris Companies Inc. 1992 Compensation Plan for
Non-Employee Directors.
bb. "Profit-Sharing Plan" means the Philip Morris Deferred Profit-Sharing
Plan, effective as of January 1, 1956, as amended from time to time.
cc. "Retainer Fee" means the portion of a Participant's Compensation that is
fixed and paid without regard to his or her attendance at meetings, but
shall not include amounts credited to a Participant's account under the
Philip Morris Companies Inc. Stock Unit Plan for Non-Employee Directors.
dd. "Retired Participant" means a person who is not a Participant who had
amounts credited to his or her account under the Former Plan as of April
1, 1992.
ee. "Subaccount" means one of the bookkeeping accounts established within each
Participant's Account in accordance with Section 3.2.2.
ff. "Transfer Election Date" means the date set forth on a Transfer Form.
gg. "Transfer Form" means a valid Deferred Fee Program Transfer Election Form
completed and signed by a Participant or Beneficiary.
hh. "Trustee" means the trustee administering the Fund.
SECTION 2. Eligibility.
Each member of the Board who is not a full-time employee of the Company (or any
corporation in which the Company owns, directly or indirectly, stock possessing
at least (50%) of the total combined voting power of all classes of stock
entitled to vote in the
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<PAGE>
EXHIBIT 10
election of directors in such corporation) shall be eligible to receive an award
in accordance with Section 4. In addition, each Participant shall be eligible to
participate in the Deferred Fee Program.
SECTION 3. Deferred Fee Program.
3.1 Participation.
3.1.1 Deferral Elections.
A Participant may make a deferral election with respect to all or a
part of his or her Compensation to be earned and payable thereafter by
completing and executing an Election Form and submitting it to the Secretary of
the Company. Any deferral election relating to Retainer Fees shall be in
integral multiples of twenty-five percent (25%) of the Retainer Fee. Any
deferral elections relating to Meeting Fees shall be one hundred percent (100%)
of each Meeting Fee.
In accordance with the terms of the Plan, the Participant shall
indicate on the Election Form:
a. the percentage of the Retainer Fee that he or she wishes to
defer and whether Meeting Fees are to be deferred;
b. the Distribution Date;
c. whether distributions are to be in a lump sum, in installments
or a combination thereof;
d. the Participant's Beneficiary or Beneficiaries; and
e. the Subaccounts to which the Deferred Amount is to be
allocated.
A deferral election shall become effective with respect to a
Participant's Retainer Fee accruing on and after the first day of the calendar
quarter (and payable on the first day of the second calendar quarter) following
the Election Date. A deferral election shall become effective with respect to a
Participant's Meeting Fees accruing on and after the first day of the calendar
month following the Election Date. A deferral election shall remain in effect
with respect to all future Compensation until a new deferral election made by
the Participant in accordance with Section 3.1.2 or Section 3.1.3 becomes
effective.
3.1.2 Change of Deferral Election.
A Participant may change his or her deferral election with respect
to Compensation to be earned and payable thereafter by completing and executing
a Modified Election Form and
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<PAGE>
EXHIBIT 10
submitting it to the Secretary of the Company. A change to increase the amount
of future Compensation to be deferred shall become effective with respect to a
Participant's Retainer Fee accruing on and after the first day of the calendar
quarter (and payable on the first day of the second calendar quarter) following
the Election Date. A change to defer Meeting Fees shall become effective with
respect to a Participant's Meeting Fees accruing on and after the first day of
the calendar month following the Election Date. Subject to Section 3.1.3, a
change to decrease the amount of future Compensation to be deferred shall become
effective with respect to Compensation accruing on and after the later of (i)
January 1 (and, with respect to Retainer Fees, payable on April 1) of the year
following the Election Date or (ii) the first day of the second calendar quarter
(and, with respect to Retainer Fees, payable on the first day of the third
calendar quarter) following the Election Date.
3.1.3 Cessation of Deferrals.
A Participant may cease to defer future Compensation in the Deferred
Fee Program by completing and executing a Modified Election Form, and submitting
it to the Secretary of the Company. An election by a Participant to cease
deferrals in the Deferred Fee Program shall become effective with respect to
Compensation accruing on or after the later of (i) January 1 (and, with respect
to Retainer Fees, payable on April 1) of the year following the Election Date or
(ii) the first day of the second calendar quarter (and, with respect to Retainer
Fees, payable on the first day of the third calendar quarter) following the
Election Date.
3.1.4 Beneficiary Election Modification.
A Participant shall be permitted at any time to modify his or her
Beneficiary election, effective as of the Election Date, by completing and
executing a Modified Election Form and submitting it to the Secretary of the
Company.
3.2 Investments.
3.2.1 Accounts.
The Company shall establish an Account for each Participant and for
each Beneficiary to whom installment distributions are being made. On each
Allocation Date, the Company shall allocate to each Participant's Account an
amount equal to his or her Deferred Amount.
3.2.2 Subaccounts.
The Company shall establish within each Account one or more
Subaccounts, which shall be credited with earnings and charged with losses, if
any, on the same basis as the corresponding Fund, as the same may change from
time to time,
-5-
<PAGE>
EXHIBIT 10
under the Profit-Sharing Plan; as of the date hereof, the Subaccounts are,
respectively:
Subaccount A - a bookkeeping account whose value shall be based on a
theoretical investment in the U.S. Obligations Fund of the
Profit-Sharing Plan.
Subaccount B - a bookkeeping account whose value shall be based on a
theoretical investment in the Equity Index Fund of the
Profit-Sharing Plan.
Subaccount C - a bookkeeping account whose value shall be based on a
theoretical investment in the Interest Income Fund of the
Profit-Sharing Plan.
Subaccount D - a bookkeeping account whose value shall be based on a
theoretical investment in the Philip Morris Stock Fund of the
Profit-Sharing Plan.
Subaccount E - effective January 1, 1996, a bookkeeping account
whose value shall be based on a theoretical investment in the
Balanced Fund of the Profit-Sharing Plan.
Subaccount F - effective January 1, 1996, a bookkeeping account
whose value shall be based on a theoretical investment in the
International Equity Fund of the Profit-Sharing Plan.
Subaccount G - effective January 1, 1996 a bookkeeping account whose
value shall be based on a theoretical investment in the Growth
Equity Fund of the Profit-Sharing Plan.
To the extent additional funds are provided under the Profit-Sharing Plan, the
Senior Vice President - Human Resources and Administration of the Company is
authorized to establish corresponding Subaccounts under the Plan.
Subject to the provisions of Sections 3.2.3 and 3.2.4, on each
Allocation Date, each Participant's Subaccounts shall be credited with an amount
equal to the Deferred Amount designated by the Participant for allocation to
such Subaccounts. Each Subaccount shall be credited with earnings and charged
with losses as if the amounts allocated thereto had been invested in the
corresponding Fund.
The value of any Subaccount at any relevant time shall be determined
as if all amounts credited thereto had been invested in the corresponding Fund.
3.2.3 Investment Directions.
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<PAGE>
EXHIBIT 10
In connection with his or her initial deferral election, each
Participant shall make an investment direction on his or her Initial Election
Form with respect to the portion of such Participant's Deferred Amount that is
to be allocated to a Subaccount. Any apportionment of Deferred Amounts (and of
increases or decreases in Deferred Amounts) among the Subaccounts shall be in
integral multiples of one percent (1%). An investment direction shall become
effective with respect to any Subaccount on the first day of the calendar month
following the Election Date. All investment directions shall be irrevocable and
shall remain in effect with respect to all future Deferred Amounts until a new
irrevocable investment direction made by the Participant in accordance with
Section 3.2.4 becomes effective.
3.2.4 New Investment Directions.
A Participant may make a new investment direction with respect to
his or her Deferred Amount only by completing and executing a Modified Election
Form and submitting it to the Secretary of the Company. A new investment
direction shall become effective with respect to any Subaccount, on the first
day of the calendar month following the Election Date.
3.2.5 Investment Transfers.
A Participant or a Beneficiary (after the death of the Participant
may transfer to one or more different Subaccounts all or a part (not less than
one percent (1%)) of the amounts credited to a Subaccount by completing and
executing a Transfer Form and submitting it to the Secretary of the Company;
provided however that no Transfer Form may be submitted by a Participant who is
subject to Section 16 of the Exchange Act, if a Transfer Form requesting an
opposite way transfer had been submitted by such Participant within the
preceding six months. Any transfer of amounts among Subaccounts shall become
effective on the first day of the calendar month following the Transfer Election
Date.
3.3 [Intentionally Omitted]
3.4 Distributions.
3.4.1 Distribution Elections.
Each Participant shall designate on his or her Election Form one of
the following dates as a Distribution Date with respect to amounts credited to
his or her Account thereafter:
a. the first day of the calendar month following the date of the
Participant's death;
b. the first day of the calendar month following the date of the
Participant's Disability;
-7-
<PAGE>
EXHIBIT 10
c. the first day of the calendar month following the date of
termination of the Participant's service as a member of the
Board;
d. the first day of a calendar month specified by the Participant
which is at least six months after the Election Date; or
e. the earliest to occur of a, b, c or d.
A Distribution Date election shall become effective on the Election
Date.
A Participant may request on his or her Election Form that
distributions from his or her Account be made in (i) a lump sum, (ii) no more
than one-hundred eighty (180) monthly, sixty (60) quarterly or fifteen (15)
annual installments or (iii) a combination of (i) and (ii). Each installment
shall be determined by dividing the Account balance by the number of remaining
installments. If a Participant receives a distribution from a Subaccount on an
installment basis, amounts remaining in such Subaccount before payment shall
continue to accrue earnings and incur losses in accordance with the terms of
Section 3.2.2. Except as stated in the next paragraph, all distributions shall
be made to the Participant.
If the Distribution Date is the first day of the month following the
Participant's death or a fixed date which in fact occurs after the Participant's
death or if at the time of death the Participant was receiving distributions in
installments, the balance remaining in the Participant's Account shall be
payable to his or her Beneficiaries as set forth on the Participant's current
Election Form or Forms. Upon the death of a Beneficiary who is receiving
distributions in installments, the balance remaining in the Account of the
Beneficiary shall be payable to his or her estate without interest.
All distributions to Beneficiaries shall be in a lump sum, without
interest, except when the Distribution Date is the first day of the month
following the Participant's death and the current Election Form or Forms specify
installment payments.
All distributions shall be paid in cash and, except as provided in
Section 3.4.3, shall be deemed to have been made from each Subaccount pro rata.
3.4.2 Modified Distribution Elections.
A Participant may modify his or her election as to Distribution Date
and distribution form with respect to Compensation to be earned and payable
thereafter by completing and executing a modified Election Form and submitting
it to the Secretary of the Company. No more than one such modification shall be
permitted. Any modified Distribution Date or
-8-
<PAGE>
EXHIBIT 10
distribution form election shall become effective on the Election Date.
3.4.3 Extraordinary Distributions.
Notwithstanding the foregoing, a Participant or Beneficiary (after
the death of the Participant) may request an extraordinary distribution of all
or part of the amount credited to his or her Account because of hardship. A
distribution shall be deemed to be "because of hardship" if such distribution is
necessary to alleviate or satisfy an immediate and heavy financial need of the
Participant.
A request for an extraordinary distribution shall be made by
completing and executing an Extraordinary Distribution Request Form and
submitting it to the Secretary of the Company. All extraordinary distributions
shall be subject to approval by the Board.
The Extraordinary Distribution Request Form shall indicate:
a. the amount to be distributed from the Account;
b. the Subaccount(s) from which the distribution is to be made;
and
c. the "hardship" requiring the distribution.
The amount of any extraordinary distribution shall not exceed the
amount determined by the Board to be required to meet the immediate financial
need of the applicant.
An extraordinary distribution shall be made with respect to amounts
credited to each Subaccount on the first day of the calendar month next
following approval of the extraordinary distribution request by the Board.
SECTION 4. Share Distribution.
4.1 Awards.
Each Participant who is not a Director Emeritus and who was not on January 1,
1990 a full-time employee of the Company or any corporation in which the Company
owned, directly or indirectly, stock possessing at least (50%) of the total
outstanding voting power of all classes of stock entitled to vote in the
election of directors of such corporation shall be awarded on each Date of Grant
that number of full shares of Common Stock equal to the lesser of (i) twelve
hundred (1,200) or (ii) that number having an aggregate Fair Market Value on
such Date of Grant nearest to but not exceeding one hundred percent (100%) of
the Retainer Fee payable for the twelve-month period ending on the preceding
April
-9-
<PAGE>
EXHIBIT 10
30 (exclusive of the value of the Common Stock received by such Participant
pursuant to the Plan).
4.2 Vesting of Shares.
The shares of Common Stock awarded pursuant to the Plan will be immediately
vested and nonforfeitable. Subject to the requirements of Section 4.5, the
shares awarded under the Plan may not be sold or transferred until six months
after the Date of Grant.
4.3 Shareholder Rights.
On each Date of Grant, a Participant shall have all the rights of a shareholder
with respect to shares of Common Stock awarded under the Plan on such date.
Accordingly, the Participant will be entitled to vote the shares and receive
dividends.
4.4 Shares Authorized.
Up to 600,000 shares of Common Stock may be awarded under the Plan. In the event
of any merger, share exchange, reorganization, consolidation, recapitalization,
stock dividend, stock split or other change in corporate structure affecting the
Common Stock, appropriate substitutions or adjustments shall be made to item (i)
of Section 4.1 and in the aggregate number and kind of shares reserved for
issuance under the Plan.
4.5 Regulatory Restrictions.
All certificates for shares of Common Stock or other securities delivered under
the Plan shall be subject to such stock transfer orders and other restrictions
as the Company may deem advisable under the rules, regulations and other
requirements of the Company, any stock exchange upon which the Common Stock is
then listed and any applicable Federal, state or foreign securities law, and the
Company may cause a legend or legends to be put on any such certificates to make
appropriate reference to such restrictions.
SECTION 5. General Provisions.
5.1 Unfunded Plan.
It is intended that the Plan constitute an "unfunded" plan for deferred
compensation. The Company may authorize the creation of trusts or other
arrangements to meet the obligations created under the Plan; provided, however,
that, unless the Company otherwise determines, the existence of such trusts or
other arrangements is consistent with the "unfunded" status of the Plan. Any
liability of the Company to any person with respect to any grant under the Plan
shall be based solely upon any contractual obligations that may be created
pursuant to the Plan. No such obligation of the
-10-
<PAGE>
EXHIBIT 10
Company shall be deemed to be secured by any pledge of, or other encumbrance on,
any property of the Company.
5.2 Rules of Construction.
Headings are given to the sections of the Plan solely as a convenience to
facilitate reference. The reference to any statute, regulation, or other
provision of law shall be construed to refer to any amendment to or successor of
such provision of law.
5.3 Withholding.
No later than the date as of which an amount first becomes includible in the
gross income of the Participant for Federal income tax purposes with respect to
any participation under the Plan, the Participant shall pay to the Company, or
make arrangements satisfactory to the Company regarding the payment of, any
Federal, state, local or foreign taxes of any kind required by law to be
withheld with respect to such amount.
5.4 Amendment.
The Plan may be amended by the Board, but no amendment shall be made that would
impair prior Common Stock awards or the rights of a Participant to his or her
Account without his or her consent. Notwithstanding the foregoing, Section 4.1
shall not be amended more than once every six months, unless such amendment is
required because of changes in the Code or ERISA. In addition, no amendment may
become effective until shareholder approval is obtained if the amendment (i)
except as expressly provided in the Plan, increases the aggregate number of
shares of Common Stock that may be awarded under the Plan, (ii) materially
increases the benefits accruing to Participants under the Plan or (iii) modifies
the eligibility requirements for participation in the Plan.
5.5 Duration of Plan.
No Common Stock awards will be made pursuant to Section 4 after May 1, 2001 or
at any time at which there are insufficient shares of Common Stock authorized
under the Plan for such awards. There shall be no time limitation with respect
to the Deferred Fee Program. The Board may terminate the Plan at any time, by
appropriate action. Upon termination of the Plan, amounts then credited to each
Account shall be paid in accordance with the Distribution Election then
governing such Account or as otherwise provided in Section 3.4.1.
5.6 Assignability.
No Participant or Beneficiary shall have the right to assign, pledge or
otherwise transfer any payments to which such Participant or Beneficiary may be
entitled under the Plan other than by will or by the laws of descent and
distribution or
-11-
<PAGE>
EXHIBIT 10
pursuant to a "qualified domestic relations order" (as defined by Title I of
ERISA).
5.7 Construction.
The Plan shall be construed and interpreted in accordance with Virginia law. The
Plan is intended to be construed so that participation in the Plan will be
exempt from Section 16(b) of the Exchange Act pursuant to regulations and
interpretations issued from time to time by the Securities and Exchange
Commission.
-12-
EXHIBIT 12
PHILIP MORRIS COMPANIES INC. AND SUBSIDIARIES
Computation of Ratios of Earnings to Fixed Charges
(in millions of dollars)
-------------------
Six Months Ended Three Months Ended
June 30, 1997 June 30, 1997
---------------- ------------------
Earnings before income taxes and
cumulative effect of accounting changes $ 6,064 $ 3,085
Add (Deduct):
Equity in net earnings of less than 50%
owned affiliates (105) (54)
Dividends from less than 50% owned
affiliates 82 48
Fixed charges 743 377
Interest capitalized, net of amortization 2 1
------- -------
Earnings available for fixed charges $ 6,786 $ 3,457
======= =======
Fixed charges:
Interest incurred:
Consumer products $ 636 $ 324
Financial services and real estate 35 17
------- -------
671 341
Portion of rent expense deemed to represent
interest factor 72 36
------- -------
Fixed charges $ 743 $ 377
======= =======
Ratio of earnings to fixed charges 9.1 9.2
======= =======
<PAGE>
EXHIBIT 12
PHILIP MORRIS COMPANIES INC. AND SUBSIDIARIES
Computation of Ratios of Earnings to Fixed Charges
(in millions of dollars)
-------------------
Years Ended December 31,
----------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
Earnings before income
taxes and cumulative
effect of accounting
changes $ 10,683 $ 9,347 $ 8,216 $ 6,196 $ 8,608
Add (Deduct):
Equity in net earnings
of less than 50%
owned affiliates (227) (246) (184) (164) (107)
Dividends from less
than 50% owned
affiliates 160 202 165 151 125
Fixed charges 1,421 1,495 1,537 1,716 1,736
Interest capitalized,
net of amortization 13 2 (1) (13) (3)
-------- -------- -------- -------- --------
Earnings available for
fixed charges $ 12,050 $ 10,800 $ 9,733 $ 7,886 $ 10,359
======== ======== ======== ======== ========
Fixed charges:
Interest incurred:
Consumer products $ 1,197 $ 1,281 $ 1,317 $ 1,502 $ 1,525
Financial services
and real estate 81 84 78 87 95
-------- -------- -------- -------- --------
1,278 1,365 1,395 1,589 1,620
Portion of rent expense
deemed to represent
interest factor 143 130 142 127 116
-------- -------- -------- -------- --------
Fixed charges $ 1,421 $ 1,495 $ 1,537 $ 1,716 $ 1,736
======== ======== ======== ======== ========
Ratio of earnings to
fixed charges 8.5 7.2 6.3 4.6 6.0
======== ======== ======== ======== ========
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary information extracted from Pages 3-5 of the
Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30,
1997 and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> JUN-30-1997
<CASH> 317
<SECURITIES> 0
<RECEIVABLES> 5,335
<ALLOWANCES> 160
<INVENTORY> 8,860
<CURRENT-ASSETS> 15,919
<PP&E> 19,929
<DEPRECIATION> 8,382
<TOTAL-ASSETS> 54,972
<CURRENT-LIABILITIES> 14,100
<BONDS> 13,135
0
0
<COMMON> 935
<OTHER-SE> 13,513
<TOTAL-LIABILITY-AND-EQUITY> 54,972
<SALES> 36,630
<TOTAL-REVENUES> 36,630
<CGS> 13,407
<TOTAL-COSTS> 21,654
<OTHER-EXPENSES> 8,346
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 566
<INCOME-PRETAX> 6,064
<INCOME-TAX> 2,455
<INCOME-CONTINUING> 3,609
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,609
<EPS-PRIMARY> 1.49
<EPS-DILUTED> 1.49
</TABLE>
